To help you start making sense of the various different types of pension schemes available, we have put together the following guide which covers all the main issues you might be thinking about. You can find out more on this subject by looking on the government's impartial pension information site, www.direct.gov.uk.
Basic State Retirement Pension
Think of this as a 'first pension', as all other pensions are normally referred to as 'second pensions'.
This pension is from the government and is 'mandatory' because employees have to pay into it if their earnings are high enough. This makes a lot of people assume they will be fine when they retire but this isn't necessarily the case.
The Basic State Retirement Pension is dependent upon the amount of National Insurance (NI) contributions paid. These contributions are taken out of pay cheques and paid into the pension automatically.
To qualify for paying National Insurance, earnings must be over £89 per week (as set in April 2002). So, obviously, the more years people work and pay their contributions, the more money they'll get when they retire.
We'd all like an easy life - especially in our old age - so, for more security, most people should take out an extra pension, on top of the basic state pension. Second Pensions can be any one of the following:
- State Earnings-Related Pension Scheme (SERPS)
- Occupational Pension
- Personal Pension
- Stakeholder Pension
And depending on the schemes, people could even choose to pay into more than two pensions at once.
State Earnings-Related Pension Scheme (SERPS)
Thankfully, the name and the details of this scheme run by the Government have recently been changed to the Second State Pension, with the following key points:
- based on NI contributions
- covers employees, not the self-employed
- linked to a higher salary bracket than the Basic State Retirement Pension
- can cover certain carers and people with a long-term illness or disability
- private pensions
Occupational, Personal and Stakeholder Pensions are Second Pensions that all come under the umbrella term of Private Pensions.
Occupational Pensions (also known as 'Superannuation')
These are basically set up by employers for employees and are generally considered to be very good deals but as always, individual details must be checked as they do vary from employer to employer.
Occupational Pensions are divided into two main schemes:
- money purchase schemes
- salary-related schemes (also known as Final Salary or Defined Benefit schemes)
As its name implies, the pension under this scheme is based on how much someone earns, as well as the number of years they've been in the scheme. Contributions are normally paid by the employer, but employees may also have to make contributions of their own.
Money Purchase schemes (also known as Defined Contribution schemes)
Here, both employee and employer make contributions into a pension fund that is then invested on the employee's behalf. The money from this scheme is based upon how much has been invested and the success of the investments. When the employee retires, this money is used to buy an 'annuity' from an insurance company that will then pay the pension.
Changing jobs, changing pensions?
If someone has an Occupational Pension and then changes employers, they can either transfer their pension to a new Occupational or Personal Pension scheme, or leave the money in the existing scheme and start another one with the new employer if they are eligible.
Which option to take simply depends on which offers the employee the better benefits.
Changes out of your control
With the introduction of a new accounting law (FRS 17), combined with falling investment returns and longer life expectancy, many companies are now realising that salary-related schemes are making them lose out.
This means they are putting an end to these schemes and are offering the Money Purchase scheme instead and in most cases, employers are well within their legal rights to do so, as long as they wind down their schemes in accordance with the details of the scheme's trust deed. The trust deed basically sets out the scheme's legal requirements and its details should be looked at closely when considering a pension.
If an employee feels that their employer is not playing by the book, they should:
1. follow their pension scheme's dispute procedure
2. go to the Office for the Pensions Advisory Service (OPAS) for an independent explanation and advice
3. take their complaint to the Pensions Ombudsman who can make a legal ruling.
These are probably the pensions most people know about. They are available from a wide range of financial institutions such as banks, building societies and insurance companies.
With a Personal Pension scheme, people pay a regular amount or a lump sum to the scheme provider who will then invest it. There will be charges for starting up and running the pension, so reading the small print and shopping around is vital.
Introduced in April 2001, these are the new kids on the block. Specifically devised for people who don't have many options available to them, Stakeholder Pensions are low-cost schemes, which could be particularly beneficial to people in the following situations:
- employed, earning around £10,000 a year
- have no actual income but have enough to spare for a low-cost pension
Choosing your Second Pension
Every Second Pension option has its pros and cons. Before you even start looking, you need to have a rough idea of your:
- future needs and responsibilities
- career plans
- how much you can afford to pay into a pension
If need be, you can also get the advice from a professional, but you must be aware of their fees and impartialities. Choosing a Second Pension does take time, and thorough research is the only way to find the pension scheme to best suit your needs.
This information was sourced from the government's impartial pension information site, www.direct.gov.uk.