A money purchase scheme(also known as defined contribution) is a scheme where the final value depends on:
- the amount of contributions made by the member, their employer and any third party
- the performance of the investments underlying the scheme
- the charges within the plan.
This means the benefits payable to or in respect of the member are calculated by reference to the capital value of the pension pot at the time of payment. As the contributions are normally invested in a range of funds or allowable investments, which can fluctuate in value, the value of benefits payable are not known in advance and the member bears the investment risk.
Money purchase schemes can be occupational or personal pension schemes. Personal pensions, SIPPs, SSASs and retirement annuity contracts are all types of money purchase schemes.
Definitions of a money purchase
The definition of a money purchase arrangement from the Finance Act 2004 is; 'an arrangement is a money purchase arrangement at any time if, at that time, all the benefits that may be provided to or in respect of the member under the arrangement are cash balance benefits or other money purchase benefits.'
The definition of money purchase benefits from the Pensions Act 2008 (as amended by the Pensions Act 2011) –
'means benefits the rate or amount of which is calculated by reference to a payment or payments made by the member or by any other person in respect of the member and which are not average salary benefits which fall within section 99A'.
‘A benefit other than a pension in payment falls within this section if its rate or amount is calculated solely by reference to assets which (because of the nature of the calculation) must necessarily suffice for the purposes of its provision to or in respect of the member.’
Pensions Act 2011 Part 4, Section 29
Therefore, where the benefit from a scheme is not wholly calculated with reference to the assets it is not a money purchase arrangement.
What are the options for taking pension income from a money purchase scheme?
The pension member can usually take up to 25% of their money purchase fund as a pension commencement lump sum (PCLS) (tax-free) and designate the balance of the funds to a product that can provide pension income (which will be taxed at the member’s marginal rate). Depending on the option selected, pension income may be in the form of a secure regular income or give the option to draw down income as required (the level of this drawdown may be limited, according to the option selected). The options available are as follows:
- Lifetime annuity – provides a secure level of taxable income.
- Scheme pension – provides a secure level of taxable income.
- Flexi-access drawdown – provides the flexibility to withdraw taxable lump sums and / or taxable income, with the income being drawn directly from the fund or by the purchase of short-term annuities. There’s no limitation to the level of withdrawals allowed.
- Capped drawdown (this is only available for top-ups to some existing capped drawdown plans arranged before 6 April 2015) providing the flexibility to withdraw taxable lump sums and / or taxable income, with the income being drawn directly from the fund or by the purchase of short-term annuities. There are limitations to the level of withdrawals allowed within capped drawdown plans.
In addition to the above methods of providing a retirement income, following the introduction of flexible options, the pension holder may elect to take all or part of their uncrystallised pension fund as a lump sum. 25% of the lump sum will normally be paid tax-free, with the balance of the fund being taxed at the point the pension holder receives it. This method of extracting funds is calledUncrystallised funds pension lump sum (UFPLS)
Small pensions may be taken as cash lump sums – up to threesmall potsof £10,000 each from non-occupational pension schemes and an unlimited number from occupational pension schemes, subject to rules.
However, the rules for each scheme will dictate what options are available for the member.
