Workplace pensions are set up by employers for their employees, as part of auto-enrolment and/or as part of company benefits. There are two main types of workplace pension:
Defined Contribution
- It is essentially just a type of savings account.
- They allow you to put money in while you are working.
- The size of your “Pension Pot” – the amount of money in your pension when you come to retire – will depend on how much you and your employer put in, and the investment returns on this money. Your employer does not guarantee how much income you will have in your retirement – all the risks are down to you.
- There are lots of different types of defined contribution pension schemes including personal pensions, group personal pensions (GPP) and stakeholder pensions.
- The majority of people will have this type of pension.
Defined Benefit
- These pensions are largely funded by employers, though staff sometimes have to pay into them.
- With one, you get a percentage of your final salary before retirement, or when leaving that firm, as an annual income. They are sometimes called final salary pensions.
- What that percentage is depends on how long you worked for that particular firm. There is normally an ‘accrual rate’ set by your employer as a fraction of your final salary.
- Say the rate is 1/60th, you get 1/60th of your final salary as a retirement income for each year you worked for that firm. So if you worked for 30 years, you’d get 30/60ths, or 1/2 your final salary with that firm. Other schemes may take a career average salary for the length of the scheme.
- This type of pension is in decline. Only 28% of employees had defined benefit pensions in 2012 (source) and it’s likely to fall further. Almost all private companies have closed their final salary pension schemes to new members, and most have closed them to current staff. None of the FTSE100 companies offer final salary pensions to new employees. (source)
- Public sector workers such as Teachers, NHS workers and Local Government Workers are the most likely to have this type of pension.
| Pension | Can you contribute? | Can your employer contribute? | Do you invest the cash? |
|---|---|---|---|
| Standard pension | Yes | Yes | Yes |
| Stakeholder pension | Yes | Yes | Yes |
| Sipp | Yes | Yes | Yes |
| Final salary | Yes | Yes | No |
| State pension | Yes, by paying national insurance | No | No |
IMPORTANT FACTS- Pros and Cons of Pension Schemes
VIDEO– Watch this for an outline of the pros and cons of different pension schemes.
| Pros | Cons | |
| Defined contribution * | Tax efficient Employer pays into them | Can’t access until at least 55 years old No guaranteed incomeAll risks are down to youEmployer doesn’t guarantee how much income there will be for retirement |
| Stakeholder pension* | FlexibleLimit on annual management chargesPayments are lowCan stop & re-start paymentsCertain security standards | Annual management charges |
| Personal Pension* | Pay regular amounts to pension provider- stabilityPension provider invests on your behalfCan make lump sum paymentsEmployer may also make regular monthly paymentsCan choose pension company | Annual management charge from financial organisation- percentage of money investedMoney stays in pension pot regardless of changes |
| Group Personal Pension (GPP)* | Employer pays into themDon’t lose any employer contributions when you leave youremploymentEmployer choose financial provider on your behalfNegotiated by employer for group of people so may get better termsthan an individualCan continue to pay into them if change employers | Lack of choice- employer makes decisions for pension providerLikely to lose some of benefits if you leave your employer. e.g.they are unlikely to make any further contributions to your pension. Also, you may have to pay higher administration costs to the pension provider. |
| Defined benefit | Risk is on the employer | Career average salary schemes are not as generousIn decline-not offered by many employersMany of these schemes are in deficit i.e. they don’t have enough moneyto pay all the benefits that have been earned by their members. due to people living longer and low investment returns |
| Self-invested personal pensions (SIPPS) | DIY pensions- lots of choiceCan run a Sipp cheaply if know what they’re doing | Require lots of work Risk carried by individualIndividual investor has to do legwork |
All of the schemes with a star (*) are types of Defined Contribution schemes