FOOL SCHOOL
Defined Contribution Schemes

September 10, 2003

The effect of a defined contribution occupational scheme is similar to having a personal pension into which your employer makes contributions. Your benefits depend on what is put into the pension fund and how the investments perform. At retirement you can get a small part of the fund as a tax-free lump sum, while the remainder must be used to purchase an annuity. Basically this involves you swapping the capital you have built up for a guaranteed rate of income for the rest of your life.

Your employer may offer to match the amount you put into the pension or they might say we'll put in 1% of your salary for every 2% that you put in up to a certain limit. Your employer will work out how much to pay everyone as a salary, taking into account the average amount that it has to contribute to everyone's pension. The effect of this is that if you are putting in less than average, then you are missing out on an employment benefit.

However, just because your employer offers to put money into your pension scheme if you do, it doesn't necessarily mean that you should. It really depends on the relative level of the contributions. If your employer offers to match your contributions (or better), then it would almost certainly make sense to take it. However, if your employer only puts in, say, £1 for every £9 that you put in, then the decision is more difficult. You might want to look at other ways of saving for retirement, like an ISA.

Sometimes the employer will absorb the administration and investment charges on a defined contribution scheme. They may also offer additional life cover to those in the scheme. This may give the company plan the edge when compared to a personal pension or stakeholder scheme.

Unlike defined benefit schemes, with a defined contribution scheme you have much more responsibility for your pension. You have to:

• Decide how much to put in;
• Decide which fund(s) to invest in;
• Monitor their progress and considering increasing your investment.

Our compound interest calculators can help you with the first and third points. Choosing a fund can be bewildering. We believe it's best to keep it simple and go for a low-cost option like an index tracker.

Find out more in our pension centre.