Explained: Defined Benefit and Defined Contribution Pensions

In the UK there are two main types of private pensions:

  • defined contribution – a pension pot where the value is determined by investment growth on the funds which you and your employer pay in.
  • defined benefit – also commonly known as a final salary pension, usually a workplace pension based on your final salary and how long you’ve worked for your employer.

Defined contribution pensions

These are usually personal pensions they are often also known as ‘money purchase’ pension schemes.

They can be:

  • Workplace pensions arranged by your employer as part of the UK’s auto-enrolment system
  • private pensions arranged by you, through a private pensions provider

Defined contribution pensions receivee funding from you and/or your employer. The money is then put into investments such as mutual funds, stocks, or bonds by the pension provider.

Depending on the arrangement and the scheme you may be able to choose the risk level of your underlying investments.

Because the pot is invested the value of your pension pot can go up or down depending on how the investments perform. Riskier investments such as stocks will generally produce more volatility, but also have the potential to produce the greatest rewards. More cautious investments such as bonds will generally be less volatile, however, they also generally produce a lower return.

Certain schemes switch your funds into lower-risk investments as you approach retirement age. Other schemes only make investment switches when instructed by you, the member. If your scheme was set up many years ago, your investments may be too risky for your age and stage. Which is why it’s important to stay in close contact with your pension.

How much will I get from my Defined Contribution Pension?

The amount you will be able to draw from your pension pot depends on:

  • the amount which has been paid in 
  • the performance of the underlying investments 
  • how long you leave the money invested 

You usually get 25% of your pension pot tax-free up to the Life Time Allowance.

The pension provider usually takes a small percentage as a management fee. This is further reason to review your pension. Certain schemes have far higher fees than others.

Defined benefit pension schemes

Defined benefit pensions are conventionally workplace pensions arranged by your employer. They’re sometimes called ‘final salary’  pension schemes.

How much will I get from my Defined Benefit Pension?

Defined benefit pensions are quite different from defined contribution pensions.

The amount you will receive depends on your pension scheme’s rules, not on investment performance or how much you’ve paid in.

Defined benefit schemes usually pay members a retirement income based on a number of factors including your final or average salary and your years of service for the employer.

The pension provider will promise to give you a certain amount each year for life.

You can usually choose to get 25% tax-free. You’ll get the rest as regular payments.

Most defined benefit pensions can be accessed aged 55. 

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