Company pensions - money purchase schemes

How they Work

Unlike final salary, money purchase schemes do not give any guarantees with regards to level of income. In other words, they do not provide a pension that is linked to your final earnings before retirement. Contributions made by you & your employer (if it's contributory) are invested & allowed to grow. The resultant fund is ‘allocated’ to you & upon reaching retirement age, you use the money that has built up in your pension to purchase an annuity within Inland Revenue limits. Its the annuity which then provides you with income in your retirement. So it follows that the value of the pension at retirement, is dependent upon:

• How much money has been paid in over the life of the plan,
• How well the money has grown
• What annuity rate your pension fund purchases when you retire.

In other words a money purchase pension is just a long term savings plan (albeit a very tax efficient one) that's designed to produce a lump sum at retirement. This then purchases an annuity which in turn provides the retirement income. It follows that unlike a final salary scheme, you are unable to predict with any accuracy, what pension you will receive before your retirement date.

The benefits that come with money purchase company pensions tend to be not as good as the ones associated with final salary schemes. Widows & dependent children's pensions, death & disability benefits are all quite rare in money purchase schemes. Though some employers offer them as options you can pay towards.