All About Money Purchase Schemes
Also known as ‘defined contribution’ pensions, money purchase schemes enable your employer (and you) to pay money into your retirement fund, supplementing the income you will receive from the basic State Pension. When you retire, the pension pot is used to buy an annuity - which provides an income throughout your retirement.
The Benefits of Money Purchase SchemesThe major benefit of money purchase schemes is that they are relatively straightforward. Your employer will help you build up a retirement fund, usually giving you a choice of different investments to help you reach your retirement goal. There are two different types of scheme that your employer can set up.
Occupational SchemesWith these schemes, both the company and the employee make contributions to the scheme, which is then managed by a board of trustees. The trustees decide on the most appropriate way to invest all contributions, with the objective of meeting all pension payout requirements over the long-term. Occupational schemes are expensive to set up and maintain, but they work well for larger companies with lots of employees.
Group Personal Pension SchemesFor smaller companies, individual pensions or Group Personal Pensions are less costly to manage. The company chooses an insurance company to manage the pension contributions on behalf of employees.
Stakeholder PensionsThese were introduced by the Government in 2001, and are intended as a low cost alternative pension for employers earning between £10,000 and £20,000 a year, but without access to company pension schemes.
Companies who offer stakeholder pensions are not required by law to make a contribution. Instead, the employee is expected to make their own pension provisions.
What Level of Contributions Will Your Employer Make?How much your employer chooses to contribute to your pension scheme will have a significant impact on your overall pension pot when you retire. Most pension experts believe that, to enjoy a comfortable standard of living when you reach retirement, you should save around 15 percent of your salary each year.
Therefore, if your employer is able to make a contribution worth 10 percent of your salary, you are advised to make a further contribution of at least 5 percent yourself. Some employees are willing to pay more than 10 percent, and some will also agree to match any additional contribution amount that you choose to make.
The Risks of Money Purchase SchemesWhen you pay into a money purchase pension scheme, you are investing your money in the hope that your investment will grow significantly as you get closer to retirement. Unfortunately, unlike a final salary scheme, there is no guarantee that your investment will grow to the level you want it to. All investments carry a degree of risk, and although your employer will be expected to put your money into well-managed low-risk pension schemes, you have little comeback should you be disappointed with the level of performance made by your pension.
Most money purchase pension schemes offer a range of different funds – with differing levels of risk - in which you can choose to invest, perhaps putting a larger proportion into higher risk funds in your early years, and then allowing you the option to increase your weighting into safer assets as you get older and closer to retirement.
What Happens If You Change Jobs?Most people do not work for the same company their entire life. When you leave a job your money purchase scheme will stop and be known as ‘paid up’. This means that the company will no longer make any contributions and the pension pot you have already accrued will stay at the same level.
You can choose to keep the pension where it is, but each year the company will continue to deduct management fees from your pot. A better alternative would be to try to transfer your paid up pension to your new employer, although you may have to pay a charge to do this.
Deciding on whether it makes more sense to keep your pension paid up or to transfer will largely depend on how large your pension pot is and how long you have until retirement. If you find yourself in this situation, it is well worth seeking independent financial advice from a pensions expert who can help you make the best decision.