First, let me say many thanks for the great advice you give in your column. Now, my question is related to optional contributions to a pension fund. I contribute an additional five per cent to my pension fund and I have found myself in a little financial difficulty at this time. Are my optional contributions available to me on request? Many thanks for your reply.

- Douglas

PFA: Pension savings are long-term savings with one purpose: to provide income to the employee at the end of his working life, thereby enabling him to enjoy a reasonable standard of living in retirement.

The size of the pension which replaces pay at retirement depends heavily on the investment performance of the pension funds.

You have not indicated if you are a member of a defined benefit pension plan or of a defined contribution plan, also called a money-purchase pension plan; but that does not matter seriously for this discussion.

The pension payable from a defined benefit plan is determined by a formula based on salary, age and years of employment.

Regular actuarial valuations are done to determine if the fund is able to make future benefit payments.

The employer, or sponsor, funds the deficit, so it is important that the funds are invested wisely to give a good yield.

A surplus may result in pensioners enjoying enhanced benefits.

The pension payable from a defined contribution plan is determined primarily by the investment performance of the pension funds.

There is no guarantee of how much will be paid, so good investment performance is absolutely necessary.

Whereas it is the employer who takes the risk in the case of the defined benefit plan, it is the employee who takes it in the case of the money-purchase plan.

Both employer and employee contribute to the pension fund. In your case, you effectively make two contributions: your basic, or mandatory contribution, and the voluntary, or optional, contribution.

It is reasonable to assume that you did so to improve your chances of getting a very good-quality pension when you retire, because of the relationship between your pension and how much is in the fund for your account.

If your plan is a defined contribution plan, your pension will be determined by the accumulated value of your employer's contributions, your basic contributions, and your voluntary contributions.

Voluntary contributions

If it is a defined benefit plan, you still stand to benefit, although the pension benefit is determined by a formula, as I mentioned above.

In this case, as your voluntary contributions accumulate, they effectively function as a money-purchase plan from which you would effectively get an additional pension.

An actuary would determine what pension the accumulated value of these contributions can purchase.

The accumulated value of your funds is also important because it determines the size of the tax-free lump sum you may be entitled to at retirement, such sum being equivalent to 25 per cent of the cost of the pension benefit.

The cost of the benefit in a defined contribution plan is the accumulated value of the member's contributions, but such benefit in a defined benefit plan is as determined by an actuary.

Of course, taking a lump sum would mean a lower monthly pension.

There is merit in electing to make voluntary contributions to your pension fund because of the favourable tax treatment such contributions receive. The contributions themselves are deducted before tax is applied and earn income free of taxes while in the fund, just like mandatory contributions; but tax is payable on the pension.

tax incentives

You should not lose sight of the fact that the small sums you pay regularly over an extended period - the longer the better - give you a large sum when you need it most.

It is to encourage adequate preparation for that time that Government gives these tax incentives.

You may withdraw your voluntary contributions - and for now, your compulsory contributions as well - when you cease to be a member of the pension scheme.

As long as you are a member, though, you cannot withdraw your voluntary contributions, though you can discontinue making them.

Oran A. Hall is principal author of the 'Handbook of Personal Financial Planning'. For free advice and counsel, email: finviser.jm@gmail.com.