A defined contribution pension is a common type of pension used for personal pensions and workplace pension schemes. A defined contribution pension plan gives you a lot of control over your pension, but it has certain risks that you should know about, and it can be challenging to manage.
What is Defined contribution?
A defined contribution pension is a pension plan where you or your employer pay money into investments managed by a pension provider. Depending on how well the investments perform, the value of your pension pot will rise or fall. Because of this, it is customary to move a pension pot into lower risk investments the closer you get to retirement.
What investment options are available for my defined contribution (dc) pension plan?
You can choose from a range of index funds invested in stocks and shares. Some will be higher risk than others. Remember that the performance and value of your portfolio and, thus, your plan, will depend on the performance of the investments the plan provider decides to invest your money in.
What are the tax implications of withdrawing money early from my DC pension plan?
Pension providers do not usually allow you to take money out of your plan early unless there are specific circumstances. For example, they may consider an athlete’s early retirement or the need for money by someone who has fallen ill and cannot work anymore.
There are serious consequences for doing this, the most severe being a tax charge of up to 55% of the amount withdrawn. Additionally, you will be charged income tax on the amount you withdraw.
The exception is withdrawing the first 25% of your pension pot without having taken a taxable income from your pension.
If you have a private pension plan, the provider might charge you over 30% of the withdrawn amount.
What are the advantages and disadvantages of a defined contribution (DC) pension plan compared to a defined benefit (DB) plan?
Defined benefit plans are advantageous because employees are guaranteed a set sum per year when they retire, which is typically based on their final salary at retirement or calculated based on the average amount they earned throughout their career with the company. Because defined contribution pensions are riskier for the employer, they are rarely an option these days.
The main advantage of defined contribution plans over defined benefit plans is that low-earning workers can have their pension contributions topped up by additional contributions from their employer. This helps them build a larger pension pot for retirement.
What is the maximum contribution limit for a DC pension plan?
There is no maximum limit for defined contribution pension plans, but you cannot get tax relief if your contributions are higher than your salary or £3,600, whichever is greater.
What are the differences between a defined benefit pension plan and a defined contribution pension plan?
A defined benefit plan is where the pension payment depends on how much you make before you retire and how long you have been a pension scheme member. On the other hand, how much you receive after retirement through a defined contribution plan depends on your contributions. While you do not receive a lump sum or a combination of a lump sum and a payment with this plan, you can arrange for regular income throughout your life after retirement.
A defined contribution pension plan is an excellent option for those saving for retirement. Employers can add to it, and there are tax reliefs and benefits for preparing for retirement through a defined contribution pension plan.
