28 May 2024

What is a defined contribution pension?

A defined contribution pension (aka a DC pension or a money purchase scheme) is a type of private pension that you contribute to on a regular basis. You define how much and when you pay into it. That’s why it’s called a defined contribution pension.

A DC pension can be:

  • A workplace pension, set up for you by your employer
  • A personal pension, that you set up for yourself

You might also have heard of defined benefit (aka DB or final salary) pensions. They work slightly differently from DC pensions. We explain how and talk you through some of the key defined benefit vs defined contribution pension questions below.

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Types of pension

Learn more about the different types of pension, and which might be right for your personal circumstances.

How do defined contribution pensions work?

When you pay money into your defined contribution pension plan, it’s invested on your behalf. The amount of control you have over how it’s invested depends on your pension type. With a SIPP you’re in full control, but with most other types of pension you’ll be choosing between a range of investment funds.

When you pay into your DC pension, you’ll get a little help:

  • If you’re paying into a workplace pension, your employer will top it up. They’ll match your payments up to at least 3% of your salary. If you’re not sure how your employer might top up your payments, check with them.
  • If you’re paying into any kind of personal pension, you’ll get tax relief on the money you invest, on up to 100% of your annual earnings. Depending on the type of pension scheme you’re in, you’ll either get it automatically or have to claim it back yourself.

You can start taking money out of your DC pension pot once you’re 55 (or 57 from 2028). You can usually take up to 25% of your pot as a tax-free lump sum, subject to the availability of any allowances. If you take any more, you’ll have to pay income tax on it.

Whether or not you take your lump sum, you’ll need to decide what to do with any money still invested in your pot. You can choose one or both of:

  • Buying an annuity, giving you a guaranteed income for a set period or the rest of your life
  • Investing it, ready for you to draw down some or all of it whenever you need to

All of this is quite a big contrast with DB pensions. They’re only ever set up for you by an employer. You often don’t have to pay into them and you’ll get a guaranteed amount from them, usually based on your final salary and length of service.

You won’t have any choice over how your money is invested and how much you can take out. You probably will be able to choose when it starts paying out, though you’ll usually have to wait until you’re at least 65 or have reached State Pension age.

What are the advantages of a defined contribution pension?

  • You have more ways of taking your money out of your pot
  • You can usually start taking it out at a younger age (55 or 57 as opposed to 60 plus)
  • You have more flexibility around what to do with it when you die

What are the disadvantages of a defined contribution pension?

  • Any money that goes into your pension is invested, which means that its value can go down as well as up – you might get back less than you put in
  • Because your retirement income is based on how well your investments do, it’s you rather than your employer who’s taking the investment risk
  • Unless you buy an annuity, your income from your DC pension isn’t guaranteed and could run out

Can you have both a defined contribution and a defined benefit pension?

Yes – in fact, you can have several of each at once.

With each new employer you’ll become a member of a new pension scheme, which could be either a DB or DC one. You might even end up with a hybrid pension that combines the benefits of both types of pension. You’ll probably only be paying into one pension scheme at any given time, though.

You can also save into either or both alongside other kinds of investment. Oh and, once you’ve got several different jobs on your CV you’ll probably also have several different pensions up and running. It can be difficult to keep track of them all. If you’ve lost one, our How to track down your old pensions article can help.

Want to learn more about bringing your pensions together?

Learn how finding lost pots and bringing them together can help you manage your pension and might save you money on fees.

How much to contribute towards your defined contribution pension?

There’s no single answer to that question because it depends on many different factors, including:

  • How much money you’ve got coming in and what your outgoings are
  • What sort of retirement lifestyle you’d like to save for – the Retirement Living Standards website can help you learn more about that
  • How much you’ve already saved and how long until you retire

Our How much should I put into my pension article will help you work out how much you might need or want to save into your pension.

What happens to your defined contribution pension when you die?

When you die, you can leave any money in your DC pension pot to one or more beneficiaries. They won’t have to pay tax on it – and your pension isn’t treated as part of your estate, so it won’t count towards any inheritance tax calculations. 

  • If you die before the age of 75, any death benefit payments will normally be free of income tax provided the benefits paid under this plan and any other pension you have don’t exceed your available Lump Sum and Death Benefit Allowance. The allowance is normally £1,073,100 (unless you have a protected allowance), although any tax-free money you’ve already taken out will be subtracted from it.
  • If you die once you’re 75 or older, any payment money will normally be taxed as income at your dependent or beneficiary’s highest rate of income tax. 

Our What happens to your pension when you die article explains more.

What should I do next?

We hope that’s helped you with your quest for defined contribution meaning. If you have any more questions, then:

Check your pension paperwork, or just ask your provider or employer. As a rule, if you set up your pension yourself it can’t be a DB pension, but if an employer set it up for you it might be.

You’ll have to wait until you’re 55, or 57 from April 2028 on. Once you’re the right age, you can take money out as a lump sum (usually with the first 25% tax free, subject to the availability of any allowances), put it into drawdown to pull out as and when you need it or buy an annuity if you want a guaranteed income.

It depends on what you want from your pension. So for example, if you want to control how your pension pot’s invested a DC pension will probably be a better bet than a DB one. But if you want a guaranteed income without having to buy an annuity, a DB one will be preferable. It also depends on how much you have invested in it – a high-value pension of one kind will usually be better than a low-value pension of the other. And of course, you can choose to set up a DC pension for yourself but you can only ever join a DB pension through an employer.

Yes, you can have both of each kind of plan at once. And you can have more than one of each kind at the same time too.

In a defined contribution plan, the saver bears the risk. If an employer’s also paying into the plan, their responsibility ends once they’ve made their own contributions to it.

Yes, you can cash in a defined contribution plan. Once you reach the age of 55 (or 57 after April 2028) you can start taking money out of it, either as a lump sum, through drawdown or by buying an annuity.

Yes, a SIPP is a defined contribution pension scheme.

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