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The word “pension” is one of the least helpful words in the English language if you want to work out what someone is actually talking about. For example, the word can be used to describe the old age benefits that someone receives from the state, an investment portfolio from which they draw benefits at irregular intervals or as the savings vehicle that they are paying into for their eventual retirement via their company. There are also a host of other meanings, so the purpose of this article is to talk about the various meanings and how they apply to you. This is our beginners’ guide to pensions, and we hope that you find it a useful reference.
What Is A Pension?
As already alluded to, this is definitely not a simple question to answer. In general, a pension is either a retirement income paid for life or the means of building up such an income wrapped up specifically in a tax wrapper that falls into pension legislation. This means that the answer is essentially that a pension is a pension, which may seem rather unhelpful but is actually more profound than it first seems.
This definition helps with a few fairly common approaches:
- “My house is my pension” – nope, because your house isn’t included in the list of pension tax wrappers.
- “My company is my pension” – nope, because your company is not legally defined as a pension tax wrapper. In this case, though, your company can establish a company pension scheme which would count as your pension.
- “My investments are my pension” – nope, you might be saving up for retirement, meeting one part of the definition, but your investments are not a pension unless they are held inside a pension wrapper.
This might be seen as a pedantic view that ignores the methods of saving for retirement that fall outside pension legislation, but it is important to remember that pensions have different tax treatment both in life and on death. Investments which are not pensions do not receive these benefits, hence my comment that they aren’t pensions.
So what do pensions actually look like?
State Pension
The anomaly on this list is the state pension. This is a benefit paid by the UK to its elderly citizens. It does not require accruing a fund or paying a certain threshold of taxes, instead it is awarded for having a complete National Insurance record regardless of the amount of National Insurance actually paid. On this basis, the State Pension is actually fairly close to a Universal Basic Income, though it is not truly universal because it is only paid to people of a certain age and who have either worked in the UK or obtained certain qualifying benefits like Child Benefit.
At the moment, the full state pension is paid from age 66, though it is rising gradually for anyone born after 5 April 1960, expected to be 68 or higher. Due to the phasing, state pension age is fairly personalised, but you can use a number of different calculators to work out when your state pension will be due, including the official one from the Department of Work and Pensions – Check Your State Pension Age.
This is often done as a prelude to finding out your projected benefits using a form BR-19, also available from the DWP. Using this form, you can request a State Pension Forecast, which will inform you how many years you have currently qualified for as either an employed or self-employed worker and any years of qualifying non-working benefits, e.g. Child Benefit.
If you obtain these statements and find there is a gap in your records, you will also have the opportunity to make up the difference using Class 3 National Insurance Contributions. These currently cost £17.45 per week, meaning a year’s missing record costs £907.40.
At present, the full state pension is £221.20 per week. You will receive this with a complete National Insurance record spanning 35 years, and the payment amount is proportionately reduced for records with fewer years. If you have 34 years of record, your amount of state pension will therefore be 34/35 of the full amount, or £214.88 per week. It might not seem like much of a reduction, but it means that paying £907.40 to make up a year of missing record results in an income payment for life of £6.32 per week, or £328.64 a year. By any measurement, this is a bargain and it is something that you should definitely consider if you have missing years in your National Insurance record.
It is a very common misunderstanding that the state pension is not taxable. This stems from the fact that whilst it is taxable, it is always the first bit of income to be taxed in someone’s name, and as the state pension is (currently) below the Personal Allowance (the amount of income you can earn before paying tax), someone in receipt of only the state pension will pay no tax, and by long-standing convention, someone with a higher state pension that pushes them into taxation pays either through self assessment or by PAYE for another source of income. In short, though, the state pension is in fact taxable income, even though most people will never directly pay tax on it.
State pension income is currently protected by a “triple lock”, which means the weekly payable amount will go up each year by the higher of:
- Inflation as measured by the Consumer Price Index.
- Inflation of Average Weekly Earnings.
- 2.5%.
This triple lock makes the UK pension one of the most guaranteed forms of income available in the country, which makes it extremely valuable. It is also very expensive for the government to keep providing this guaranteed benefit, hence the increase in state pension age mentioned above.
Defined Benefit Pensions
Defined Benefit pensions were actually among the first type of pension available. In essence, an employer wanting to offer retirement benefits to its staff would say that once they retired after a full working career they would receive a pension for life paid for from a central fund set up for that specific purpose. This became known as a “final salary” pension because the amount paid would depend largely on an employee’s final salary with the company.
As an example, a company might have set up a scheme where employees would accrue 1/60 of their final salary for each year of service. This would become known as a “60ths scheme”. Typically this would be capped at 40 years of service, meaning the maximum pension would be 40/60 of an employee’s final salary, or two thirds. These schemes were great for the model of employee that existed at the time, i.e. they would start working for one company at the start of their career and work for that company for several decades before retiring, enjoying a few years of retirement, then dying probably less than a decade after starting to take their pension on average. Problems for these schemes started to arise, though, including:
- People began living longer. Someone retiring at 60 after four decades of work might now live for close to another four decades, during which time the company would need to pay them most of an employee’s salary without getting an employee’s productivity from them.
- Employees started changing jobs much more frequently. When final salary schemes were the norm, it was not normal for someone to work for several companies over the course of their lifetimes.
- Unscrupulous employers started raiding the funds put aside for payment of their former employees’ pensions for personal benefit. Most recently, Robert Maxwell did just this despite various safeguards in place that should have stopped him doing so.
These problems all led to changes to the final salary scheme as a whole, including, but not limited to:
- Schemes started to offer less generous accrual rates, e.g. 1/70 instead of 1/60.
- Companies adjusted their pensions so that the accrual was based on Career Average Earnings rather than final salaries. This had the impact of limiting the potential future liabilities of companies to their pension schemes because increasing an employee’s salary would not have an immediate effect on all their previous years of accrual.
- The UK government legislated to allow a different form of company pension scheme based on an investment pot that a member would look after and convert into an income by buying an annuity with their funds.
- Introduction of the Pension Protection Fund, designed to make sure that members of a final salary pension scheme would not lose their benefits if the scheme itself went bust.
As a result of these changes, the term “final salary” was no longer the only descriptor of such schemes, so a more modern term of “defined benefit” was introduced. Defined Benefit schemes include final salary schemes, but also Career Average Earnings and some other lesser known accrual methods.
It is fair to say that Defined Benefit schemes as a whole are becoming rarer, especially in the private sector. This is largely down to the fact that companies these days prefer to only pay for productivity, therefore they do not want to pay retirement incomes for employees that are no longer working for the company.
Deemed Contributions
Everyone in the UK has a maximum allowance they can pay into pension schemes if they want the tax reliefs available to such schemes. At the moment that is typically £60,000 a year with some notable exceptions. This doesn’t mean that you simply take the new pension and test it directly against that allowance, because legislation has been written to account for how valuable scheme accruals are.
In order to work out the deemed accrual level, there is a fairly complex formula, but it is generally simplified to being 16 times the increase in real terms of your entitlement to a scheme pension plus the increase to any separate Pension Commencement Lump Sum (PCLS).
This means that if you accrue an additional £500 per annum of new scheme pension, it will be equivalent to making a contribution to your pension of £8,000, which sits comfortably within the £60,000 Annual Allowance, assuming you have not made significant additional contributions elsewhere.
Pension Commencement Lump Sum and Commutation
Defined Benefit schemes accrue an entitlement to a Pension Commencement Lump Sum (PCLS). This is calculated based on 25% of the overall value of the scheme, but this is complicated by the concept of commutation.
Commutation is the practice of converting some of the scheme income into a lump sum, usually to provide a PCLS. The Commutation Factor is the amount of lump sum generated by surrendering £1 of income. This means that a scheme with a Commutation Factor of 15 would generate a lump sum of £15,000 for giving up £1,000 a year of scheme income.
All income is valued by multiplying the income at outset by 20, but the Commutation Factor used by the trustees can be wildly different to this – I have seen lower that 12 and higher than 25 in my career as an adviser.
This difference means that the whole value of the scheme changes as more or less income is commuted to PCLS except in the very unique case where the Commutation Factor is exactly 20. At that rate, the scheme is worth a fixed amount regardless of how much PCLS is selected, but this is extremely rare.Â
There is a formula for calculating the available PCLS from a Defined Benefit scheme with a given commutation rate, but it is a more advanced subject than this beginners’ guide warrants, so suffice it to say the PCLS is available from Defined Benefit schemes and will be included in statements and retirement illustrations.
Normal Retirement Age, Early Retirement and Late Retirement
All Defined Benefit schemes have a Normal Retirement Age (NRA) that the benefits accrued are expected to be paid from. Typically this is 60 or 65, but it can be any age over the statutory minimum, which is currently 55 but scheduled to rise to 57 from 6 April 2028). These is usually some flexibility in this arrangement, however, with early and late retirements being permissible.Â
In the case of early retirement, typically the scheme trustee will maintain a list of Early Retirement Factors which apply to your pension based on the age that you wish to retire at. For example, if you have accrued a pension of £10,000 and want to retire 2 years early where the Early Retirement Factor is 0.9, the scheme pension would be reduced to £9,000.
A similar story applies for late retirement, though in many cases the calculation basis is slightly different, often resulting in a percentage uplift each year rather than relying on actuarial tables.
The Commutation Factors used to convert scheme income into lump sum can also vary according to age.
Scheme Death Benefits
Most Defined Benefit pension schemes will include a pension for a surviving spouse and might also include a pension for surviving dependants until they attain a certain age. Beyond this, Defined Benefit scheme rights typically die with the member, with the funds that would have been used to provide that member’s pension redistributed among the other surviving scheme members. This is often not considered to be an acceptable result for many Defined Benefit scheme members, especially if they see 7-figure scheme values which have the potential to extinguish completely without giving any benefit to heirs. There are means of sidestepping this particular restriction, including:
- Transferring the Defined Benefit scheme to a Defined Contribution scheme. This locks in the value of the scheme at the point of transfer, converting it into outright ownership that the member can then choose to leave to their heirs. As this represents the loss of a very valuable guarantee, the starting position that the regulator expects to see from advisers is that such transfers as unsuitable, therefore a very strong case needs to be made to justify the transfer.
- Using a proportion of the income from the Defined Benefit scheme to fund an insurance policy for the benefit of heirs. This has the effect of converting a proportion of the pension into an inheritable lump sum. Structured correctly, this amount can sit outside the estate just like a pension, therefore not attracting inheritance tax.
Assuming the scheme is left in situ, any scheme death benefits are treated as pension income earned by the survivor.
Defined Contribution Pensions
While Defined Benefit schemes accrue an entitlement to a specific amount of pension income in retirement, Defined Contribution schemes instead build up an investment balance which you can then use to fund retirement benefits. Immediately you can likely see that this is a significant loss of guarantee, in that investments are inherently variable in price, so the actual value of this scheme is far less dependable. This is absolutely true, and whilst it is possible to outperform the investment portfolio of a Defined Benefit scheme, thereby providing enhanced benefits, it is likewise possible to underperform and be worse off as a result.
Given the choice, most people would probably choose a Defined Benefit scheme rather than a Defined Contribution scheme, but the reality is that it is rarely a choice. As mentioned earlier, most Defined Benefit schemes have closed to new members, meaning Defined Contribution is the only game in town. This might sound like Defined Contribution schemes are poor, but far from it – they are excellent retirement savings vehicles and only seem potentially poor when compared to their almost non-existent cousin.
At the heart of Defined Contribution schemes is the tax relief that is available. The general idea behind this is to allow someone to take some of their salary or self-employed earnings and defer paying tax on it until they take benefits. This can push some earnings from higher rate to basic rate tax, for example, which is quite powerful in and of itself. Coupled with this is the Pension Commencement Lump Sum (PCLS), which allows a proportion – usually 25% – of the eventual fund to be taken without payment of any tax. This is an incredibly powerful benefit to pensions on its own, but coupled with the tax relief on the way in it is incredibly powerful.
For example, here’s a table that shows the impact of making a £10,000 cash contribution into a pension scheme as a higher rate taxpayer that can potentially retire as a basic rate taxpayer:
What this shows is that someone in that position can potentially make £3,125 just from the combination of tax relief, tax deferment and PCLS. This ignores the additional benefit of tax-exempt investing that applies to assets held within the pension and only focuses on what can be achieved by careful consideration of the tax relief rules.
Personal Pensions and SIPPs
Most Defined Contribution schemes established in the last 20 years or so will be one of these types of scheme. In essence, “Personal Pension” is a generic descriptor for a Defined Contribution scheme available for an individual consumer to access. This is slightly complicated by the existence of “Group Personal Pensions” which are workplace schemes, but the nature of these is that the employer gives easy access to a pension and makes contributions into it, but after that it is essentially identical to a normal Personal Pension.
Personal Pensions vary enormously in terms of both cost and investment range. Traditionally these products were only available from insurance companies and would have a limited fund range based on what that insurer wanted to sell, but more and more commonly we are seeing personal pensions with access to a huge range of investments, though sometimes they charge more for this access. We have also seen the rise of platform pensions, which are something of a hybrid between Personal Pensions and Full SIPPs.
A Full Self-Invested Personal Pension (SIPP) is a stand-alone product usually offered by a bespoke pension trustee. The main structure will be to create a SIPP bank account for payment of benefits and collection of contributions and investment income and a legal entity that can own investments on behalf of the member. Typically this might be a stock broking account, a fund platform or cash accounts, but more rarely it can also include commercial property or directly-owned shares.
Full SIPPs tend to charge a fixed fee each year for their trustee services. Typically this fee is hundreds of pounds a year, but this can balloon if certain bespoke services are required, e.g. letting out an owned commercial property and filing VAT returns for the letting business can end up being a very expensive proposition.
Generally it is unlikely that most people need a Full SIPP, as the features are likely available via a Platform SIPP. As a rule, I would suggest not even considering a Full SIPP for pensions worth less than £250,000.
Platform SIPPs are, as already mentioned, something of a hybrid of the personal pension and the Full SIPP. A Platform SIPP grants access to the attached platform’s investment proposition, meaning someone has access to whatever that platform offers in terms of investments. Usually this means Unit Trusts and Open Ended Investment Companies (OEICs) as a minimum, but often it includes Equities, Bonds, Gilts, Exchange Traded Funds (ETFs) and Investment Trusts as well. This opens pension investments up to include almost any strategy you are likely to want to implement.Â
Stakeholder Pensions
Stakeholder pensions are part of a suite of financial products developed in the early 2000s with the intention of simplifying the bewildering landscape that was financial services at the time. This includes stakeholder pensions, stakeholder mortgages, stakeholder Child Trust Funds and several other subtypes. In the case of the stakeholder pension, it was largely modelled on the Personal Pension, but included some additional rules:
- There could be no restriction on transfers in or out and no charge could be levied for these.
- Contributions were kept as accessible as possible, with a minimum of £20 and with complete flexibility as to regularity.
- Charges were capped at 1.5% for the first 10 years of operation and 1% thereafter.
At the time this may have been quite revolutionary, but most modern personal pensions supersede all of these requirements very comfortably. For example, most modern pension schemes already have no restrictions on transferring out (and often offer this service at no cost), allow contributions even below the £20 level because modern technology makes contributions much easier to manage, and charges are often as little as 0.25% per annum for the pension plus whatever investment the client chooses (this could be in something like a UK Equity Index fund with an investment cost of 0.1% for total charges of 0.35%, considerably below the 1.5% charging cap).
Stakeholder pensions do still work, but those that still operate usually have gone much further than the rules for being a stakeholder, meaning they charge a lot less than the cap. In general, though, stakeholder pensions are very limited in terms of both investment choice – typically offering fewer than 15 choices – and retirement options – most stakeholder pensions only offer annuity purchase or Uncrystallised Fund Pension Lump Sum (UFPLS), meaning they generally do not give access to income drawdown if that would be useful.
Small Self-Administered Schemes
Small Self-Administered Schemes (SSASs) are mostly beyond the scope of this beginner article. In very brief summary, a SSAS is an option for companies where the senior staff want a pension scheme where they can co-invest in – usually – their corporate premises. In the majority of cases, a SIPP or a Personal Pension is likely to do the job cheaper than a SSAS, but this pooling of investments is made much simpler by using a SSAS instead of a series of SIPPs.
Investment Options
Pensions are generally permitted to invest in a wide range of investments. There are some restrictions (e.g. no residential property or “tangible movable assets” like paintings), but these limitations still leaves tens of thousands of options just looking at UK funds. In practice, most pensions will have a much more limited range of investments they allow their members to access. For stakeholder pensions and old-style pension contracts, this might only be a handful of funds, because at the time adding funds was more complex to administer and customers were generally assumed to want simplicity rather than choice. At the other end of the spectrum, stand-alone Self-Invested Personal Pensions (SIPPs) generally allow investors to access any investment they could access via a platform or stock broker.
In all cases, as long as the investment is permitted by HMRC rules, no income tax or capital gains tax is due on the returns from cash and investments
Retirement Benefits
Defined Contribution schemes are legally allowed to be much more flexible than their Defined Benefit counterparts, but importantly these features are product specific, meaning they might not all be available in any given pension plan. At the very basic level, retirement benefits from Defined Contribution schemes are as follows:
- An amount to be crystallised (commenced) is designated.
- Up to 25% of the crystallised amount is designated to be a Pension Commencement Lump Sum and paid out as a tax free sum.
- The remainder of the crystallised amount is designated for income and must be earmarked for one of the following:
- An annuity purchase.
- Income drawdown.
- A scheme pension.
Of these, the scheme pension is almost never seen, and is usually only done in response to some very specific tax circumstances, so I will not spend any more time on this.
Annuities are generally bought on the open market these days, meaning you do not have to take an annuity with the same company that manages your pension during its accumulation stage.
Drawdown is conceptually the simplest option for retirement income, in that almost nothing actually needs to change. Instead you have a right to withdraw directly from your crystallised investments whenever convenient. There is no time limit on making the withdrawals, nor is there a limit on the size of the withdrawals – you can fully withdraw your pension on day 1 if you like, though that has the clear disadvantage that you will not be able to make any further withdrawals going forward.
Death Benefits
Death benefits are probably the most complicated area of planning to understand for Defined Contribution schemes, largely because many legacy Defined Contribution pensions will have restrictions more stringent than those outlined by law. As such, it is always worth checking what will happen to your scheme when you die because it might not be what you expect based on the law.
At the heart of the treatment on death is the idea that most of these schemes are a form of trust. This means they are separate legal entities to your estate and are not therefore covered by your will. Instead these schemes are subject to an Expression of Wish document that you complete and send to the pension trustee. If you fail to do so, the trustee will act either as they think you would have instructed them or in accordance with their standard terms and conditions, which may be very restrictive or outdated. For example, one scheme I saw a few years ago still had the default position that death benefits would be paid as a lump sum into the deceased’s estate, which would unnecessarily include them for inheritance tax.
Importantly, even if you do nothing, death benefits are almost certain to be paid. Defined Contribution schemes do not die with their members, in that the money accrued will end up being paid out somewhere, it’s just a question of where.
If you have full freedoms to leave your pension as you see fit, your options are:
- Leave a lump sum payment to someone.
- Leave a pension in payment to someone.
Before going in to any more detail on these options, it is also worth considering tax. A decade or more ago, this was a fairly complicated series of flow charts, but this has been simplified based purely on age of the member at the time of death:
- Under 75, free of tax on receipt.
- 75 or over, subject to income tax in the hands of the recipient.
This applies to the two options that you have for death benefits. This means that if you die before the age of 75 and leave a pension in payment to your grandchild, they will have a drawdown pension that is permanently exempt from income tax on payments made to them. This can be an extraordinary bit of planning, as it is the only investment vehicle that is exempt from income tax, capital gains tax and inheritance tax all in one place.
It is now fairly rare to see lump sums being left from pensions rather than pensions in payment, as the inherited drawdown pension gives flexibility on when and how to pay any tax due. The exception to this is if the pension death benefits are being paid into a family trust, as a trust cannot have a drawdown pension.
Annuities
An annuity is essentially reverse insurance. While with insurance you pay a regular premium to an insurance company and they pay a lump sum to you if a predetermined event happens (e.g. death), with an annuity you instead pay a lump sum to an insurance company and they pay you a regular income for either a predetermined period or for the rest of your life. Conceptually this is the simplest way to generate retirement benefits, as it passes all responsibility for deciding how to invest the funds to the insurance company, and you then just enjoy retirement for as long as you live.Â
Unfortunately insurance companies have not been offering particularly good rates on annuities for over a decade because the gilt markets (where UK government debt – the safest investment for UK denominated investment portfolios and the market which generally drives annuity rates) have been so expensive that the rates on annuities have been particularly poor for a long time. This trend has changed a little in recent years as the gilt markets have somewhat normalised following the Global Financial Crisis and the subsequent European Sovereign Debt Crisis so that annuities now seem like something of a decent option again.
That said, annuities should always be considered as an option when it comes to generating a retirement income because of the shifting of investment risk away from the individual onto an insurance company. Couple this with the fact that annuities are 100% protected by the Financial Services Compensation Scheme (FSCS) and you have a very reliable means of providing an income, albeit not one that is always appealing because of the rates on offer.
Annuities come with a number of optional features which impact the rate offered by a provider. I have tried to cover off some of these below.
Survivor’s Pensions
Without this option, an annuity dies with the recipient. If you want to bolt on a pension for a surviving spouse, that can be done. Typically this varies from 50% to 100% of the original income, and the higher this percentage the more the rate will be reduced to facilitate it. The rate will also be increased more for a significantly younger spouse than an older one because the insurance company will expect a younger spouse to live longer and therefore receive more income payments.
Indexation
Most annuities by default provide a level income, meaning the income you get in year 1 is the same as the income you get in year 20. Indexation is the jargon way of saying “inflation linked”. Typically this means that the income can be linked to the Consumer Price Index, meaning the purchasing power of the income stays the same, at least with reference to the standard basket of goods and services that make up the Consumer Price Index.Â
Unfortunately indexation is very expensive, and it is not uncommon to see annuity rates half just by adding indexation.
Guarantee Period
One of the major worries with annuities is that they might not be good value if the annuitant dies, in that they will have paid a large lump sum in exchange for only a couple of payments if they die very early. Whilst this can be addressed in part using a Survivor’s Pension (see above), an alternative is to include a Guarantee Period. This means that the income is guaranteed to be paid for a certain period even if the policyholder dies. Typically this is either 5 years or 10 years, and it is usually relatively inexpensive compared to other annuity options.
Capital Guarantee
Another way of addressing the risk of losing money with an annuity is the Capital Guarantee. This is a very rare feature of annuities, but it essentially offers a known death benefit for the annuity, meaning there can still be some remaining value to pay to survivors or heirs.Â
Most insurance companies do not include Capital Guarantees as an option for their annuities, but there are a few niche providers who offer this.
Guaranteed Annuity Rates
Some old pension plans include Guaranteed Annuity Rates (GARs) as a legacy benefit. These generally came about when insurance companies were certain that they would be able to offer high rates on annuities indefinitely, and did not account for the collapse in gilt yields that happened even before the Global Financial Crisis. As a result, these guarantees are often much higher than the rates currently available on the open market, and any plan which includes GARs should be analysed very carefully before doing anything to jeopardise this guarantee.
If there is a GAR attached to one of your old pensions, your provider will be able to tell you, and they should certainly inform you if you ever request a transfer pack to start the process of moving your pension to a new provider. A good financial adviser will always check your policies for GARs or other guarantees before recommending a transfer.
No modern pension schemes include a GAR – this is a legacy feature that likely requires a scheme to have commenced in the 1990s or earlier.
Pension Taxation
Pension Investments
As long as they are permitted investments, pension holdings are generally not assessed for income tax or capital gains tax. If the pension is carrying on a trade, then it might be subject to corporation tax, but this is something I have never actually encountered because most trustees are very careful to make sure that this sort of situation cannot arise.
Pension Income
In general, pension income is taxable. The exception is an inherited drawdown pension for someone that died before age 75, which is tax free.
Pension Commencement Lump Sum
Pension Commencement Lump Sums are paid free of tax.
Death Benefits
Most death benefits are treated as taxable income in the hands of the recipient. The exception is death benefits where the deceased individual was under age 75.Â
Automatic Enrolment Pensions
For many years it has been mandatory for companies to offer pension schemes for their staff, but until recently the bare minimum requirement was simply to make a stakeholder pension available to those who wanted access to a scheme. This did not have to be accompanied by any form of contribution matching or salary sacrifice options, and employees would have to make the decision to join the company pension scheme regardless of the options available. This meant that the take-up of company pension schemes was fairly low, so the government brought in the requirement for Automatic Enrolment.
Automatic Enrolment changed the playing field for company pensions, requiring most companies to automatically sign their staff up for the company pension scheme unless they actively choose to opt out of this enrolment. In addition, companies are required to make contributions of at least 3% of the employee’s qualifying salary, with a further 5% from the employee for a total of 8%. There are slightly different rates which apply for employers that look at an employee’s basic earnings or total earnings instead of their qualifying earnings, but it is always close to 5% from the employee and 3% from the employer.
Automatic Enrolment schemes are generally Group Personal Pensions, and therefore share the same characteristics as any other Personal Pension (see above). There is a quirk where the maximum total charge for the default investment option cannot exceed 0.75%, but this is not a particularly challenging maximum default for pensions with access to low-cost passive investments.
These schemes can set up their eventual retirement income in exactly the same way as standard Defined Contribution schemes.
It is technically possible that a company would offer a Defined Benefit scheme as the standard pension scheme, in which case they would not need to have a Group Personal Pension set up on this basis – in essence the requirement for offering a pension scheme would already have been met. In practice, almost no companies in the private sector currently offer Defined Benefit schemes, so this is usually seen in the public sector, for example the NHS pension or the Teachers’ Pension Scheme.
TL;DR
There are a staggering array of pension schemes out there, but they generally fall into three categories:
- State pensions
- Defined Benefit schemes, which accrue an entitlement to a certain amount of income each year for life.
- Defined Contribution schemes, which build up an investment pot that you can use for retirement.
Pensions are generally a very tax efficient way to save for retirement and should be very high on everyone’s agenda when it comes to looking after their finances.
Help With My Pensions!
If you would like to find out more about how a financial adviser can help you streamline your retirement plans, feel free to get in touch to arrange a free consultation.
