Q&A: Money purchase pensions

Pension performance is linked to share price moves

As part of its understanding pensions series, the BBC News website provides an introduction to money purchase schemes.

What are these schemes?

Under a money purchase pension scheme employees pay money into a retirement fund which is invested, for example, in the stock market.

When the employee retires, the retirement fund is used to buy an annuity - a financial product which provides an income for the rest of that person's life.

The size of the pension therefore depends on how well the retirement fund performs, and also on what annuity rates are available on retirement.

Unlike final salary pension schemes, there is no guarantee offered by the employer that a pension fund will pay out a set amount on retirement.

The investment performance risk of the pension is borne by the employee, not the employer.

What's wrong with this?

This is fine if retirement coincides with a rising market.

However, the stock market has been falling in recent years - and many workers are facing a poorer retirement than expected.

Stakeholder plans, introduced by the government in April 2001, are a form of money purchase scheme.

What about "defined contribution" schemes?

Money purchase schemes are also known as "defined contribution" plans, for short.

One big issue with these schemes is that employers often contribute less than they would under final salary plans.

According to the National Association of Pension Funds (NAPF), employers contribute on average 11% of salary into final salary schemes, compared to only 6% into money purchase.

This means employees will have to save more of their own income into a pension fund to achieve a decent retirement income.