With a defined contribution pension (sometimes called money purchase) you build up a pot of money that you can use to provide an income in retirement. Unlike defined benefit schemes, which promise a specific income, the income you might get from a defined contribution scheme depends on factors including the amount you pay in, the fund’s investment performance and the choices you make at retirement.
What is a defined contribution pension?
Defined contribution pensions can be:
- workplace pension schemes set up by your employer, or
- private pension schemes set up by you.
If you’re a member of a pension scheme through your workplace, then your employer usually deducts your pension contributions from your salary before it is taxed. If you’ve set the scheme up for yourself, you arrange the contributions yourself. The money in your pension is put into investments (such as shares) by the pension provider.
The value of your pension pot can go up or down depending on how the investments perform.
Some schemes move your money into lower-risk investments as you get close to retirement age.
You might be able to ask your pension provider for this if it doesn’t happen automatically.
How defined contribution pension schemes work
This is a type of pension where the amount you get when you retire depends on how much you put in and how much this money grows.
Your pension pot is built up from your contributions and your employer’s contributions (if applicable) plus investment returns and tax relief.
It helps to think of defined contribution pensions as having two stages:
Stage 1 – while you’re working
The size of your pension pot when you retire will depend on:
- how long you save for
- how much you pay into your pension pot
- how much, if anything, your employer pays in
- how well your investments have performed
- what charges have been taken out of your pot by your pension provider.
The fund is usually invested in stocks and shares, along with other investments, with the aim of growing the fund over the years before you retire.
You can usually choose from a range of funds to invest in. But be aware that the value of investments might go up or down.
Stage 2 – when you retire
You don't have to stop work to begin taking money from your pension pot, but you must normally be at least age 55 (57 from 2028).
When you start to take money, up to a quarter (25%) of your pension pot can be taken as a one-off tax-free lump sum. The rest can be used to provide a taxable income, or one or more taxable lump sums.
More about your options for taking money from your pension are below.
If you’re age 50 or over you can book a free Pension Wise appointment to find out more about your options.
How do the contributions work in a defined contribution pension plan?
Workplace pensions
If you’re in a workplace pension, your employer decides the levels of contributions paid into the scheme.
The contributions are usually a percentage of your earnings, although it could be a monetary amount.
The employer might set out minimum contribution amounts that both you and they must pay.
If the scheme you’re in is being used for Automatic enrolment, there are minimum contribution amounts.
Find out more about minimum contribution amounts in our guide Automatic enrolment - an introduction
Contributions made to a defined contribution scheme by you and/or your employer are invested in your individual ‘pot’ held in your name.
Personal Pensions
Be aware
Think about how much you can afford to contribute to the scheme - so you’re on track for the retirement you want.
If you have a pension that you’ve set up yourself, it will be up to you to decide how much to contribute to your pension and how often.
Depending on how steady your income is, you could set up a regular contribution, on a monthly basis for example. Or you could decide to make single contributions when you have spare income available.
Check our Pension calculator
You can get an estimate of the income you'll get when you retire with our Pension calculator
Tax relief on contributions
You get tax relief on the contributions paid into your pension. This means that Income Tax you would normally pay to the government goes towards your pension instead. This is one of the advantages that saving into a pension can bring over saving in a normal savings account.
Tax relief can help you build up your pension pot faster.
Find out more in our guide Tax relief and your pension
How are contributions invested?
Many defined contribution schemes offer you a choice of how your contributions, and the contributions your employer makes on your behalf, are invested.
The choice might consist of a limited range of funds or could allow investment in a wide range of different types of funds. Many schemes will choose a fund to invest your money in if you don’t make a choice.
You can decide to move money that you’ve built up from one fund to another (switch funds). Or you can choose to have future contributions invested in a different fund.
Over time, the value of your pot will change. Its value at any time will depend on:
- how much has been paid into it
- the length of time that each contribution has been invested
- investment growth over this period
- the charges deducted from the scheme.
You should be sent regular statements showing the value of your pot. But you can ask the scheme administrator for a value at any time.
Some schemes have an online system you can access that will provide details of your pot and a valuation.
Find out more in our guide Pension investment options
Taking money from your pension
From the age of 55 (rising to 57 from 2028), you have the choice of accessing your pension pot through one of the options below, or a combination of them. Depending on your age and personal circumstances, some or all these options could be suitable for you.
Your main options for using your defined contribution pension in retirement are listed here:
- Keep your pension savings where they are – and take them later. Find out more in our guide on Retiring later or delaying taking your pension pot.
- Use your pension pot to buy a guaranteed income for life or for a fixed term – also known as a lifetime or fixed term annuity. The income is taxable, but you can choose to take up to 25% (sometimes more with certain plans) of your pot as a one-off tax-free lump sum at the start.
- Use your pension pot to provide a flexible retirement income – also known as pension drawdown. You can take the amount you’re allowed to take as a tax-free lump sum (normally up to 25% of the pot), then use the rest to provide a regular taxable income.
- Take a number of lump sums – usually the first 25% of each lump sum withdrawal from your pot will be tax-free. The rest will be taxed. Find out more in our guide Taking your pension as a number of lump sums.
- Take your pension pot in one go – usually the first 25% will be tax-free and the rest is taxable.
- Mix your options – choose any combination of the above, using different parts of your pot or separate pots.
Find out more in our guide Options for using your pension pot
Got questions about how your pension can be paid?
If you need help making sense of how and when you can access your pension pot, you can speak to someone from Pension Wise, a free service from MoneyHelper.
What to do if you’ve lost the contact details for your scheme
If you’ve lost track of your pension details don't worry. There are lots of things you can do to find them.
