Defined Contribution Pension Schemes Demystified
The defined contributions pension plan or money purchase scheme is a form of a workplace pension. Your contributions build it up, your boss ‘contributions, and tax relief1 from the state. These pension schemes provide you with an accumulated amount when you get into retirement, and you can use it as a monthly income or get an investment product like the lifetime annuity or income drawdown. You can also opt to take the capital in one payout, but you might face several hefty tax bills.
Here’s an interesting fact:
Most modern company or organization pension plans today are defined contributions pension plans.
How to Build Up Your Defined Contributions Pension Pot
While the final salary scheme or the defined benefits pension pays you an income depending on your salary when you’re working, a money purchase scheme or defined contributions pension plan operates more like a tax-friendly investments account.
Let’s dig deeper.
You contribute capital into your pension fund, and your boss can pay into it too. Your pension lender claims some tax relief on your behalf and then includes it in your pension fund. Your pension provider usually places the cash in various asset classes like bonds2, stocks, shares, property, and capital.
The amount the defined contributions pension scheme is worth upon your retirement is based on factors like:
- The amount of capital you’ve placed into your pension plan
- The amount of cash your boss has paid into your pot
- The amount of tax relief you get
- Your investments ‘performance over time
You can also use the defined contributions pension calculator to find out your estimated retirement income, depending on the amount of capital that’s in your pension fund and the amount you’re paying into it.
Defined Contribution Pension Withdrawal Rules
Provided that you’re 55 years when you retire, you have a variety of options on what to do with your defined contribution pension scheme. You can draw down up to 25% of your pension savings as a lump sum amount tax-free. You can leave the other 75% to be invested or purchase an annuity that assures you’ll get a specific income, either for a certain period or for your lifetime.
What You Need to Think About
If your current job provides you with access to a pension fund that your boss will contribute to, staying out is like refusing a pay rise. Unless you can’t afford to pay into the pension pot or your priority is handling unsurmountable debt, you should consider joining.
Here’s the catch:
The amount your boss contributes to the pension depends on the amount you’re willing to put in and can increase as you age. For instance, your boss might be ready to match your contributions on a typical like to like basis, up to a specific level, but they can also decide to be more generous.
What Happens When You Decide to Change Occupations?
Well, if you move to another firm, you stop contributing to your pension fund, and you can leave it where it currently is. That’s referred to as a deferred pension or the preferred pension.
What does this mean for you?
If you can’t or don’t want to keep the pension pot, you can move it to your new boss or the personal or stakeholder pension scheme, but there are always some risks and expenses associated with that.
Got Questions? Check These First
Can You Withdraw Money from A Defined Contribution Pension Plan?
No, you can’t. You usually take capital out a defined contributions pension plan when you reach 55 years. However, there the law can offer you some leeway if you have any barring extreme financial situations or severe illnesses.
What’s A Defined Contribution Pension?
Defined contributions pension is the most popular pension plan. When you retire, the amount your money purchase scheme is worth is based on the amount of cash you’ve paid in and how your investments perform. Most current workplace and personal pensions schemes are defined contribution plans.
What Happens to the Defined Contribution Pension When You Retire?
If you’re part of the employer-sponsored defined contributions pension or the defined benefits pension, your savings are usually held by the government until you get into retirement.
What’s the Difference Between Defined Benefits Pension and Defined Contribution Pension?
The defined benefits pension or the final salary scheme is a work pension that offers you some retirement income depends on your salary and how long you’ve worked for your boss, instead of the amount of capital you’ve paid into your pension scheme.
To sum it up,
Defined contribution pension schemes are often more affordable for employers and employees because they require less administration.
This is an excellent choice when you need a retirement plan that can be administered with minimal effort on your part or if the company does not have enough funds to offer a traditionally defined benefit plan. If you’re considering switching from one type of retirement savings account to another, it may help you understand what kinds of benefits each category offers before making any decisions.