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Planning Retirement Online

Retirement Pensions - What to Expect.

Occupational Pensions

Part 3 - Occupational Pensions


There are two types of occupational retirement pensions:

Defined benefit (final salary schemes)

Defined contribution (money purchase schemes).

This page also covers 'Buying an Annuity'

Retirement Pensions - What to Expect. Links

Defined Benefit

 

Defined benefit schemes are those in which the pension is typically calculated on the final salary of the employee and the number of years they have been in the pension scheme. Very simply, the final salary is, in most cases, divided by 60 or 80 and then multiplied by the number of years’ contributions into the scheme and this figure is the pension that is paid. The final salary is calculated differently in different schemes and, in these recessionary times, some schemes are now changing to a career average scheme.

Once the retirement pension has been calculated, the employee is then allowed to take up to 25% of their pension pot (usually the pension multiplied by 20) as a tax free lump sum. Some pension schemes have a minimum lump sum of three times the pension and some have no minimum. The employee is allowed to take any lump sum between zero or the minimum, to the maximum.

Most organisations have a ‘pension age’ at which employees may take their pension (the minimum age allowed by law is 55). If you wish to take it before the normal pension age, there will be a reduction in the annual amount paid. The vast majority of defined benefit schemes will increase every year with inflation, usually up to a given limit.

You may also make extra payments into your pension by paying Additional Voluntary Contributions (AVCs) and any payment into a retirement pension attracts tax relief, so it can be a very efficient way of saving money. For more information on AVCs, go to:

Simply Finance - Additional Voluntary Contributions Explained


That is a very brief and broad overview of how final salary schemes work. For a bit more information on them, visit Sharing Pensions - Pensions in Retirement. However, to find out how yours works in detail you should speak to your pensions administrator, who will be able to provide you with all the details for your own particular scheme.

Since 5th April 2015, when ‘Pension Freedom’ started (see below in the Defined Contribution section) people in most private sector defined benefit schemes are now allowed to change their pension fund to a defined contribution arrangement when they wish to access it. This means that they will be able to access their fund in different ways. They can still buy an annuity, they can take it as 'Drawdown' but with the old restrictions removed or they can access it as and when they wish to, as if it were a bank account. However, there are serious implications in doing this, not least from the tax point of view, and, for this reason, people will be required to take proper financial advice before being allowed to do this.

Defined Contribution

Defined contribution schemes are schemes into which the employee and the employer pay money each month. The money is invested on the employee’s behalf and the pension that is payable depends how much the accumulated savings are worth when the employee wishes to take their pension. Remember that all money paid into a pension scheme brings tax relief with it. Also, as with final salary schemes, you are allowed to take up to 25% of the pension pot as a tax-free lump sum. In this case, the pension pot is simply the value of the fund at the time you wish to take the pension.

Until April 2015, most people with defined contribution schemes bought an annuity with their pension fund, which provided a guaranteed income for the rest of their lives. It used to be the case that you had to purchase an annuity by the age of 75. This is not the case now but, nevertheless, some people will still want to buy an annuity so that they know that they will have a guaranteed income until they die. However, many people will want to take advantage of 'Pension Freedom' and change their defined contribution scheme to a personal pension arrangement. This means that they will then be able to access their pension in different ways. However, as we explained above, they will need to take proper financial advice before being allowed to do this.

Pension Freedom

Since the beginning of April 2015, when ‘Pension Freedom’ started, people now have much more flexibility with how they access their defined contribution (and personal) pension. People with these type of pensions (as well as many people in private sector defined benefit schemes – see above) will be able to access them in any way they choose. Some people will still choose to purchase an annuity, so that they have a guaranteed income until they die. However, many others will choose to take lump sums out of their pension fund as and when they need or want to. Some may even take the entire fund as soon as they are able to.

There are many implications in doing this. It means that the fund may not last throughout someone’s lifetime and there will also be tax implications, depending on how much is taken in any financial year. Therefore, there are many more choices and complications for people. For this reason, everyone will be offered the Guidance Guarantee before they access their pension fund. This will involve talking through the options with an financial expert. It will not be detailed individual financial advice but will give people the opportunity to understand their choices. For more information about the Guidance Guarantee, go to Pension Wise.

Buying an Annuity


Even after April 2015, some people will buy an annuity at some stage and, when you do, there are some things to remember:

  1. You do not have to buy your annuity from the same organisation that you have saved with. There is something called the ‘Open Market Option’, that allows you to ‘shop around’ to get the best deal.

  2. There are many different kinds of annuity and you have to choose which you think will be best for you. You can buy a level annuity, which is just for you and that will provide you with the same pension income for the rest of your life. You can buy an annuity that will increase every year with inflation, one that will continue for your partner should you die, one that will pay out for a guaranteed period of time even if you die within it and so on. You need to research annuities carefully and make sure that you get the very best deal for your own circumstances.

For more information on annuities, go to This Is Money - Annuities Explaned. It is also a good idea to have a look at the FCA website whenever you are considering financial matters.

This Guide is written by Retirement Specialist Dave Sinclair supported by members of the LaterLife team. As well as writing on retirement matters Dave is Training Director at LaterLife and responsible for the content and continuous improvement of LaterLife's Retirement Courses.
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