What is a defined contribution pension?

By AMY ANDREW

Updated: 04:36 EST, 12 August 2014

A defined contribution pension is a pension in which an individual, or employer and employee, agree on a set amount to be paid regularly into an individual retirement pot.

This is normally a set percentage of a person's salary, which is usually paid monthly, but can also be contributed annually or at a time that works with their pay schedule.

Workplace pensions: What are your options?

The contributions are invested to provide a fund, which has traditionally been used to buy an annuity on retirement - although this is predicted to change with new rules.

Unlike final salary schemes, the level of retirement income for the member is not guaranteed.

Defined contribution schemes - sometimes referred to as money purchase schemes - are generally the preferred option for employers because the amount spent is gradual and controlled and the liability for investment performance is passed on to the individual.

In other words, should the pension fail to provide the expected returns on investment, payouts for an individual during retirement are likely to be lower - the fallout rests with the pensioner, rather than an employer or pension provider.

However, defined contribution schemes do offer a number of benefits.

As well as tax relief on any contributions, those paying into a defined contribution pension have the security of knowing what payments to the fund will be month-to-month, allowing them to budget more easily.

Employee contribution come from their salary, before tax is applied.

There are two kinds of defined contribution schemes: work pensions, offered via your employer, and personal pensions, a scheme that you take out as an individual.