A pension is designed to provide you with an income in retirement. Broadly speaking, there are two main types: the State Pension and private pensions. Private pensions can be further subdivided into workplace pensions and personal pensions. Here we explain what each of these entail.
The State Pension
The State Pension guarantees a retirement income for those who reach a certain age, currently 65 for men and most women (although this is rising to 66 by 2020 for both sexes).
If you have made the required National Insurance contributions, you’ll be entitled to the full State Pension. The basic flat-rate state pension is currently £113.10 a week and is automatically paid out when you reach State Pension age.
Under the existing system, contracted-in pension savers who have made extra National Insurance contributions are
also eligible for the Additional State Pension. However, anyone retiring after 5 April 2016 will not be eligible for this.
As from 6 April 2016, the Basic and Additional pensions are being replaced by the new State Pension. This is expected to pay around £155 a week to those who have made the required National Insurance contributions. It’s because of the relatively low income offered by the State that many people have their own private pension. It is also why the government is in the process of rolling out a programme of automatic pension enrolment. This means the vast majority of workers will be enrolled into a private workplace pension by 2018.
Should you defer your state pension to boost your retirement income?
Workplace pensions are arranged by employers to provide their staff with an income when they retire. You might hear them referred to as ‘occupational’, ‘company’ or ‘work-based’ pensions.
A percentage of your gross monthly salary is put into the pension scheme automatically every payday. Your employer may also make a monthly contribution (and will be obliged to under the new auto-enrolment rules), plus you get tax relief from the government.
A new law means that soon every employer must automatically enroll workers into a workplace pension scheme if they work in the UK, earn more than £10,000 a year and are aged between 22 and State Pension age.
Read more about auto enrolment...
Defined contribution and defined benefit schemes
There are two main types of workplace pension – defined benefit and defined contribution schemes. Defined benefit plans are more commonly known as ‘final salary’ or ‘salary-related’ pensions, and promise to give you a certain amount each year when you retire. Exactly how much you get depends on your salary and how long you’ve worked for your employer.
Defined contribution (also known as money-purchase) pensions are investment-based schemes. The size of your pension fund at retirement will, therefore, depend on how much has been invested, how these investments have performed over time and any management charges deducted by the scheme provider.
Read more about the new pension rules...
Personal pensions are another way of saving for your future so you don't have to rely on the State Pension alone. You can pay into one regardless of whether or not you have a workplace pension. You can either make regular contributions or individual lump-sum payments.
All personal pensions are defined contribution pensions (as above), which mean your money is invested. There is usually a choice of investment funds, ranging from low to high risk.
A stakeholder pension is a particular type of personal pension, which is required to meet certain minimum standards set by the government. For example, annual management charges can’t be more than 1.5% of the fund’s value for the first ten years and 1% after that, and you must be able to start and stop payments when you want, or switch providers, without being charged.
Due to the tax-relief available on your pension contributions, there are set limits on how much you can invest in your pensions each year.