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What is a defined contribution pension?
March 9th, 2010 | Best Questions

Pension schemes are very broadly characterised as either defined benefit schemes or defined contribution schemes. It used to be the case that many employers offered defined benefit schemes, but in recent years they have not wanted to shoulder the increasing defecit burden and have moved to defined contribution schemes. With defined contribution schemes poor investment performance means smaller pension pots and the employer is not responsible for “guarenteeing” a certain pension outcome.

Defined contribution pensions are also known as money purchase arrangements, as essentially they are based on consitstent investment amounts from the individual and/or employer. In fact the contributions from the employee are all they have control of in a defined contribution pension. The final pension pot is not defined from the start, rather it is dictated by there contributions, the pension charges and the fund performance.

Generally a defined contribution scheme will have more risky funds at the outset in order to try and achieve fast initial gains, with a move to more stable funds the closer the fund comes to maturity. This is an attractive feature of these types of schemes as it allows fast g gerowth initially, moving towards more security when it is required. DCs also normally have a default plan for those not confident in making any investment decisions themselves.

The term defined contribution can cover a broad spectrum of pensions including both occupational and private. As with the most pension schemes, you get tax relief on your contributions. You can claim relief on contributions up to the equivalent of 100% of your salary. You can also withdraw 25% of your total pension fund as a tax-free lump sum on retirement. Unfortunately, as most defined contribution schemes rely at least in part on stocks and shares investments, you may well have to pay some tax on any dividend payments received on share perrormance.

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