Defined Contribution Pension Schemes
There are no guarantees as to the amount of the pension or PCLS under a defined contribution scheme because the benefits available will depend upon the size of the fund that has been built up. However, benefits from a defined contribution pension scheme can usually be taken in the form of a pension and a pension commencement lump sum (PCLS).
Pension Commencement Lump Sum
Benefits can generally be taken before, on or after the scheme’s selected pension or normal retirement age and a pension commencement lump sum is usually available.
There are two exceptions when a defined contribution pension scheme will not provide a PCLS:
- The scheme rules do not permit any the proceeds to be paid out as a lump sum
- The member has used up all of their PCLS allowance
Usually, anyone who has the chance to take a PCLS selects the maximum available which is generally 25% of fund.
The pension provided by a defined contribution scheme is based on the fund that the member has accrued to the date the benefits are being taken. The actual amount of annual income provided will also depend upon the method by which benefits are drawn such as
This is where an income is drawn from the pension fund. It can be drawn directly from the fund or via a series of short term annuities.
The pension is paid directly out of the scheme assets or paid by an insurance company selected by the scheme administrator.
Annuities are payable by an insurance company and it is the most common method by which a defined contribution scheme will provide an income in retirement. The amount of income provided will depend upon lifetime annuity rates available at the point of retirement.
All defined contribution schemes can offer the option of a lifetime annuity, but the advent of Pension Freedom in April 2015 and the poor returns available for annuities mean that many people opt for a form of drawdown.
The Financial Conduct Authority (FCA) requires providers of individual pension arrangements to ensure that members are aware of their right to take an open market option, i.e. buy a lifetime annuity from any authorised insurer. This enables members to benefit from the best annuity rates available on the open market.
If benefits are taken from a pension before the age of 75, the value of the fund will be assessed against your lifetime allowance. Any excess above the lifetime allowance will be subject to a tax charge which is currently 55% if taken as a lump sum or 25% if taken as an income.
If benefits are not taken by the age of 75, a test against the lifetime allowance will take place at the age of 75.
Once in payment, the income is treated for income tax purposes as earned income. However, pension income is not subject to National Insurance contributions (NICs).