The most obvious consideration is whether a pension is a final salary or a defined contribution (also sometimes called Money Purchase). A pension will always be one or the other
Final salary pensions – defined benefit
These pensions sometimes referred to as defined benefit schemes or Career Average Revalued Earnings (CARE) schemes. They tend to be workplace pensions funded by both employers’ staff contributions, albeit this type of scheme is being widely written down and rarely offered to new employees these days as it guarantees a level of income regardless of how the fund manager who manages the funds invested performs.
The payout consists of a percentage of your final salary before retirement or when leaving that firm, as an annual income. That is the ‘defined benefit’ that the pension scheme produces. What that percentage is depends on how long you worked for that firm.
Also known as final salary schemes, defined benefit pension schemes are being phased out in favour of defined contribution pensions. This is because they cost more to administer and they create the burden of providing a payment guarantee to current and past staff. They work by promising to pay out a certain amount when you retire, based on your salary – unlike Defined Contribution schemes, which are based on your contributions. How the investments perform won't affect what you get.
People who work in the public sector – such as for the NHS, armed forces or police – tend to be enrolled in final salary schemes. This has led to criticism of public sector pension schemes as being more generous than private sector schemes and has been cause for reform.
Money purchase pensions – defined contribution
Money purchase pensions, also known as defined contribution schemes, save into your pension pot under a 'money purchase arrangement'.
After years of saving, this cash can then be withdrawn from the age of 55 or can often be swapped for an annuity - an income for life – which in effect is a replacement for the type of annual income that a defined contribution scheme produces. Most personal pensions are saved for with this method.
The amount they produce for you to draw on as your pension can as a result of how the money is invested across different time horizons (most fund managers allow you to transfer funds between their different products), how long you/your employer have invested and/or the level of charges.
Defined Contribution – further considerations
If you're 55 or over and have a ‘defined contribution’ (also known as money purchase) pension plan, you can:
- Leave your pension pot invested
- Buy a guaranteed income for life
- Take a flexible income from your pension pot
- Take a cash lump sum from your pension pot
You could consider combining one or more of the options above. You can take cash and/or income at different times to suit your needs.
You should shop around to find the best product to suit your circumstances. It's always worth checking what's available in the wider market as you may get a better deal than the one offered by your existing pension provider. You can take your pension with you and transfer it to another provider particularly if you move job
Transferring to another provider
Different products offer different options so you may need to transfer your pension pot to another pension provider to access some or all of these options. Speak to an adviser before taking any drastic action though and before any transfers go ahead – your pension is one of the most important pension wealth products that you will ever own...perhaps even more than a mortgage/house buy is. Everyone seems to know the ins and outs of investing in and buying property these days but few seem to get a firm understand of the rules and the assumptions involved in pension funding and projecting future outcomes from pension schemes
Trust-based pensions - A board of trustees manage investments on your behalf. You and possibly your employer pay into the pot, and it's invested. These are usual arrangements that take place within an employer workplace pension be it defined benefit or defined contribution.
The trust fund is kept at an arm’s length principle, separate from the company and its management has representation of different employees who have invested in the scheme, obviously a different body to the management of the company. The employee participants are decided on periodically by a vote of existing pension scheme members
Those involved in the running of the Pension are known as Trustees and they have a certain level of statutory obligations as a result of taking such a position and will have further responsibilities based on the schemes rules and governance documents
The ultimate benefits from being invested in the scheme can be handed to your partner or other dependant members.
Arranged through your employer, you will be automatically enrolled in a workplace pension if you’re over 22, work in the UK and earn more than £10,000 a year.
Both you and your employer pay in, with your contributions coming out of your salary. These arrangements changes slightly on the 6 April and if you are not aware of these changes by now please do read our article on this subject
Pensions don't just come through work. You can also set up your own personal pension and invest through that too.
You can do this in addition to - or instead of - a work pension. There are different types of personal pension ranging from a cheap and basic stakeholder pension, which limits where you can invest, to what is known as a self invested personal pension, or Sipp, where you can access many different types of investment.
These are also defined contribution pensions - building up the pot is your responsibility.
Personal pensions, stakeholder pensions and self invested personal pensions (SIPPs) all count as individual pensions. How regularly you pay in is usually up to you, and what you get back largely depends on how well your investments perform.
The value of your pension can go down as well as up. Others such as your partner or employer can contribute to your individual pension.
There are many different options for an individual pension, from many different providers.
But remember you will need to keep monitoring the performance yourself and make any changes.
There are several factors that will determine your financial choices at retirement, such as your age, health and spending plans. It may be best, in particular if you are self employed to consult an independent financial adviser as they can walk you through any financial or tax implications. Although this might seem like an unnecessary cost, investing in decent advice could save you a huge amount long-term.
To get a State Pension, you must first reach State Pension age, usually with at least 10 qualifying years on your National Insurance record. Your State Pension is based on your National Insurance record when you reach State Pension age which is currently 65/66 for men and women but is likely to rise in the future as life expectancies are widely rising.
While the State Pension probably won’t be enough to support you on its own, it can be a useful addition to your retirement income. It’s currently set at circa £155 per week for a full state pension
Many employers contribute into pension schemes on behalf of employees. Check with your employer to see if they currently offer this.
From the minimum retirement age, currently 55, you can normally start taking money from your defined contribution pension. It’s up to you – you can take it all at once, only take some and leave the rest invested, or leave it where it is for when you retire.
Personal pensions for the self-employed - when should I start a pension?
If you do decide to take control of your own pension, make sure to keep track of any charges which can eat into your returns.
When it comes to saving for retirement, time is your friend.
- The earlier you start investing the more you are likely to get when it comes to retirement. Even starting with just a small amount at first can make a difference.
- See our article where Royal London Insurance provide some worked examples which are eye catching when considering different pension contributions and starting points. One reason for the discrepancies’ is because your pot will have benefited from compounding, where your returns build up on returns that you have already received.
- The other great advantage is that with time on your side, you have more breathing space to regain lost ground if your investments fall in value which is likely to happen throughout your retirement saving lifetime.
Since 2012, all employers have had to offer a pension scheme to staff. The reason for this is that, currently, not all employers provide workplace pension schemes, and many employees also don't bother to join their company's scheme.
All workers who earn above £10,000 a year will be automatically enrolled into a pension. Companies without a scheme of their own can enrol workers into the National Employment Savings Trust (Nest).
Pension and changing jobs?
If you have left a job, you can transfer your pot to the scheme at your new workplace. However, this can be complicated. If you are transferring out of a defined benefit scheme into a defined contribution scheme, for example, you should consider the fact that you are giving up a promised payment at retirement.
Transferring defined contribution schemes is much easier – you can just take the funds with you. Watch out for any exit fees imposed and the annual management charges on the new scheme, which could decrease your pot.
And transfers of pension pots held with occupational schemes (those set up by employers) will be blocked unless the scheme it is being transferred to is regulated by the Financial Conduct Authority, has an active employment link with the individual, or is an authorised ‘master trust’ (a pension scheme used by several companies).