Defined Contribution vs Defined Benefit Pension Plan
What is a Defined Contribution Pension Scheme?
DC pensions are the most common form of pensions.
The value of your DC pension at retirement is straightforward. It is a combination of how much you or your employer contributed and how well the underlying investments have performed. There are no other factors to consider which makes them more straightforward. This is unlike Final Salary Pension Schemes which have guaranteed and safeguarded benefits.
Defined Contribution vs Defined Benefit Pension Plan
Defined Benefit and Defined Contribution Pension Plan are the most well-known employer-sponsored pension plans. While they are the most common, and have basic similarities, they are two very different pension schemes. The key difference between DB and DC is the employee's contribution. In DC, the employee contributes a certain amount of money to the pension fund and the employers may or may not match that contribution. In contrast, DB or Final Salary is a pension scheme where the amount you get when you retired is determined by the number of years you've been working for the company and the salary you've earned. They provide a guaranteed income for the rest of your life, which is typically indexed to inflation each year. Due to this, Defined Benefit pension scheme is dubbed as the 'gold-plated' pension. You should complete thorough due diligence to help you understand your DB Pension Transfer options. At expatwealthatwork, we are qualified pension transfer specialists who have transferred more than 30 and reviewed hundreds of DB pension transfers.
What is a Defined Contribution Pension Transfer?
Transferring a company or stakeholder pot into a personal pension.
Most expats complete a defined contribution pension transfer into an international SIPP or QROPS/EURBS (EEA residents). These transfers provide greater control of all their DC pensions as they are able to manage them together in one place. DC pension transfers are an essential area of financial planning. The costs of a DC pension transfer are lower than a transfer from a Defined Benefit pension.
What is a pension tax free lump sum?
If you have a UK pension, you are eligible to a 25% tax free lump sum
The technical term for this tax-free pension lump sum is a Pension Commencement Lump Sum (PCLS). You are permitted to take the first 25% of your pension without income tax. The remaining 75% will count as income and be taxed at your marginal tax rate. On Defined Contribution schemes, access to your pension is permitted from your 55th birthday. For example, an individual with a £250k DC pension would be able to draw their 25% (£62.5k) tax-free pension lump sum from age 55. The remaining 75% (£187.5k) would be taxed at their marginal income tax rate in their country of residence.
Can I access my DC Pension at age 55 or not?
Since 2015, you are free to draw down on your pension from age 55
In 2015, the UK government confirmed that DC pensions would be accessible from age 55 instead of age 60 or 65. This change in legislation is referred to as UK Pension Freedom Rules. As such, if you are 56 you are free to withdraw all your DC pension retirement income. Unless you explicitly need this retirement income we would advise against such withdrawals. You will be better off gradually drawing down your pension income on a regular basis to minimise your tax.
Advantages of Defined Contribution Plan
Consolidate Pension Pots In One Place
While working in the UK it is likely you had numerous employers. Perhaps you were only employed with some for a few years. Each employer will have set up a company pension scheme for you though. For example, a client could have £200k spread across four previous employers (£19k, £100k, £20k, £61k). You can consolidate all these pensions together in one easy to manage location.
Whether an international SIPP or QROPS is the best advice you, both pensions are internationally flexible. As such, if you move country again in your expat career your pension planning will remain in place. There is no need to change it every time you move. Much like our service, we can continue servicing you internationally as your career progresses.
Each of your UK pension pots has its own set of charges and fees. Few people read p.34 of their pension contract when starting a new job. These charges can be excessive though, particularly on older schemes. Consolidating your pensions allows you to eliminate duplicate charges.
Online Access 24/7
Consolidating your DC pension also allows you to have full online access much like your online banking. Helping you monitor your investments more closely at a time that suits you. As DC Pensions are a long-term investment, we do not advise checking them daily but you always have full access.
Quarterly Advice Review
At expatwealthatwork, all our clients receive a quarterly review. This allows us to update our clients on the portfolio and provide a general overview. It also provides an opportunity for our clients to update us on any changes in their situation. Such as moving employer, returning to the UK or anything else that might affect their finances. Many clients opt for an in-depth annual or bi-annual review once they feel more comfortable working with us.
Planning Your Retirement
With your pension pots consolidated together in one place, we can provide an accurate estimate of what your pensions will be worth at retirement. In contrast, estimating the growth of four different pension pots with various fees and charges is not an easy task.
Tailored Investment Choice
Depending on where your DC Pensions are currently located, a DC Pension transfer can provide access to a broader range of investments. Expatwealthatwork is on hand to advise on the portfolio best suited to your needs from a whole of market analysis. This may be different from your existing DC provider who may offer a limited in-house range of model portfolios.
Low Cost & Straightforward
As DC pensions have no guaranteed benefits you are not giving up any rights in transferring it. This is different from Final Salary pensions where a more thorough analysis of your options is required. FCA stipulations on DC pensions transfers are less onerous which removes an additional layer of costs for our clients.
Disadvantages of Defined Contribution Plan
Set-up Fee of 1%
We are only looking to work with clients where we can add value to their financial planning. If you already previously consolidated all your pensions in the UK then you are one step ahead of most people. The costs of transferring your pension - 1% - might not outweigh the benefits. We will always happily review this for you but will be honest if we cannot add any value for you. You may be better off keeping your DC pensions where they are.
How do I obtain my DC pension transfer valuation?
Your UK DC pension provider will supply this
Obtaining the transfer value for your DC pension is always the best practice. This allows us to see all possible information pertaining to your policy. However, if you already have the latest valuation this will provide a very accurate estimation of your transfer out value. Remember there are no safeguarded or defined benefits so your transfer value is normally the same as your current value. Also, if you are transferring to an international SIPP we no longer require physical forms as transfers are completed electronically. We simply will let you sign our "Letter of Authority" and we will gather all the required information on your behalf. Including your transfer value, your existing costs and much more. Completing our letter of authority is not transferring your pension or agreeing to do anything. It simply allows us to collect the information for a limited time period. Please contact us to complete our letter of authority: firstname.lastname@example.org
Are Defined Contribution pension schemes benefits guaranteed?
Pension Benefits are not guaranteed
A DC pension offers no form of guarantee as to the pension benefits that you will receive at retirement. Your retirement income and tax-free lump sum are only related to the performance of your portfolio. This is why DC pensions are considered more straightforward as there are no complicated calculations. Your pension plan value is your transfer value.
When were your DC Pensions previously updated?
Markets change and portfolios need to be aligned
The final value of your pension benefits in retirement is important to you. You cannot control what the markets do. There will be recessions like the 2008 Financial Crisis and there will be bull markets like the past decade. What you can control though is ensuring you have a portfolio allocation with a proven track record of outperforming the marketplace. Upon transfer, your portfolio will be updated to ensure it is in line with current market trends and opportunities.
How much will a DC pension transfer cost?
There will be a set-up fee of 1%
DC pension transfers do not require additional FCA sign-off which keeps the costs low for our clients. Our set-up for DC and DB pension transfer portfolios is 1%. We work on a transparent model of advice for all pension transfers and do not receive any form of hidden commission. So you will know exactly how much your advice is going to cost before you make any decisions or commitments.
What happens to my DC pension if I die?
Your beneficiaries receive your pension in full
Nominating your own beneficiaries is a task we complete with all clients before your pension is even transferred. It is a simple form which takes less than 30-seconds to complete. You are also free to decide on the percentages. For example, spouse 100% or son 50% and daughter 50%, you are free to complete this as you wish. You can then rest assured that in a worst-case scenario your financial affairs are simple for your family.
Would a DC pension transfer be the right advice for me?
There is no one size fits all answer
Any pension transfer decision should be considered carefully. For many clients, the advantages of a DC transfer outweigh the costs of completing a transfer. This is always best discussed with us. We hope the above resonates with you and you can share this with any expat colleagues or friends through the social buttons below.