What types of pensions are available to save for retirements?
Here are details of some of the different types of pensions you may have already invested in or that are available for investing in to save for your retirement.
Defined Benefit pension schemes
A Defined Benefit (DB) pension scheme is one where the amount paid to you is set using a formula based on how many years you’ve worked for your employer and the salary you’ve earned, rather than the value of your investments.
If you work or have worked for a large employer or in the public sector, you may have a DB pension.
DB pensions pay out a secure income for life which increases each year. They also usually pay a pension to your spouse or registered civil partner and/or your dependants when you die.
The pension income they pay is based on:
- The number of years you’ve been a member of the scheme – known as ‘pensionable service’
- Your pensionable earnings – this could be your salary at retirement (known as ‘final salary’), or your salary averaged out over a career (known as ‘career average’), or some other formula
- The proportion of these earnings that you receive as a pension for each year of membership (known as ‘accrual rate’ and typically set at either 1/60th or 1/80th of your pensionable earnings for each year of pensionable service)
These schemes are run by trustees who look after the interests of the scheme’s members. Your employer contributes to the scheme and is responsible for ensuring there is enough money at the time you retire to pay your pension income.
Check your latest pension statement to get an idea of how much your pension income may be. Statements vary from one scheme to another, but they usually show your pension based on your current salary, how long you’ve been in the scheme and what your pension might be if you stay in the scheme until the scheme’s normal retirement age.
If you’ve left a DB scheme, you’ll still receive a statement every year showing how much your pension is worth. In most cases, this pension will increase by a set amount each year up until retirement age.
When you take your pension, you can usually choose to take up to 25 per cent of the value of your pension as a tax-free lump sum. With most schemes, your pension income is reduced if you take this tax-free cash – the more you take, the lower your income. But some schemes, particularly public sector pension schemes, pay a tax-free lump sum automatically and in addition to your pension income.
It is important that you understand whether the pension shown on your statement is the amount you’ll get before or after taking a tax-free lump sum. Also, don’t forget that your actual pension income will be taxable.
Most DB schemes have a normal retirement age of 65. This is usually the age at which your employer stops paying contributions to your pension and when your pension starts to be paid.
If your scheme allows, you may be able to take your pension earlier (from the age of 55), but this can reduce the amount you get quite considerably. It’s possible to take your pension without retiring.
Depending on your scheme, you may be able to defer taking your pension, and this might mean you get a higher income when you do take it.
Once you pension starts to be paid, it will increase each year by a set amount – your scheme rules will tell you by how much.
It will continue to be paid for life. When you die, a pension may continue to be paid to your spouse, registered civil partner and/or dependants. This is usually a fixed percentage (for example, 50 per cent) of your pension income at the date of your death.
You may be able to take your whole pension as a cash lump sum. If you do this, up to 25 per cent of the sum will be tax-free, and the rest will be subject to income tax. You can usually do this from age 55, sometimes earlier if you’re seriously ill.
A workplace pension is a way of saving for your retirement that’s arranged by your employer. Workplace pensions can be called ‘occupational’, ‘works’, ‘company’ or ‘work-based’ pensions.
As a result of automatic enrolment, millions of people now have a workplace pension. Workers are often automatically enrolled into a workplace pension by their employer. Saving into a workplace pension is easy – you don’t have to do anything. Once you’re enrolled by your employer, not only will you pay into the scheme, but so will your company, and you may also get tax relief from the government.
Pensions can take many forms, and you may have previously been invited to join a defined contribution or personal pension by your employer.
Your employer will need to enrol you into a workplace pension scheme if you:
- Are not already in one, or they’ve not enrolled you into one
- Are aged between 22 and State Pension age
- Earn more than £10,000 a year
- Usually work in the UK
You can opt out if you want to, but that means losing out on employer and government contributions – and if you stay in, you’ll have your own pension that you receive when you retire.
The minimum contributions for the workplace pension are 2% for employers and 3% for employees. It is, of course, possible for both you and your employer to pay more than the minimum contributions.
Tax-efficient savings for retirement
If you haven’t got a workplace pension, getting a personal pension could be a good way of saving for retirement.
A personal pension is a type of defined contribution pension. You choose the provider and make arrangements for your contributions to be paid.
Your pension provider will claim tax relief at the basic rate and add it to your pension pot. If you’re a higher rate taxpayer, you’ll need to claim the additional rebate through your tax return. You also choose where you want your contributions to be invested from a range of funds offered by your provider.
Your pension pot builds up in line with the contributions you make, investment returns and tax relief. The fund is usually invested in stocks and shares, along with other investments, with the aim of growing the fund over the years before you retire.
When you retire, the size of your pension pot when you retire will depend on:
- How much you pay into your pension pot
- How long you save for
- How much, if anything, your employer pays in
- How well your investments have performed
- What charges have been taken out of your pot by your pension provider
Your retirement options
You now have more choice and flexibility than ever before over how and when you can take money from your pension pot.
From the age of 55, you have the freedom to use your pension money. You can take the first 25% tax-free and the rest will count as part of your annual income, taxed at your marginal rate.
You have various options when it comes to taking money from your pension pot. You can choose one or a combination of these options.
- Use your pension pot to buy a guaranteed income for life
An annuity is a retirement product that turns your pension pot into an income that’s paid to you for the rest of your life.
- Take your whole pension pot as a taxable cash lump sum
It’s possible to take all of your pension savings as a cash lump sum, but there can be serious tax implications if you do this.
- Leave your money invested and make withdrawals when you need to
If you don’t need all of your pension pot right now, you can leave it invested and take money out when it suits you.
Self-Invested Personal Pensions
A tax-free wrapper in which you can hold a wide range of permitted investments
Self-Invested Personal Pensions (also known as ‘SIPPs’) are being used by a rising number of private investors keen to take control of their retirement planning.
First introduced in 1989, SIPPs have evolved into the favoured investment vehicle for individuals seeking more control and flexibility in their retirement planning.
SIPPs are a form of pension available to all investors who choose to invest into a private pension. They have one distinctive element: they allow the investor to self-invest, or to take control of the pension. This is why they are sometimes referred to as ‘self-controlled’ pensions.
SIPPs are essentially a type of tax-free wrapper in which you hold a wide range of permitted investments, and the contribution limits, tax reliefs, eligibility and age at which you can start drawing an income are all exactly the same as for other pensions.
It is important to bear in mind that the favourable tax treatment associated with SIPPs may change in the future, and the value of this tax treatment depends on your individual circumstances, which can also change.
The only major difference between a standard personal pension and a SIPP is the self-investment element – and this creates a series of advantages for pension investors to benefit from.
Investing in a SIPP is a tax-efficient way to save for your retirement. Not only are your investment gains free from income or capital gains tax, but you are also currently eligible for a generous tax relief of up to 45%.
Who can have a SIPP?
Just like any other kind of pension, SIPPs are designed to help you save for retirement and take an income when you reach it.
Any individual who is resident in the UK under the age of 75 may make contributions to a SIPP, and in certain circumstances non-UK residents who have had UK earnings in previous years may also be eligible.
Even if you’ve already retired, you can still open a SIPP and take advantage of the extra flexibility that it gives you over your pension savings in retirement – but you may be limited by how much you can pay into it.
You can be a member of as many pension schemes as you wish, and contributions to a SIPP can be paid directly by yourself, your employer or by transfer from your previous pension plans.
New State Pension
The State Pension changed on 6 April 2016. If you reach State Pension age you will now get the new State Pension.
It is designed to be simpler to understand than the old system, but there are some complicated changeover arrangements which you need to know about if you’ve already made contributions under the old system.
Already receiving a State Pension
If you were already reviewing a State Pension you continue to receive this under the old rules.
Women born before 6 April 1953 and men born before 6 April 1951 will also have their State Pension paid under the old system, even if they have deferred their State Pension.
State Pension under the old system
Women born on or after 6 April 1953 and men born on or after 6 April 1951 receive the new State Pension. Any funds paid into the old system have been converted into an amount under the new.
Changes to State Pensions
The earnings-related part of the old system which applied to employed people, called the ‘Additional State Pension’, is now abolished.
The new State Pension is based on your National Insurance (NI) record alone.
‘Starting amount’ under the new State Pension
The new State Pension is calculated from your NI record as at 6 April 2016 and converted into a ‘starting amount’. Under the old system, if you were employed (rather than self-employed), you paid Class 1 National Insurance which entitled you to the Basic State Pension and an Additional State Pension. The Additional State Pension was based on your earnings as well as the National Insurance contributions you had made or been credited with.
Substantial entitlement to Additional State Pension
If you had built up substantial entitlement to Additional State Pension, you will be receiving the full new State Pension amount, and you’ll also keep any amount above this as a ‘protected payment’ which will increase with inflation.
If your starting amount is lower than the full new State Pension, this might be because you were ‘contracted out’ of the Additional State Pension. You can continue to build up your State Pension to the maximum until you reach State Pension age. You can do this even if you already have 35 years of NI contributions or credits.
Less than 35 years of NI?
- To receive the full amount, you’ll need to have 35 years’ worth of NI contributions or credits (known as ‘qualifying years’) during your working life (these don’t have to be consecutive years)
- If you have less than 35 years of NI contributions or credits, you’ll receive an amount based on the number of years you have paid or been credited with NI
- If you have less than 10 years, you won’t normally qualify for any State Pension
- The 10-year minimum qualifying period does not apply to certain women who paid married women and widow’s reduced-rate National Insurance contributions
- If you have gained qualifying years in the European Economic Area or Switzerland (or certain bilateral countries which have a social security agreement with the UK), these can be used towards achieving the minimum qualifying period. However, the actual UK State Pension award will normally be based on just the UK qualifying years
Deferring the new State Pension
You can still defer taking your State Pension. For each year you defer, you receive just under a 5.8 per cent increase in your State Pension. You cannot take the deferred amount as a lump sum.
The new State Pension is normally based on your own NI contributions alone, but you may be able to have your State Pension worked out using different rules that could give you a higher rate if you chose to pay married women and widow’s reduced-rate NI contributions (sometimes called ‘the married woman’s stamp’).
Not enough NI record to qualify for State Pension?
If you have not yet reached State Pension Age but are worried that you might not have enough NI record to qualify for State Pension (or to receive the maximum amount), you can make Class 3 National Insurance contributions. These contributions are voluntary and allow people to fill gaps in their record to improve their basic State Pension entitlement.