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Defined Contribution Schemes

Defined contribution (DC) schemes

A defined contribution (DC) scheme is a pension scheme in which the pension benefits payable at retirement reflect not only the size of the pension 'pot' that has been built up during the member's working (and saving) life but also the options that the member selects on their retirement. The pension 'pot' is built up from contributions from the member and the employer, and from reinvested investment returns, and can be sizable where the contributions have been relatively high and the returns good.

Consequently, they can provide members with a decent income in retirement. However, the problem is that the level of contributions going into the 'pot' are rarely high enough to deliver that retirement income in practice; as well as that there are no guarantees, or promises (such as in a defined benefit scheme), of what that income will be. Members are also forced to accept the risk of increasing longevity in retirement. Members can plan, based on making a series of assumptions, to save at a certain level to deliver the income in retirement that they think they will need, but there are no certainties that that income will be there when they need it.

Additionally, whereas particularly medical retirement is usually well catered for in DB provision, defined contribution schemes tend towards under-provision in this important area. The same is often true as regards dependant's pensions for members who die while they are still of working age.

On retirement, members have a number of options of what they can do with their pension 'pot'. Traditionally, pension 'pots' were exchanged for an annuity, i.e. an income stream based on the choices that the member exercised at retirement (concerning indexation, spouse's pensions and any guarantee period - with all these costing extra money ). Nowadays, members have a range of other choices, where the scheme rules permit, to take their 'pots' in a more flexible way.

On taking a defined contribution pot, proper financial advice is essential to ensure that members get the best possible deal from their savings which suits their circumstances and their wishes.

The DC scheme that BT has been offering to all new employees since 2001 is now called the BT Retirement Saving Scheme.