Final salary pensions and money purchase

With a final salary pension scheme (otherwise known as a 'defined benefit' scheme), the employer is contractually obliged to pay the employee a percentage of their final salary when they retire, depending on how long they have 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 company's fund perform, the employer still has to pay out a set amount to the employee on their retirement. For the employee, this has the advantage of providing a guaranteed retirement income. This is now a rare type of pension. When you can take your pension pot depends on your pension scheme’s rules – it’s usually 55, at the earliest.

With money purchase or defined contribution pensions, the employee makes contributions to a pension fund, with top-ups from the employer, but here the employee takes on all the risk. The size of the employee's pension pot depends entirely on the value of the fund when they retire. Those with money purchase pensions are hostage to the performance of the markets and to the skills of their pension fund manager.

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