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Defined Contribution Pension

Also known as: Money Purchase Pension, DC Pension, Personal Pension

Definition

A defined contribution pension is a retirement savings pot where the amount you receive depends on contributions made by you and your employer, plus investment performance, rather than being guaranteed based on your salary.

Understanding defined contribution pensions is crucial for estate planning because they cannot be distributed through your will and from April 2027 will be subject to Inheritance Tax.

What Does Defined Contribution Pension Mean?

A defined contribution pension—also called a money purchase pension—is a type of retirement scheme where you build a pot of money based on contributions and investment growth. Under the Pension Schemes Act 2015 and auto-enrolment regulations from the Pensions Act 2008, most workplace pensions in the UK are now DC pensions. Your eventual retirement income depends on four key factors: how much you and your employer contribute, how well those investments perform over time, how long the money is invested, and what fees your pension provider charges. This differs fundamentally from defined benefit pensions, where you receive a guaranteed income based on your salary and years of service—with DC pensions, you bear the investment risk but also benefit from potential investment gains.

If you're employed and earn over £10,000 per year, you're likely automatically enrolled in a DC pension. The minimum contribution is 8% of your qualifying earnings: typically 5% from your employer and 3% from you, though many employers contribute more. The government adds tax relief, effectively boosting your contribution based on your tax rate. For example, Sarah, 35, earns £40,000 and contributes 5% (£2,000 per year). Her employer adds 3% (£1,200), and the government adds tax relief of £500 (20% tax relief), giving a total annual pension contribution of £3,700 that gets invested in her pension pot. You can typically access DC pensions from age 55 (rising to 57 in 2028), taking up to 25% as a tax-free lump sum, with the remaining 75% subject to income tax when withdrawn. You can then buy an annuity for guaranteed income, keep the money invested and withdraw as needed through drawdown, or take it all as cash.

For will-makers, the critical point is that DC pensions are held in trust by your pension provider and do not automatically form part of your estate. This means you cannot distribute your pension through your will—instead, you must complete a nomination form (sometimes called an expression of wish) with your pension provider to indicate who should receive your pension when you die. Pension trustees typically have discretion over the final distribution, though they consider your wishes. This discretion exists to keep the pension outside your estate for Inheritance Tax purposes, though this tax advantage ends from 6 April 2027. From that date, unused DC pension pots will be included in your estate for IHT, potentially creating a 40% tax liability on top of any income tax your beneficiaries pay. If you die before age 75, beneficiaries currently receive your pension free of income tax. If you die at age 75 or after, they pay income tax at their marginal rate on inherited pension benefits. Combined with the new IHT from 2027, beneficiaries could face total tax rates of 55-67% on inherited pensions, making it essential to review your nominations and estate plan before the 2027 changes take effect.

Common Questions

"How does a defined contribution pension differ from a defined benefit pension?"

With a defined contribution pension, your retirement income depends on how much you and your employer contribute plus investment growth—you bear the investment risk. A defined benefit pension guarantees a specific income based on your salary and years of service, with the employer bearing the investment risk.

"What happens to my defined contribution pension when I die?"

Your pension provider typically asks you to nominate beneficiaries, though they usually have discretion over who receives the funds. From April 2027, unused DC pension pots will form part of your estate for Inheritance Tax purposes, representing a major change from current rules where they're normally IHT-free.

"Can I include my defined contribution pension in my will?"

No, you cannot directly control DC pensions through your will because they're held in trust by the pension provider. Instead, you complete a nomination form (sometimes called an 'expression of wish') with your provider to indicate who should receive the funds, though the trustees usually retain final discretion.

Common Misconceptions

Myth: "My will controls who gets my pension when I die"

Reality: Defined contribution pensions are held in trust by your pension provider and do not form part of your estate, so they cannot be distributed through your will. Instead, you must complete a nomination form with your pension provider. While pension trustees typically consider your nomination, they usually retain discretion to pay benefits to whoever they determine is appropriate. This discretion allows the pension to remain outside your estate for tax purposes under current rules, though from April 2027 unused pensions will be subject to Inheritance Tax regardless.

Myth: "Defined contribution pensions are always better because you can pass them on tax-free"

Reality: From 6 April 2027, unused DC pension pots will be included in your estate for Inheritance Tax purposes, meaning they may be subject to 40% IHT if your estate exceeds the nil-rate band of £325,000 (or £500,000 with residence nil-rate band). If you die after age 75, beneficiaries also pay income tax at their marginal rate on inherited pensions. This means beneficiaries could face up to 67% total tax—40% IHT plus income tax on the remaining amount. While DC pensions currently enjoy favourable IHT treatment, this tax advantage ends in 2027.

  • SIPP: A Self-Invested Personal Pension is a type of defined contribution pension that gives you greater control over investment choices, though it follows the same nomination rules.
  • Pension Beneficiary: The person who receives your DC pension when you die, typically someone you've nominated on your expression of wish form.
  • Death Benefits: The payments made from a DC pension when the member dies, which can include lump sums or ongoing pension payments to dependants.
  • Nomination: The process of telling your pension provider who you want to receive your DC pension, though trustees usually retain final discretion.
  • Defined Benefit Pension: The contrasting pension type that guarantees specific income based on salary and service rather than depending on contributions and investment performance.
  • Pension Lump Sum: The tax-free cash you can take from a DC pension at retirement (25% of your pot) or the death benefit lump sum paid to beneficiaries.
  • Drawdown: A way of taking retirement income from a DC pension by keeping the pot invested and withdrawing as needed, with unused amounts passing to beneficiaries on death.

Need Help with Your Will?

Understanding how your defined contribution pension fits into your estate plan is essential for ensuring your family receives the maximum benefit. While your will cannot control your pension, coordinating your will with your pension nominations ensures your entire estate passes according to your wishes.

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Legal Disclaimer:

This article provides general information only and does not constitute legal or financial advice. WUHLD is not a law firm and does not provide legal advice. Laws and guidance change and their application depends on your circumstances. For advice about your situation, consult a qualified solicitor or regulated professional. Unless stated otherwise, information relates to England and Wales.