Under new automatic-enrolment rules being phased in between 2012 and 2018, all employers will have to enrol most employees into a pension scheme through work and pay into it for you. The biggest employers have signed up first, but by 2017 even the smallest firms will be covered (with new employers of any size coming into the system by 2018).
Until then, very small employers do not have to offer any workplace scheme but, 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:
- A company scheme (also called an occupational 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% 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 a final salary 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 inflation up to a cap of at least 2.5% a year, up to the time it starts to be paid.
You are most likely to be in a final salary scheme if, for some time, you have worked in the public sector, such as for the National Health Service, a school or local government and you are within 10 years of retiring.
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.
Most public sector final salary pension schemes are being replaced with career average schemes except for employees within 10 years of retiring. For more information, see our article on the public sector pension reforms.
Many occupational schemes are money purchase schemes (also called defined contribution or DC 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 your own pension pot. At retirement, the pot may be 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. These can vary a lot from, say, 0.5% to 1.5% a year and can have a big impact on your eventual pension.
- How much of the pot is drawn out as a cash lump sum. Under current rules, the maximum lump sum is a quarter of the pot but, under new rules due to come in from April 2015, you will have the freedom to take any amount you choose – even the whole pot – in one or more lump sums.
- The annuity rate you get at retirement. For example, in spring 2014, a 65-year-old man could get a fixed pension of £3,028 a year (£252 a month) for a £50,000 pension pot*.
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.
Other guides which might interest you
- Auto-enrolment and NEST explained
- National Employment Savings Trust (NEST)
- Understanding your employer's pension statement
* Money Advice Service comparison tables. Highest rate available on 27 March 2014.