Defined benefit and defined contribution pensions explained

5 minutes

What is a defined contribution pension?

Defined contribution (DC) pensions are investment backed schemes and enable you to set aside money to build up a pension pot. You'll normally be able to access your savings once you turn 55.

The size of your pension pot will depend on how much you pay in and how the investments perform. These plans can be set up by yourself as a personal pension or through an arrangement set up by your employer. The value of your pension pot will depend on:

  • How much you've paid in
  • How long you've been paying in
  • Annuity rates (if relevant)
  • How much has been taken in charges
  • How well the investment has performed
  • What you do with your pension pot

Things to consider

  • The money is most likely to be invested by a pension provider chosen by your employer.
  •  As you reach retirement age certain schemes will gradually move your money into lower-risk investments, but it may not happen automatically. You may need to ask your pension provider.
  • In the short term the value of your pension could increase or decrease, but pensions usually grow more than savings accounts over the long term.

What is a defined benefit pension?

DB pensions sometimes known as ‘final salary’ or ‘salary-related’ pensions, are only offered through an employer. The pension you receive is based on the pension scheme rules, but is mostly influenced by your salary and your length of service. The amount you'll get depends on:

  • How long you've worked for the employer and your salary in the last year (or over a number of years) as an active member
  • Why you're accessing your pension pot (retirement, early payment etc)

Things to consider

  • Unlike defined contribution schemes, the amount you’ll get is guaranteed, and will automatically be paid to you.
  • You’ll usually be able to get 25% tax free and the rest as regular payments.
  • These schemes are run by trustees who look after the interests of the scheme’s members.

Any references we make to taxation are based on our understanding of current legislation and HM Revenue & Customs practice, which can change.

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