Defined contribution plans form the backbone of retirement savings in both the United States and the United Kingdom.
In the US, the most common plan is the 401(k), which allows employees to contribute alongside employer matches and profit-sharing. In the UK, workplace pensions include occupational DC plans, group personal pensions, and master trusts. Both systems give savers tax advantages and investment flexibility, but each country manages participation and distribution differently. This article explores how defined contribution plans work in the US vs UK, highlighting their similarities and differences.
Participation
Employee contributions, whether partial or full, drive the success of defined contribution plans, so broad participation plays a critical role. Both the US and UK have developed strategies to encourage employees to join and stay invested, although the approaches differ.
The United States
US employers widely use auto-enrolment to boost participation in defined contribution plans. They automatically enrol new employees at a default contribution rate, often 3 percent of pay, unless the employee opts out. Many simply accept the default due to inertia, which helps increase savings rates across the workforce.
Some employers use auto-escalation, increasing contributions each year until they reach a set maximum. Although the law does not require auto-enrolment or auto-escalation, employers often adopt them to help pass the 401(k) “ADP test.” This test ensures highly compensated employees do not contribute disproportionately more than other employees, protecting the plan’s tax-advantaged status.
However, mistakes in applying these features can cause compliance issues and tax penalties. This makes some employers hesitant to implement them.
The United Kingdom
The UK has gone further by mandating auto-enrolment for all eligible employees. Employers must enrol staff into a qualifying pension plan that meets minimum standards, including employer contributions. The UK gradually introduced the system, starting with large employers and later extending it to smaller businesses. Employers must re-enrol eligible employees who previously opted out every three years.
Although UK law allows auto-escalation, employers rarely use it. Still, as concerns grow about retirement adequacy, this feature may become more common in the future.
Distribution
The effectiveness of a defined contribution plan as a retirement vehicle is heavily reliant on how employees withdraw their account balances. Early and fast distributions might result in insufficient retirement savings and poor financial decisions.
As an outcome, employers and policymakers in the US have set up mechanisms to support long-term, intentional distribution patterns in defined contribution plans. As a result, in the US, savers have had more control over how they utilise their retirement assets stored in defined contribution plans since 2014.
The United States
401(k) plans in the US usually provide distribution in a lump payment upon cessation of employment. Employees can withdraw the lump sum as taxable cash or transfer it tax-free into an individual retirement account (IRA). You have a flexible income drawdown once transferred to an IRA. Some 401(k) plans also allow for instalment payouts and, in rare cases, purchasing an annuity with the account balance.
Some employers avoid offering payments other than lump sums because instalments and annuity purchases increase costs, administrative work, and fiduciary risk. As a result, the US government has taken certain regulatory steps in an attempt to persuade 401(k) defined contribution plans sponsors to provide these distribution options. One measure aimed to reduce the fiduciary risk employers face when selecting an annuity product to offer through the plan.
Another step was designed to smooth the way for the introduction of a new annuity product known as a qualified longevity annuity. This product is intended to be purchased with a portion of the employee's account balance and provides an annuity benefit only if the employee lives to a specific age. This protects against the possibility that the employee may use up their account balance too quickly.
Although this product has not yet been widely adopted due to concerns about administration and portability, among other things, it may become an appealing way to offer employees the best of both worlds, a controllable account balance and protection in the event they outlive their 401k defined contribution assets.
The United Kingdom
Generally speaking, employees in the UK can access their defined contribution plan funds without penalty at the age of 55 (increasing to 57 by 2028) or sooner if they are unwell. They also have had far greater control over distributions from their pension pot.
Savers may withdraw up to 25% of their savings as tax-free cash, and then with the remaining 75%, they can take an annuity or have a flexible income drawdown.
In the past, employees that took more than 25% of their savings as cash would have to pay a 55% tax penalty on the excess, above 25%. As a result, only a small number of people performed this step.
Furthermore, systematic withdrawal alternatives were only available to those with substantial pension funds. However, substantial modifications to the tax regulations were enacted in April 2015’s Pension Scheme Act, which means that:
- There are no longer any limitations on who can employ systematic withdrawal alternatives, and
- There is a great deal of flexibility in terms of distribution.
As savers reach the age of 55 and begin to make decisions regarding the distribution of their pension funds, the decline in the predominance of annuity distributions needs more support and knowledge. Providers are also considering the possibility of offering default decumulation alternatives for those who do not make a decision for any reason.
To summarise, the US and the UK confront comparable issues regarding the essential role of defined contribution plans in retirement planning. Some similar remedies have been applied by the countries, while the methods have been extremely diverse in other situations. Employers and policymakers in each jurisdiction would benefit from learning about the trials, successes, and challenges that each country has faced in this area.
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In summary, both the US and UK recognise the critical role of defined contribution plans in retirement planning. While each system has introduced different rules for participation and distribution, both continue to evolve to support long-term financial security.
If you are considering transferring your UK defined contribution pension to the US, professional guidance is essential. At Cameron James, our Independent Financial Advisers specialise in cross-border pension planning for expats. We can help you understand your options, compare benefits, and make informed decisions for your future.
Take the first step toward securing your retirement. Book your free consultation today with a Cameron James adviser and get expert support tailored to your DC pension needs.
For US-based readers, we also have a dedicated website at Cameron James USA with resources designed specifically for expats.