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Financial Planning • Defined Contribution

What is a defined contribution (DC) pension?

In the UK (United Kingdom), Defined Contribution pensions, sometimes called Money Purchase schemes, are now the most common type of pension. When you retire, the value of a defined contribution pension will simply be determined by how much money you and/or your employer have paid into the pension, how the investment of those funds has performed, and how much tax relief you have received.

You and/or your employer can both pay money into your pension. Your pension provider will claim tax relief on your behalf and add it to your pension. Your pension provider usually makes the investment decisions and places the money in asset classes such as shares, property, bonds, and cash.

  • Defined contribution vs. defined benefit pensions

    Defined Benefit schemes promise an income in retirement – a promise made by your employer. Defined Contribution schemes do not promise an income – what you get in retirement will be determined by the value of your pot when you retire. That pot will provide you with an income, but there is no guarantee of what that will be.

    Defined Benefit schemes tend to be run collectively, whereas Defined Contribution schemes are individual products. Defined Benefit schemes are based around a theoretical average member, with average life expectancy and pay rises. Someone who lives a long time and who leaves a dependent who receives a pension may personally benefit more than someone who will not live as long and who has no surviving dependents. Some people will fare better than others out of this collective model.

  • Defined contribution schemes and investing

    A vast area of risk is the return on investments. In a Defined Contribution scheme, if your investments perform very well, you should be on track for a better retirement, whereas poor investment performance means that you lose out as a member. Poor investment performance in a Defined Benefit scheme means that a sponsoring employer must find more money to meet their promise.

    Similarly with life expectancy – if people are living longer, then a Defined Contribution member will have to make their savings last longer, whereas a Defined Benefit scheme member will not see their pension changed, but the sponsoring employer would have to find extra money to pay the pension for longer.

    There is no way of knowing if someone would be better or worse off under a Defined Benefit or Defined Contribution scheme – a good Quality Defined Contribution scheme could give a much better outcome than a poor-quality Defined Benefit scheme.

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Transferring a defined contribution pension

Transferring a defined contribution pension transfer involves moving your pension from one place to another. This might be as simple as switching pension funds with the same provider to achieve a better investment risk balance or moving your pension pot to an entirely new provider for similar reasons.

Consolidating multiple schemes

Consolidation of multiple pensions is another common reason for transferring – it has become incredibly common to have multiple pension pots, especially since auto-enrolment came into effect in the UK, where everyone who qualifies is automatically enrolled into a workplace pension scheme.

Consolidating multiple schemes can:

  • Reduce Costs if you are currently paying several sets of fees across multiple schemes
  • Simplify the task of keeping track of your retirement investments and their performance
  • Make it easier to estimate your projected retirement income and estimate any existing shortfall
  • Provide simpler visibility of where you stand versus any pension limits such as Lifetime Allowance.

How to transfer

To transfer your defined contribution pensions, you (or us on your behalf as your adviser) will need to contact your current pension provider, check that the scheme will allow a ‘transfer out’ and request an up-to-date valuation. You can request and obtain a current valuation at any time.

Undertaking an analysis to determine whether a transfer is suitability advice based on your personal circumstances, if so, identifying an appropriate destination for the transfer and ensuring that your retirement assets moving forward are being held, invested, and managed in the most suitable type of pension for you if you decide to take ongoing advice.

Withdrawing money from your defined contribution pension

When you come to retire, you have several choices for what to do with your defined contribution pension. If you are at least 55, you can withdraw up to 25% of your pension as a lump sum without paying tax (sometimes called ‘Tax-Free Lump Sum’ or ‘PCLS’ or ‘Payment Commencement Lump Sum’). You can leave the rest invested or use the money to buy an annuity which will guarantee an agreed income – this can be either for a specified period or the rest of your life.

What Are Your Pension Transfer Options

SIPP

A SIPP is a pension ‘wrapper’ that holds investments until you retire and begin to draw an income. It works in a similar way to a standard personal pension.

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QROPS

A qualifying recognised overseas pension scheme (QROPS) is an overseas pension scheme that meets specific requirements set by HMRC.

Read More

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