The different types of pension plan
The state pension, made up of the basic state pension and the state second pension gives you a regular income once you reach 65. It is based on National Insurance contributions and the amount you receive depends on how much you paid in.
Company or occupational pensions
There are two main types of pension scheme:
Final Salary Occupational Pension Schemes which are also known as Defined Benefit Schemes. These are schemes available through your employer into which you may be required to make a personal contribution. The benefits provided are usually based upon:
– The number of years membership of the scheme
– Your earnings, which typically may be averaged over the last three years before retirement, with a proportion of your earnings being paid as a pension for each year of scheme service. It is common for 1/60th or 1/80th to be given. Your employer is responsible for making sure that there is enough money in the scheme to pay for your benefits when you retire.
Money Purchase Schemes which are also known as Defined Contribution Schemes. These are schemes where a fund is built up for each member through the payment of contributions from you and/or your employer. The fund is usually invested in stocks and shares with the aim of increasing the size of the fund up to retirement. The fund is then used to provide benefits in retirement, some of which may be taken as a tax-free lump sum. The balance of the fund must be used to provide an income. There is no guarantee as to the level of benefits provided as this will depend on the size of the fund at that time. The value of investments is not guaranteed and these may go up or down.
Since 2013, employers have had a legal responsibility to help you plan for your retirement. Companies must auto enrol all eligible workers into a pension and pay minimum contributions into the scheme. You can also contribute to increase your fund, or opt out if you want to.
Personal pension plans
Private pension plans provide retirement benefits based on the build up of your pension ‘fund’, accumulated through the investment of your contributions. These pensions are often used in addition to, or as an alternative to, company pension schemes.
The Government launched these schemes in 2001 as the basic state pension is unlikely to provide enough income in retirement. They work in a similar way to personal pensions but must meet a number of minimum standards to make sure they offer value for money, flexibility and security. These pensions are often used as an alternative to personal pensions or company pension schemes.
Self-invested personal pensions (SIPP)
SIPPs work in the same way as personal pension plans, but give more flexibility in what you can invest in. Currently a SIPP can hold investments such as commercial property, land and stocks and shares. You can also have control over the investment strategy yourself, or appoint a fund manager to manage your investments.