FOOL SCHOOL
Defined Contribution Schemes

December 1, 2004

The effect of a defined contribution occupational scheme is similar to having a personal pension (more on these in next week's Fool School) 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 part of the fund as a tax-free lump sum while the remainder must be used to purchase something called an annuity (these will be described in more detail in a later article as well). 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: other factors about whether or not to opt for the pension will probably be more relevant. We look at some of these in a later article where we compare the various merits of pensions and ISAs.

Unlike defined benefit schemes 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 about pensions here.