Contribution Structures
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DC schemes do not differ too greatly in terms of how they work.
They all have the basic need to pay contributions into a fund.
However they do differ by the rules used to determine how much the
company pays into the fund on your behalf. The most common
structures are
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Fixed contributions
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Age related contributions
-
Service related contributions
-
Contribution matching
Fixed contributions
Nothing too exciting or complicated going on here. In a fixed
contribution arrangement the company pays a fixed amount of say 3%
of your salary per year. You get this added to whatever
contributions you may be required to pay. The 3% does not change as
you get older or as you have completed more service and you cannot
increase the companies contributions. This is the simplest contribution structure.
Age related contributions
An age related scale may be implemented whereby the older you are
the higher the contributions (as a percentage of salary) given. The
basic idea here is that the cost of providing each £1 of pension at
retirement increases as you get older because you have less time in
which to earn investment returns. Therefore to try and provide
employees with the same amount of pension at retirement companies
need to make higher contributions to the pension pots of its older
employees.
The scale may look something like (the rates shown are merely to
indicate how age related scales are typically designed)
Age
|
Company contribution as % of salary
|
35 and under
|
3%
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36 to 45
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5%
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46 to 55
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7%
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56 and above
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9%
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Service related contributions
Under a service related contribution structure the level of
contributions increases with the amount of time an employee has been
a member of the scheme. Therefore in your first five years with the
company you might be given 4% of your salary per year as a
contribution. Once you have been with the company for 5 years this
might increase to say 6% of salary. The aim is to reward employees
who continue to remain loyal to the company.
The scale may look something like (the rates shown are merely to
indicate how age related scales are typically designed)
Service with the company, years
|
Company contribution as % of salary
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10 and below
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3%
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11 to 20
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5%
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21 to 30
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7%
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31 and above
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9%
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Contribution matching
Some schemes provide something called 'contribution matching'.
The general principle of a contribution matching scheme is that the
higher the contributions the member pays the higher will be the
contributions that the employer pays (normally up to some maximum
amount the company is willing to contribute).
Therefore the company may promise to pay something like 2% of
salary for every 1% paid by the member up to a maximum company
contribution of 8%. Under this sort of scheme the member could
choose to pay any of 1%, 2%, 3% or 4% and the company would make
contributions of 2%, 4%, 6% or 8% respectively.
Under this sort of scheme it makes most sense to pay maximum
contributions as this way you obtain the maximum contributions from
the company. If you are in a contribution matching scheme and are
not paying the maximum contributions in order to receive the maximum from the employer consider
increasing your level of contributions. If you are at all unsure
then seek financial advice.
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