EXPLAINED

Defined benefit and defined contribution

  • 30 December 2019
  • 2 minutes

Employers in the UK offer two types of pension savings schemes: defined benefit and defined contribution. They both do what they say on the tin if you can unravel the words.

In a defined benefit scheme your benefits are defined at the outset. That sounds like a circular argument but in simple terms it means the retirement income you receive is determined (“defined”) primarily by your final salary and years of service. For this reason these are also known as final salary schemes. Your employer bears the risk that the contributions and any investment growth aren’t enough to cover the amount due to you and your colleagues when you come to retire.

It follows that in a defined contribution scheme the element that is known up front is the level of contributions paid by you and your employer into your individual pension plan. What you get at retirement is reliant on these contributions together with any investment growth. You therefore bear the risk that it might not be enough to provide the retirement you had hoped for.

Pensions are a long-term investment. The retirement benefits you receive from your pension plan depend on a number of factors including the value of your plan when you decide to take your benefits, which isn’t guaranteed, and can go down as well as up. The benefits of your plan could fall below the amount(s) paid in.

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