An occupational scheme (often called a company pension scheme or superannuation scheme) is usually the best way to save for retirement, because your employer adds to your savings.
Pension schemes through your work
If the firm you work for has five or more employees, it must offer some kind of pension scheme that you can join. This could be:
- An occupational scheme (company pension scheme or superannuation scheme). This is run by your employer who must pay into the scheme on your behalf. You usually have to pay in too. When you leave the employer, all the contributions stop, but you keep the pension you have built up so far. This will generally be a final salary scheme, career average scheme or money purchase scheme.
- A group personal pension (GPP). This is run by an insurance company or other provider. Usually your employer pays in 3 per cent of your pay on your behalf. You choose how much extra you want to contribute. When you leave your job, your employer’s contributions stop, but the scheme stays with you and you can carry on paying into it. All GPPs are money purchase schemes.
- A stakeholder pension scheme. This is usually run by an insurance company. Your employer does not have to pay in anything on your behalf. You choose how much you want to contribute. When you leave your job, the scheme stays with you and you can carry on paying into it. A stakeholder pension scheme is always a money purchase scheme.
In future, even small employers will have to enrol most of their employees into a workplace pension scheme under new automatic-enrolment rules. These rules took effect between 2012 and 2016, depending on the size of your employer’s workforce, with larger employers coming on board first.
Final salary scheme
In a final salary scheme (the most common type of occupational defined benefit scheme), you are promised a pension at retirement that is based on the pay you were getting shortly before retiring, called your ‘final salary’. For example, you might get one-sixtieth of your final salary for each year you belong to the scheme. So, if you earned £30,000 and had been in the scheme 10 years, your pension would be 1/60 x £30,000 x 10 = £5,000 a year.
If you leave the scheme before retirement (for example, you change job), your final salary will be your pay at the time you left. But the pension you have built up will be increased, usually by at least 2.5 per cent a year, up to the time it starts to be paid.
You are most likely to be in a final salary scheme if you work in the public sector, such as for the National Health Service, a school or local government.
Career average scheme
A career average scheme works in the same way as a final salary scheme, except that the pay used to work out your pension is different. In a career-average scheme, it will be an average of your pay during the whole time you belonged to the scheme. Pay from earlier years is usually adjusted in line with inflation.
Some public sector final salary pension schemes may be replaced with career average schemes.
Money purchase schemes
Many occupational schemes are money purchase schemes (also called defined contribution schemes). And this is the case also for all personal pensions, group personal pensions and any stakeholder pension scheme.
All money purchase schemes work in the same way. The contributions paid in are invested to create a pension fund. At retirement, the fund is used to provide your retirement income, usually by buying an annuity. An annuity is an investment where you give up your pension fund and in return get an income that is usually payable for life.
How much pension a money purchase scheme provides depends on:
- How much has been paid in.
- How well the invested contributions grow.
- How much is taken away in charges. With a stakeholder pension scheme, charges may not exceed 1.5% a year of your pension fund for the first 10 years and 1% a year after that.
- The annuity rate you get at retirement. For example, in spring 2011, a 65-year-old man could get a fixed pension of £648 a year (£54 a month) for each £10,000 of pension fund*.
How much pension will you get?
Each year, you will normally get a statement from each pension scheme you belong to. This will show you how much pension you might get at retirement. The statement you get for a final salary scheme or career average scheme is a bit different from the statement you get for a money purchase scheme.