What is a defined contribution pension?

What is a defined contribution pension plan?

A defined contribution pension scheme - also known as a 'money purchase' scheme - is the most common type of workplace pension. 

The money that you and your employer pay in is invested, and the value of your pension when you retire depends on how much has been paid in, as well as how the underlying investments have performed. 

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What is auto-enrolment?

Thanks to the introduction of auto-enrolment in 2012, most people are now automatically signed up to their employer's pension scheme when they start a new job. 

Under these rules, you and your employer must pay a percentage of your earnings into your pension.

The minimum total contribution is 8% of your earnings between £6,240 and £50,270.

This is made up of 5% from you (including tax relief) and 3% from your employer.

You won't be automatically enrolled into a pension if you are under the age of 22 or over state pension age, earn less than £10,000 a year, or don't usually work in the UK.

• Find out more: how tax relief boosts your pension contributions

Where does my defined contribution pension invest my money?

Money in defined contribution pension schemes is typically invested in a default fund.

These are designed to be diversified - meaning your money is spread across several types of investment, helping to protect you from market volatility. 

Most pension providers give you the choice of alternative funds that may be a better match for your risk appetite and financial goals, so it's worth contacting yours if you're interested in taking more control of how your pension is invested.

It's also worth considering a self-invested personal pension (Sipp) if you're keen to take a more active role in managing your pension investments.

Who manages my defined contribution pension?

There are two main types of defined contribution pension scheme:

Trust-based schemes

These are run by a board of trustees that oversees investments in your pension. 

The trustees choose the professionals who look after your money and have a duty to you as the member of the scheme to get the best deal on your behalf.

Contract-based schemes

If you're in a contracted-based pension, it means that your employer has appointed a pension provider, such as an insurance company, to run your pension scheme. These are sometimes called 'group personal pensions.'

The contract is not between you and your employer, but between you and the pension provider. These types of schemes often offer a greater choice of investments for your pension savings than trust-based schemes.

How much do defined contribution pensions charge?

Workplace pension schemes used for automatic enrolment are not allowed to charge you more than 0.75% a year.

The average charge among auto-enrolment schemes is 0.48%, according to research by the Department for Work and Pensions in 2021.

But if you have an older pension that isn't covered by the charge cap you could be paying much more. 

What happens to my pension when I change jobs?

When you move to a new employer, your pension won't automatically follow you. 

This means that over time you can build up multiple pension pots in different places, making it hard to keep track of them all. 

You have the option to transfer older pensions to your new workplace scheme, but you should check whether any exit penalties apply - and how charges on your new scheme compare.

• Find out more: should I combine my pensions?

How much will I get from my defined contribution pension?

The income you'll end up with in retirement depends on various factors:

• how much you contribute each month (you can opt to pay more than the minimum)
• how much your employer contributes
• how long you contribute for
• how well the investments perform
• the charges levied by your pension scheme
• how you decide to access the money in your pot

You can use our pension calculator to get an estimate of how much your savings could be worth when you retire.

How do I access my defined contribution pension?

You have several options for accessing the money in your defined contribution pension(s) when you come to retire. The earliest you can touch this money is age 55 (rising to 57 in 2028).

You can take up to 25% of your pot tax-free, and then access the rest of the money using any combination of the following:

• Buy an annuity
• Keep it invested and take income when you need (pension drawdown)
• Take some or all of it as cash 

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