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At a very crude level:

  1. Beneficiaries put money into pension schemes (actually, their employers pay into the schemes on their behalf, but w/e, money goes in).
  2. The pension schemes pay money back to beneficiaries on some agreed schedule.
  3. The rules governing payments are complex and unique to each scheme, but the general principal is that you get a return based on the cash you put in plus/minus gains due to performance of the scheme as a whole during the period you were invested in it.
  4. Of course, the scheme provider will skim some (or a lot) of money in return for their services. This may impact performance.
  5. If the scheme runs out of money before beneficiaries are fully compensated then those beneficiaries get screwed. There are various safeguards that make this less common. I'm not sure if the UK protects investors in these scenarios (there is a Pension Protection Fund, but I think that only protects defined benefit pensions).
  6. Alternatively, some schemes must eventually run out of beneficiaries before they run out of cash. Presumably this must be relatively common, because it is clearly preferable to the situation where scenario where the scheme runs out of cash before beneficiaries.

What happens to the leftover cash in scenario 6?

I'm primarily interested in defined contribution schemes in the UK, but would be happy to hear what happens in other cases.

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    Defined contribution schemes usually track each investor's money separately and it belongs to them, so once the benefactor dies their heirs should receive what's left.
    – littleadv
    Commented Feb 1 at 23:45
  • @littleadv Interesting! That makes perfect sense (and a lot of my description above nonsense). I was under the misapprehension that the money was pooled to a greater degree. If you post that as an answer I'd be happy to upvote and accept. Commented Feb 1 at 23:48
  • 1
    I don't want to post this as an answer because I'm not very familiar with how things work in the UK, so my understanding may be very wrong.
    – littleadv
    Commented Feb 1 at 23:49
  • who gets screwed in point 5? The benefactors (if they can be called that), or the beneficiaries?
    – ilkkachu
    Commented Feb 2 at 18:51

2 Answers 2

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As @littleadv said in comments, defined contribution schemes track individual pots of money separately and it becomes part of their estate when they die, so there's no risk of a surplus or deficit.

Defined benefit schemes are underwritten by the employer or group of employers. If they end up in surplus that money generally goes back to the employer(s) in some way, and if they end up in deficit the employer(s) have to make it up, or go bankrupt themselves. The Pension Protection Fund takes on the liabilities of schemes where this happens, albeit reducing the benefits that individuals were previously entitled to. They're funded by a levy on all defined benefit schemes.

Note - the original version of the question used the term "Benefactor" which is not normally used in relation to either type of scheme. As pointed out by @nobody in comments, you probably meant "Beneficiaries" and I've edited it to say that.

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You're mixing together the paying in and drawing down phases of a defined contribution pension scheme.

While you are working you and your employer contribute to a pension fund for you. That money buys units in one or more investment funds. The fund can go up or down in value with market conditions. There's no reason for one of these funds to run out of money, or to have spare money - it holds the investments of many people, and when a person retires, it only has to pay out the current value of that person's units.

When you retire, you should have a collection of units in one or more funds. You have a choice of:

  1. Buying an annuity - a guaranteed income for life (provided that the insurance company providing the annuity remains solvent)
  2. Arranging your own "draw down" pension, where you sell off a few of your units each month and take the money as your pension income.
  3. Selling the units and taking the money. But 75% of that money is taxable, so taking all of it can leave you with a big tax bill.
  4. Any combination of the above.

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