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What are the Different Types of Pensions?

Leaf Financial Advisers Ltd. - Bristol Pension Adviser

What are the three main types of pensions?

There are three main types of pension in the UK:

  • The State Pension (paid by the Government from State Retirement Age),
  • Occupational Pensions (your pension through work), and
  • Private/Personal Pensions (a pension set up and run independently for your benefit).

 

It is possible and quite common to have more than one type of pension over a lifetime and also possible to transfer most pensions between providers or into different types of pension.

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What is the UK State Pension?

The current UK state pension was introduced on 6 April 2016.  You are able to claim if you’re:

  • A man born on or after 6 April 1951.
  • A woman born on or after 6 April 1953.

The full rate will be £179.60 per week (in 2020/21) but the amount you get will depend on a few factors.  You could get less if you don’t have enough qualifying years on your National Insurance (NI) record (currently you need between 10 and 35 years of NI contributions) .  It’s also possible you will get a higher amount if you have over a certain amount of Additional State Pension or if you defer taking your State Pension.

You will be eligible to receive your state pension when you reach State Retirement Age.  It is currently 66, but is due to increase to 67 by 2028 and will likely continue to change over the coming years.

You can still your UK State Pension receive it if you have other income like a personal or workplace pension and it is not currently means tested (although there are top ups for those with lower incomes).

Occupational Pensions

Work pensions come in two main types. Final salary (or defined benefit) pensions are dying out, unfortunately. Most of us have ‘money purchase’ (defined contribution) pensions these days.  Some people opt to combine their previous work pensions into one or move their money into a private one.

The workplace pension landscape has been significantly changed in recent years by the phased introduction of Auto Enrolment, a government scheme to make workplace pensions available to more workers.  This has resulted in many more employers offering (Defined Contribution) workplace pensions, often through the government backed NEST pension provider.  However, it should not be assumed that a pension built up via auto enrolment will be sufficient for retirement or the best way of saving for your retirement.

What is the difference between a Defined Benefit and Defined Contribution Scheme?

The main difference between a Defined Benefit scheme and a Defined Contribution scheme is that the former guarantees a specific income and the latter depends on factors such as the amount you pay into the pension pot, the pension pots investment performance and how you access you pension (i.e. no guarantee on what you will actually receive as a pension income).

What is a Defined Contribution Scheme?

With a Defined Contribution workplace pension, both you and your employer will pay money (usually a percentage of your salary) into a pension pot.  The money in the pot is then invested by the pension provider on your behalf and should grow over time, both as more money is paid in and from investment returns.

Apart from a few specific cases (e.g. terminal illness) you cannot access the money in your pension pot until you reach the agreed retirement age.  This age is set by the employer but is usually at the same age as private pensions are allowed to be accessed – 10 years below State Retirement Age.

There are a large number of Defined Contribution Occupational pension schemes all with their own rules, but broadly speaking they are quite flexible in how much you can pay in and when you can withdraw and you will usually have an input into how the funds are invested.  It is also possible to transfer and consolidate defined contribution pensions schemes from old employers.

The main difference to note between Defined Contribution and Defined Benefit is that with a Defined Contribution scheme it is you who is taking the risk on what your pension pot will grow to (and so how much you will have for retirement).

What is a Defined Benefit Scheme?

Once the standard for workplace pensions, the Defined Benefit format has been in decline for many years.  With a defined benefit scheme there is no investment risk for the employee, all the risk is taken by the employer.  This is because the pension payments are guaranteed by the employer. 

The pension that a employee will receive after they retire is based on their salary and years of employment which is then converted by a pre-agreed method to wok out the pension payments after retirement.  For example it may be your last years salary, multiplied by years of service, divided by 60.   The salary level that the pension was based on was originally mostly the final year or 2 of employment, but more remaining schemes have now moved to an average over the employed years.

More details can be found in our dedicated final salary pension article.

What is Auto-Enrolment?

Auto Enrolment began in the UK in 2012 and is a legal requirement for all UK employers to set up a workplace pension for all eligible employees and to pay in a minimum contribution into their workplace pension pot.  The scheme was set up to increase the numbers of UK workers with a pension as there was a long running concern that workers were not setting enough aside for their increasingly long retirements.  

One of the main features of this scheme is that employees are enrolled by default and must actively op-out if they do not wish to take part – this was to encourage overall participation (and it has been effective).  Other features are limits on how high charges can be, minimum contribution levels for employers and employees and a government backed pension provider (NEST) to offer employers a simple and cost effective method of providing a pension scheme for their employees.

You will be auto enrolled if you:

  • work in the UK;
  • are at least 22 years old, but under State Pension Age
  • not already in a suitable workplace pension scheme;
  • earn more than £10,000 a year (for 2021/22).

More details can be found in our dedicated article explaining Auto enrolment and NEST.

Private Pensions

A Private or Personal pension is one that you set up independently of your employer, but work in similar ways.  You can set up regular contributions (e.g. monthly) or make one-off payments into your fund, and your pension provider will add income tax relief back on.  You may take out a private pension because you want to contribute more than your employer will allow or you would like to benefit from the more flexibility, lower costs and investment choices than you can get with your work pension.

The most common types of Private Pensions in the UK are SIPPS, Stakeholder and SSAS pensions.

What is a SIPP?

SIPPS (Self Invested Personal Pensions) have been around for over 30 years and while they were originally only available for the wealth they are now very mainstream, easily accessible and low cost.  

A SIPP is basically a do-it-yourself pension.  You can pay into a SIPP as and when you like, and those under 75 qualify for top-up income tax relief.  Automatic tax relief of at least 20% is applied to money paid in and more can be claimed if you are a 40% taxpayer.  Your investments within the SIPP can then grow free from Income and Capital Gains taxes.

A SIPP is one of the most popular types of private pension arrangements because they give a lot more flexibility and control over how you manage your pension pot including over the administration, death benefits and income available from your pension.  There is also more freedom in terms of investment choices compared to other pension plans (although you may choose to leave the investment decisions to your appointed Financial Adviser).

Other Pensions

Stakeholder pensions

A type of defined contribution pension that are flexible and have low minimum savings thresholds and the ability to change how much and how frequently you pay in. Fees and charges are capped by legislation as are minimum contributions and they offer a ‘default’ fund designed to suit as many people as possible.

 

SSAS

A SSAS is a  ‘small self administered scheme’ and is a type of defined contribution pension that an employer can set up and self-manage for less than 12 members. Usually a SSAS pension scheme is set up by the directors and senior staff of a business to gain more control over how their pensions are invested to help provide increased retirement benefits and greater investment flexibility

Pension Next Steps

Pensions are an important part of retirement planning and setting them up correctly can help boost your retirement income significantly.  They are not the only way of saving for retirement but are certainly a key part of the puzzle, not least because there exist very favourable tax breaks, if used correctly.  

However, please bear in mind that pensions are extremely complicated and the above article is just an overview of the most common types of pension arrangements.  Not only are there numerous types of pensions but as rules have changed over the years, and as new pensions introduced and withdrawn, most find themselves with a patchwork of different pensions with different rules. 

When setting up a pension it’s important to think of your wider finances and your retirement plans to ensure that you make the right choices.  There are also decisions to be made around investing (unless you have a defined benefit pension) as it it the investment within the pension wrapper that will drive the overall growth of the pension pot and will determine how much you can receive in retirement.

Please review our main Pension page to see how we may be able to help you with Pension Advice.

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