When you think about retirement planning, there is probably a lot of confusion around the many types of pension schemes that are available. The uncertainty is not helped by the fact that several different terms are used to describe the same or similar pension scheme arrangements.
As an example of this kind of confusion: Defined Contribution schemes are sometimes called personal pensions and Defined Benefit schemes are occasionally referred to as final salary schemes.
What you need to know is that there are two main types of pension schemes: ‘Defined Contribution’ and ‘Defined Benefit’.
What is a personal pension?
A personal pension is a pension that you arrange yourself (or through a financial adviser) and is invested with a pension provider, which could be a financial institution like Standard Life for example.
The value of your personal pension depends on how much you have contributed (paid in) and the performance of the underlying investments (shares, bonds, property etc) held in the fund.
Personal pensions are also known as ‘Defined Contribution’ or ‘money purchase’ pension schemes and include ‘stakeholder pensions’ and Self-invested Personal Pensions (SIPPs).
What is a stakeholder pension?
Stakeholder pensions are a type of Defined Contribution pension scheme. They were introduced by the government to ensure every individual could have access to a pension scheme.
Stakeholder schemes must meet specific government requirements: they must be portable (can be taken with you if you change jobs), have capped fee charges, allow low and flexible contributions (you can stop and re-start payments).
Unlike SIPPs, investment strategy is decided by the pension provider (fund manager).
What is a SIPP?
SIPPs or Self-invested Personal Pensions are also a type of Defined Contribution pension scheme. SIPPs allow the holder much greater control and freedom over how and where their money is invested.
For example, SIPPs are allowed to borrow money to purchase a commercial property or can invest in unquoted, private limited companies.
Like stakeholder pensions, SIPPs are also flexible and portable. If you switch jobs, join a new company or even stop working for a while, you can continue to contribute to the scheme.
What is a workplace pension?
A workplace pension is another way of saving for retirement which is arranged by an employer. The employer automatically deducts a percentage of your salary each month and pays it into a pension scheme.
Usually, the employer will also contribute a further percentage of salary to the pension fund on your behalf as an employee benefit.
Workplace pensions are also known as ‘company’, ‘occupational’, ‘works’ or ‘work-based’ pensions. They can be either Defined Contribution or Defined Benefit pension schemes.
What is a Defined Benefit pension?
A Defined Benefit (DB) pension is a pension scheme based on a combination of your salary and the length of time you have worked for your employer. DB pensions are sometimes referred to a ‘final salary’ schemes.
DB pensions usually offer additional benefits such as continuing to pay your pension to your spouse, civil partner or descendants after you die.
Who is responsible for pension shortfall risk?
Under Defined Contribution schemes, the individual bears the risk of the investment performance. If the value of the shares and bonds etc fall, the pension fund will obviously be worth less. This means the expected retirement income will less than projected.
So, if you want to achieve your target pension on retirement, you will need to top up the fund from your own savings, to make up this shortfall.
Under a Defined Benefit scheme, the employer bears the risk of investment performance. If the scheme under performs, such that the value of the fund cannot meet all the members income and benefit entitlements, then it is the employer’s responsibility to make up the shortfall.
Getting access to your pension fund
With effect from the 6th April 2015, new ‘pension freedom’ rules were introduced which means that anyone aged over 55, with pension savings built up under a Defined Contribution scheme, has been given much more flexibility around how they can access their pension fund savings.
To learn more about what pension freedom means for you please follow the link.
Retirement planning
Planning for retirement is one of the most important financial decisions you will make in your life. To learn more about the advice that is available, free of charge, then please click here.
The Pension Advisory Service provides a lot of very useful information about pensions and you can find out more by clicking here.
