DC Pensions - How do they work?

click86

I was reading up about defined benefit pension schemes on behalf of a family member. I found lots of very good information so got a really good understanding of how they work.

However, for some reason, I'm struggling to understand exactly how defined contribution pensions work.

Let's say (numbers out of a hat) a person has £1000 in their DC pension pot on the day of their retirement and 25% of this is taken as tax free cash.

Does this mean that the remaining pot value is divided by a number of years until avg. death age to equate how much per annum the person will get?

I assume once your pension pot is depleted, then that's it. So what if you live longer than expected?

If I've misunderstood how this works, please let me know.

Thanks

Albermarle

Does this mean that the remaining pot value is divided by a number of years until avg. death age to equate how much per annum the person will get?

No, you have different options 

Take all the remaining pot in go . As it is taxable this can cause a big tax bill if it is a significant amount .

Buy an annuity with it

Take it out as regular income and/or irregular income by a couple of different methods.

https://www.standardlife.co.uk/c1/pensions-and-retirement/ways-to-take-your-money.page

MrDF

click86 said:

I assume once your pension pot is depleted, then that's it. So what if you live longer than expected?

If you have an annuity then it pays out for as long as you live (you essentially give your pot to an insurance company in exchange for a stream of income). Otherwise, the answer is yes! It used to be that you had to buy an annuity but this has changed now, there may still be times when an annuity may suit.

gm0

You have spotted the difficulty.  If you run out you fall back on the state pension you have earned and any eligibility for Pension Credit benefit.  Best not to run out.  The key difference with DC if you don't convert it to an until death income (annuity) is that it remains invested in some fashion and hopefully according to market conditions grows during what may be 30-40 years of retirement depending upon when retirement occurs and hopefully protects to a degree against inflation because of the investments.

Contrast:

DB or an annuity - fixed income until death in a longevity risk pool with others - may be indexed (helps a bit). But murdered in the 1970s by inflation.  When you die early or late.  It's gone.  No risk to you of living "too long".

DC - you have to worry about your personal longevity in a risk pool of - one - you.   When it runs out - that's it.  Quid pro quo is it is yours throughout and anything left over goes to your heirs currently outside of IHT. 

LHW99

With a DC pension, you do also have the benefit that you can take it (roughly) 10 years before your state pension is due, and often a few years before the "normal retirement age" of a DB pension.

This flexibility means that if you have a DB pension, but want to retire a bit earlier than it would generally let you, you can take a bit more out of the DC for a few years and cut back later, rather than taking the DB early and having it reduced.

Marcon

Plenty of clear info here: https://www.pensionsadvisoryservice.org.uk/about-pensions/pensions-basics

Prism

The assumption is that the pension remains invested and will continue to grow at roughly the same rate that someone takes withdrawal amounts from it. Nothing is guaranteed though