Final salary and money purchase pensions

In a final salary pension scheme, the employer is contractually obliged to pay the employee a percentage of his final salary when he retires, depending on how long he has worked there.

Both employer and employee generally contribute to the pension fund, but the employer shoulders all of the risk: regardless of how well the investments in the fund perform, he still has to pay out a set amount to the employee on his retirement.

With money purchase pensions, the employee makes contributions to a fund, with top-ups from the employer, but there the employee shoulders all the risk. The size of his pension depends entirely on the value of the fund when he retires.

Those with money purchase pensions are hostage to the performance of the markets and to the skills of their pension fund manager.

• See Tim Bennett’s video tutorial: A beginner’s guide to pensions.

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