What is Defined Contribution Pension?

Full Definition

A defined contribution pension (also called a money purchase pension) is a pension where the amount that ends up being built up depends on how much has been contributed by the individual, their employer, or both, plus tax relief, and how the investments held within the pension have grown (or fallen) over time, rather than being calculated from a formula based on salary and years of service as with a defined benefit pension. Contributions are typically invested in a range of funds chosen by the member (or a default fund chosen by the scheme if the member does not actively choose), and the eventual pot available at retirement, and the income it can support, is not guaranteed -- it depends directly on investment performance, charges, and how much has been paid in over the years. Most private-sector workplace pensions set up since auto-enrolment began in 2012, together with the vast majority of personal pensions and SIPPs, are defined contribution schemes. Since the pension freedoms reforms of 2015, defined contribution pension holders from age 55 (rising to 57 from 2028) have wide flexibility over how to access their pot, including flexi-access drawdown, taking lump sums, or buying an annuity, in contrast to defined benefit schemes, which pay a set income directly rather than building a transferable pot. The shift from defined benefit to defined contribution provision across most of the private sector over the past few decades has moved investment risk and longevity risk from employers onto individual savers, making decisions such as contribution levels, fund choices and drawdown strategy considerably more consequential for a defined contribution saver's eventual retirement income.

Related Calculators

See Also