How they Work?
Unlike the final salary scheme, money purchase schemes do not give any guarantees with regard to the level of pension income at retirement. They do not provide a pension that is linked to your final earnings before retirement. Contributions made by an employee and employer are invested for the purpose of long term growth. The resultant fund is ‘allocated’ to you and upon reaching retirement the money that has built up in the pension is used to purchase a pension income.
The value of the pension at retirement is dependent upon:
* How much money has been paid in over the life of the plan
* How well the investment has performed
* The interest rate available to you for converting your retirement fund into income (typically via an Annuity)
So a money purchase pension is simply a long term savings plan (albeit a very tax efficient one) that is designed to produce an income at retirement and a tax free lump sum is an option.