What is a Defined Contribution Pension?
A defined contribution pension, also known as a money purchase pension, is a pension ‘pot’ that you save into throughout your working life.
The value of the pension fund at retirement is defined by the contributions you make over your working life, as well as the investment performance of the fund over the same period.
At retirement, you can then turn this pension pot into an income as you see fit, potentially by buying an annuity or entering pension drawdown.
Most pension pots today are defined contribution; defined benefit (or final salary) pensions are far less common than they once were. Defined benefit pensions have the benefit at retirement defined. They’re a promise from your employer’s pension fund to pay you a guaranteed income for the rest of your life. This will be based on either your final salary or an average of your salary across your career.
Types of Defined Contribution Pension
Personal Pensions
The two most common types of personal pensions are:
- Stakeholder pensions
These are perhaps the simplest type of personal pension. They must meet specific government requirements, for example limits on charges, fee-free transfers, flexible contributions, low minimum contribution limits and a default investment fund (which your money will be invested in if you don’t want to choose)
- Self-invested personal pensions (SIPPs)
These allow you to control the specific investments that make up your pension fund. They’re more complicated than stakeholder pensions because they allow for investments in additional types of assets and with more flexibility than is available under a stakeholder pension
Workplace Pensions
A workplace pension is a retirement savings vehicle arranged by your employer. You pay into the scheme, usually via payroll (so before tax is deducted), and your employer typically also pays into the scheme. Since the introduction of auto-enrolment, it’s been mandatory for all employers to automatically enrol qualifying employees into a workplace pension scheme.
Transferring Defined Contribution Pensions
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, perhaps to achieve a better investment risk balance, or moving your pension pot to an entirely new provider.
It’s become incredibly common to have multiple pension pots, especially in the age of auto-enrolment where everyone who qualifies is automatically enrolled into a workplace pension scheme. While it’s good to have some diversity in your pension portfolio, there can be downsides to having multiple pension pots, such as:
- Increased costs
It may reduce the fees and charges you pay across multiple pension arrangements
- Harder to keep track of your investments and their performance
With fewer pots it’s generally easier to monitor your pension and its performance
- Harder to estimate your retirement income and plan for any pension shortfall
With fewer pension pots (and pension paperwork!) to worry about, it’s easier to get an idea of your retirement income from fewer pots, leaving you better prepared in case there’ll be less to live off than you think
- Harder to tax plan
Having your pensions in fewer places not only gives you better oversight of the funds, but can also make it easier to see whether you’re going to hit any pension limits, such as the lifetime allowance.
Should I Transfer My Pension?
There are a number of reasons you might look to transfer your pension, such as:
- Your current provider doesn’t offer the pension option you want
- You want to combine pots to simplify your pensions
- You want to pay less in fees.
What to Consider Before Transferring
To transfer your defined contribution pensions, you’ll need to contact both your current pension provider(s) and the provider you’re considering transferring to.
The first thing to check is that your existing pension provider(s) will allow you to transfer out of the scheme. Then you’ll need to see if the scheme you’re looking to transfer to will accept transfers in.
Be aware that transferring your pension could mean you’re bound to making payments into the new scheme. You might also have to pay exit fees and charges if you’re leaving the old pension, plus potentially a fee to make the transfer.
It’s also worth considering that if you transfer, you might:
- Lose any right you had to take your pension at a certain age (a fixed or guaranteed retirement date)
- Lose any fixed or enhanced protection you have when you transfer
- Lose any right you had to take a tax free lump sum of more than 25% of your pension pot (an enhanced pension commencement lump sum).
Another loss to consider is any guaranteed annuity rate that you might be entitled to. This is a promise from a provider to pay a higher annuity rate than might be available on the open market. Make sure you understand the value of any such contract options before deciding to transfer.
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