What are defined contribution pensions?
Defined contribution pensions, also known as money purchase schemes, are occupational / company pensions where the employee in the workplace sets the level of his or her contributions to the scheme.
The contributions of employees to defined contribution pensions may be supplemented by a contribution from the employer. This may, but does not have to, match the employee’s contribution. In some cases, defined contribution pensions can be based on an employer contribution alone, with no payment necessary by the employee.
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Defined contribution pensions are taking on a greater role in the pensions landscape at present, as large employers in the UK, particularly those who had previously offered pensions with built-in guarantees, seek to reduce the costs of their pensions commitments.
Defined contribution pensions lower risk for employers, as no guarantee is given to the employee in relation to the eventual level of retirement income. In defined contribution pensions, this is dictated by the returns on the underlying funds where the money is invested. The size of the individual employee’s ‘pension pot’ at retirement will then rise or fall in relation to how well these underlying investments have performed. As the employee is given no specific guarantee of what his defined contribution pension will be, he is unable to predict with certainty how much he will have to live on in retirement.
More importantly, from the company point of view: as defined contribution pensions do not include any guarantee of a specific income, the risk of the investment rests squarely on the shoulders of the employee, and not the employer.
Larger employers in particular prefer to offer their workers defined contribution pensions so that, no matter how unsatisfactory the returns from investments in the stock market, employers do not have to face the prospect of pouring additional funding into their pension scheme, making unexpected provisions that can put a considerable strain on their financial resources.
Many large companies that had formerly offered a guaranteed level of pensions income to employees are now opting to place all future workers in defined contribution pensions. These have included household names such as Barclays, IBM, Fujitsu, Costain, and Morrissons. Even Aviva is beginning negotiations to gradually move its employees into defined contribution pensions, as it struggles with large pensions deficits in its existing final salary pension schemes.
Defined Contribution Pensions savers suffer when markets fall
In difficult economic times, such as the economic downturn that affected stock market investments during 2008/9, defined contribution pensions can take a beating which is directly reflected in their returns to scheme members. Defined contribution pensions were adversely affected recently as the markets fell, and many savers in defined contribution pensions saw the prospective level of their pensions savings also fall considerably.
The general category of defined contribution pensions in the workplace includes Stakeholder Pensions and Group Personal Pensions, which are personal pensions available through your employer.
If you are unsure that a defined contribution pension is right for you, speak to one of our firendly advisers who can help work out the best way for you to save for your retirement.
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