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19th August 2019
:: Scheme Member | Types of Pension Scheme | What is a money purchase scheme? | Pensioner members of a DB scheme

What is a money purchase scheme? – Pensioner Members
There are many types of pension scheme offered by employers for their employees. 
 
This Factsheet looks at employer sponsored money purchase schemes which have become the most common type of scheme for most new employees in the private sector.
 
It is written for people who are pensioner members of an employer sponsored money purchase scheme. 
 
 
Introduction
 
This Factsheet takes a detailed look at money purchase schemes – which are being introduced by more and more employers, and are now playing an increasingly important role in employees’ pension planning.
 
To understand what a money purchase scheme is, you ought to know the very basics about employers’ pension schemes. See our Factsheets What is a pension scheme? and Types of employer sponsored pension schemes.
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What is a money purchase scheme?
 
A ‘money purchase scheme’ provides benefits based upon the amount of money that was in YOUR own pension ‘pot’ when benefits were due to be paid.
 
The amount that was in your ‘pot’ when benefits arose depended upon the payments made into your ‘pot’; the investment return achieved on each individual payment into the pot; and any costs which were charged against your growing ‘pot’. The benefits you or your dependents will get from a money purchase scheme will have come entirely from was in your ‘pot’.
 
Employer sponsored money purchase schemes include Contracted-Out Money Purchase Schemes (COMPS), Contracted-In Money Purchase Schemes (CIMPS), Executive Pension Plans (EPP) and Small Self Administered Schemes (SSAS).
 
Other types of money purchase schemes include Personal Pension Plans (PPP), Stakeholder Pensions (Stakeholder or SHP) and Group(ed) Personal Pension Plans (GPP). These arrangements may be presented as employer schemes but in fact are personal arrangements rather than employer sponsored schemes (even though an employer may pay into them on behalf of an employee).
 
Two of these arrangements – GPP and Stakeholder - operate in a different way to the others. They are ‘contract based’ rather than ‘trust based’.
 
Money purchase arrangements are an effective method of controlling the cost of running a pension scheme. However, this does provide less certainty for the scheme member in the period leading up to retirement as to how much they, or their dependents, are likely to receive.
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Contract based schemes
 
The employer selects a provider – an investment company – who will administer the arrangement and set up individual contracts with each member. The contract is a regulated product which requires the provider to set up the contract and disclose information about the arrangement directly to the member. In all other respects, they are identical to ‘trust based’ schemes. 
  • Employer selects investment company (pension provider).
  • The pension provider has an individual contract with each employee.
  • The pension provider is responsible for payment of benefits to each employee.
  • The employer has no responsibility for providing employees with benefits.
Trust based schemes
 
Trust based schemes are where a Trust is set up by the employer to administer the scheme, and look after the investments and provide benefits for the members. The members’ contract is with the Trustees, who will be their first point of contact in relation to all issues related to the scheme. To confuse the issue a little, the Trustees themselves may take out a contract (or series of contracts) with an insurance company, investment manager or third party administrator to help them carry out their duties - but this does not affect who is responsible for the payment of benefits. 
  • Employer sets up a Trust.
  • Trustees are appointed.
  • The Trustees select and manage the investments.
  • The Trustees are responsible for payment of benefits to members.
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Are there different types of employer sponsored money purchase schemes?
 
The vast majority of employer sponsored money purchase schemes provide benefits based upon the money held in individual ‘pots’ specifically on behalf of each member.
 
The amount in YOUR ‘pot’ at retirement will have depended upon how much was put in by your employer and by YOU, and the investment returns achieved on those contributions.
 
The scheme administrator or Trustees will have invested these contributions on your behalf in a range of investments and investment funds, some of which may have been chosen by you.
 
Any investment performance derived from each of these contributions became part of your ‘pot’.
 
Charges to pay for the scheme will have been paid either by the employer or by making deductions from what was put in on your behalf, or from the growing ‘pot’ itself. Often, the charges would have been a combination of all of these so that the cost was borne partly by your employer, and partly by you.
 
Summary
 
In an employer sponsored money purchase scheme your ‘pot’ will usually have consisted of -
 
employer contributions
plus 
YOUR contributions
plus
investment returns
 less 
charges
 
What was in your ‘pot’ at retirement will have been used to provide you with your pension benefits.
 
There is another form of a money purchase scheme which appears to be very similar to mainstream money purchase schemes, but which operates in a quite different way. This is called a cash balance arrangement. For further information on this, please refer to our Factsheet, What is a cash balance scheme?
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What sort of benefits are provided by a money purchase scheme?
 
The benefits that your pension scheme will have provided, depend largely on what you wanted, and your personal circumstances when you started to draw the benefit.
 
A money purchase scheme may have provided you with an income (commonly referred to as a pension) or an income and a lump sum.
 
The ‘shape’ of that income will have depended upon whether you wanted a larger benefit payable immediately when you retired, or a smaller amount initially but which enjoys a measure of inflation protection (in the form of regular increases to your pension in payment – called ‘escalation’). The more inflation protection you will have chosen, the smaller your starting pension.
  
Example:
 
How much pension could a £100,000 pension ‘pot’ have provided for a male aged 65?
 
Pension             Increases to pension      Dependant’s pension
                          after retirement                    on death
 
£6,752 p.a.                     Nil                                 Nil
 
£6,152 p.a.                     Nil                                 50%
 
£4,880 p.a.                   3% p.a.                            Nil
 
£4,316 p.a.                   3% p.a.                            50%
 
Based upon a £100,000 pension ‘pot’ for a male aged 65 at 22/09/2006, no guarantee period. Figures will vary from time to time and should not be relied upon.
 
Where you chose to provide a pension for your partner to be paid on your death, the amount of initial pension that would have been paid to you will have been lower than if you had chosen not to have dependant’s benefits. If you chose full inflation protection at outset and a generous dependant’s pension, your starting pension will have been lower still.
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When could I have got my pension benefits?
 
Benefits will normally have been payable to you when you reached your scheme’s normal pension age or Normal Retirement Date. This is important as it is the date at which you would normally have been expected to start to draw your pension benefits without the consent of the employer or the Trustees.
 
Depending upon the rules of your scheme (not all schemes allow these alternatives), you may also have been entitled to receive benefits at other dates such as: 
  • Early retirement
  • Retirement due to ill health
  • Terminal illness
  • Late retirement (where you choose to work beyond normal pension age).
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Are my benefits secure?
 
Before you retired, your pension benefits were as secure as the investments of the investment funds in which the contributions were invested.
 
The larger the investment fund and the more reputable the investment manager, the less likely the funds were to lose all their value.
 
The wider the range of investments which the fund held, the less they will have moved up and down.
 
Some funds like commodity funds, hedge funds or emerging markets can be highly speculative so values can rise and fall sharply.
 
Having retired, your benefits will usually be much more secure, particularly where your pension is being provided through an annuity policy.
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What is meant by ‘investment risk’ and ‘mortality risk’?
 
In an employer sponsored money purchase scheme, your pension benefits will have depended upon the value in your ‘pot’ at retirement, which meant that you may have been be exposed to ‘investment risk’ through weak investment performance before you bean to draw your benefits.
 
You were also exposed to a degree of ‘mortality risk’. Mortality risk is the likelihood that you will die at any given time. Evidence reveals that people are living longer in retirement. The effect of people living longer and so drawing their pensions for longer than expected, means pensions are becoming more costly. At the time you began to draw your pension, the mortality risk element will have been reflected in your pension income.
 
See what your Life Expectancy is.
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What rights do I have as a member to ensure the scheme is run properly?
 
If the scheme operates with Trustees, any member can seek election to become a Trustee. A Trustee is responsible for ensuring the scheme operates within the pensions law.
 
If you are unhappy about any aspect of the scheme, contact the scheme administrator or your employer. If they do not satisfy you, you can contact The Pensions Ombudsman or The Pensions Regulator depending on your problem (our Factsheets describe their responsibilities). Also, see our list of Useful Contacts.
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Summary & Key Points
 
When making enquiries about your pension benefit it is very important that you make it clear that you are a pensioner member rather than an active or preserved member of the scheme. Active, preserved and pensioner are different classes of membership of a pension scheme and any definitions and paragraphs contained within your Scheme Rules or scheme literature relating to any benefit may differ considerably between these categories. 
  • Keep informed. Your scheme may modify benefits and Rules. Legislation may change. Your circumstances may alter.
  • Rules differ from scheme to scheme and are wide and varied in content. Don’t assume that what applies to one of your pension schemes will necessarily apply to others that you may have.
  • HMRC impose rules which registered pension schemes must conform to.
People seldom have identical pensions and you should avoid drawing comparisons with colleagues whose circumstances may at first appear the same but could emerge as having significant differences.
 
This Factsheet forms part of our Module Types of Pension Scheme and should be read alongside the other Factsheets and Quicknotes in the series.
 
This is not an authoritative document. Seek professional advice from an appropriately experienced and qualified adviser.
 
 
What is a money purchase scheme? Pensioner v3.2
Last updated 12/01/2007 
Last reviewed 08/06/2007
 
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Glossary
View our Glossary for definitions of the terms used in our Factsheets
 

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What is a Money Purchase Scheme - Pensioner Members
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