Home > Pensions > Defined Contribution Schemes

Defined Contribution Schemes

By: J.A.J Aaronson - Updated: 23 Apr 2014 | comments*Discuss
 
Defined Contribution Schemes Pension

Broadly speaking pension schemes can be split into two categories: defined benefit schemes and defined contribution schemes. Today, the majority of available pension schemes fall into the latter category. This is as a result of several factors, generally culminating in spiralling running costs and the inability or refusal of employers to pay the deficit. This responsibility on the part of the employer is one of the key characteristics of Defined Benefit Schemes, and is covered in more detail in the relevant article on this site.

The gradual collapse of defined benefit schemes has led to a growth in the defined contribution market. These pensions are also sometimes known as ‘money purchase’ arrangements, and now fill the bulk of the UK pensions sector. The term ‘defined contributions’ is considerably broader than ‘defined benefits’, and can cover a wide variety of both private and occupational schemes.

Cost-Saving

There has been a significant backlash against the increasing reliance on defined contribution schemes. This can be explained by looking at their characteristics. One of the great advantages of defined benefit schemes is that, after the employee has made their agreed contributions, the responsibility for making up any deficit in the running costs of the scheme rests with the employer. In a defined contribution scheme, however, the risks presented by the possibility of higher costs or poor investment performance from the fund are taken on entirely by the pension holder as an individual. Many people have suggested that the move to defined contribution schemes has taken place in great part as a cost-saving exercise on the part of employers.

In a defined contribution scheme, the benefits that will be available to the pension holder at the point of the scheme’s maturity are not definite from the outset. Rather, these benefits are determined by a number of important factors, most of which are out of the control of the pension holder. These factors include:

  • The pension provider’s own charges
  • The cost of annuities at the point of maturity
  • Investment performance of the fund itself
  • The total contributions made by the pension holder – this is the only factor over which the individual has control

What are the Advantages?

Bearing in mind the drawbacks, defined contribution schemes do have a number of attractive characteristics. Primarily, they benefit from a tiered investment system. This means that your money will be invested in relatively high-risk vehicles in the early stages of the plan, with a gradual move towards lower-risk investments such as currency as you near retirement. So your fund has the capacity to grow quickly from the outset, but still provide security when it is needed. Furthermore, a well-managed plan should offer a default plan for your money, whereby it is invested in a standard way throughout the term of the pension. This is particularly beneficial if you are not confident enough to make your own decisions as to where your money should be invested.

As with the vast majority of pension schemes, Tax Relief is available on your contributions. As is mentioned elsewhere in this section, you can claim relief on contributions up to an equivalent of 100% of your wage. Similarly, you can withdraw 25% of your total fund as a single, tax-free lump sum on retirement. However, as most defined contribution schemes rely in part on stock investments, you may have to pay some tax on any dividend payments that you receive from shares.

You might also like...
Share Your Story, Join the Discussion or Seek Advice..
Why not be the first to leave a comment for discussion, ask for advice or share your story...

If you'd like to ask a question one of our experts (workload permitting) or a helpful reader hopefully can help you... We also love comments and interesting stories

Title:
(never shown)
Firstname:
(never shown)
Surname:
(never shown)
Email:
(never shown)
Nickname:
(shown)
Comment:
Validate:
Enter word:
Latest Comments
  • Kenthen
    Re: What Does Road Tax Pay For?
    I often wondered if it's legal for the council to close public roads for pedestrian usage unless it's for repair or some other road…
    11 August 2019
  • Oky
    Re: How Will My Second Job Be Taxed?
    Hi if I work for 2 agency. One job is 40 hour per week and other is 12 or 20 hours per week, only for one week it will be.…
    7 August 2019
  • Jo-jo
    Re: How Will My Second Job Be Taxed?
    I have main job at 24 hours a week and earn £198 a week if I take on a 2nd job at 10 hours a week at £9.04 an hour how much…
    3 August 2019
  • Jules
    Re: Should I be Paid Mileage Allowance?
    Im a carework i dont get paid any mileage i only get 25p per visit but my calls are 5 & 6 miles apart how do i claim some…
    24 July 2019
  • San
    Re: What is My Tax Code?
    Hello I have a first job and I am earning 290 a week and have been charged 60 for that first wage and I have started a second job for weekend…
    18 July 2019
  • MH829567
    Re: What Does Road Tax Pay For?
    Road Tax doesn't pay for anything cos it don't exist. Vehicle Excise Duty or CAR tax pays for the environmental effects of the…
    9 July 2019
  • Sandra
    Re: Payment of Pensions
    I want my pension to be paid weekly not monthly can this be changed ?
    5 July 2019
  • Sandra
    Re: Payment of Pensions
    I want my pension to change from monthly to weekly can thus happen?
    5 July 2019
  • vic
    Re: How Will My Second Job Be Taxed?
    my son is at uni and works on a sat for 8 hrs, he has just started a full time summer job until uni goes back and has been…
    4 July 2019
  • Jane
    Re: How Will My Second Job Be Taxed?
    Hi, I've recently been offered 2 part time positions (very similar roles) and am wondering if I could accept both offers? In…
    4 July 2019