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Types of pension

19 February 2019

6 minute read

Pensions can seem complex and daunting, especially if you’re new to them. But there are lots of options available to suit individual needs and circumstances. We take a look at the main types of pension and explain how they work.

Who's it for? All investors

The value of investments can fall as well as rise and you could get back less than you invest. If you’re not sure about investing, seek independent advice.

What you’ll learn:

  • How much you could receive from your State Pension.
  • What the two different types of company scheme are.
  • Why SIPPs normally appeal to more experienced investors.

It’s been well documented that many Britons aren’t saving enough in their pension for their retirement. But pensions offer generous tax benefits as an incentive. After all, if you’re a basic rate taxpayer, for every £80 you pay in, the taxman will top it up to £100. And if you're a higher or additional rate taxpayer you can claim back up to an additional 20% or 25% through your self-assessment tax return.

There’s a limit though on how much you can squirrel away every year, known as the Annual Allowance. Currently for most people this threshold is set at £40,000 or 100% of earnings – whichever is lower, provided that you haven’t withdrawn a taxable income from any pensions. However, those whose earnings exceed £110,000 and their combined income and pension contributions exceeds £150,000 will see theirs gradually reduced to a minimum of £10,000 which kicks in when these adjusted earnings reach £210,000. In addition, there’s a cap on the total value of all your pensions, called the Lifetime Allowance, which in the 2018-19 tax-year is set at £1.03m, and rising to £1.055m in the 2019-2020 tax year.

Pensions, and the types of products on offer, can seem complex. But there’s a variety of options available to suit individual needs and circumstances. We take a look at the main types of pension and explain how they work.

It’s important to appreciate though that tax and pensions rules can change in future. Their effects on you will depend on your individual circumstances. We don’t offer personal tax advice. If you’re unsure you should seek independent advice.

Find out more about why it’s important to plan

Always remember that the value of any personal, and most company pension schemes, will depend on the performance of the investments held in it and these can fall in value as well as rise. You may get back less than you and your employer invest.

The State Pension

The State Pension is provided by the government and is based on National Insurance (NI) contributions. To receive the maximum amount of £164.35 per week in the current 2018/19 tax year, you’ll need to have 35 years of NI contributions. In the 2019/20 tax year, this maximum amount will rise to £168.60 a week. If you’re thinking of relying on the State Pension alone, then it’s important to realise it’s barely going to cover the basics. You won’t get your State Pension until you reach State Pension age. This is currently 65 for men and women. You can find out how much State Pension you could get, and when, on the Government’s website.

Under current government plans, by October 2020, both men and women’s state pension age will increase to 66, and between 2026 and 2028 it will rise again to 67. These changes are being phased in gradually. For example, those who reach the age of 65 next March will only be able to claim their State Pension once they are 65.5 years old.

The State Pension age will increase further from 67 to 68 between 2037 and 2039, seven years earlier than previously planned.

Company pensions

Company pensions, as you might expect are set up by employers. These are most commonly Defined Contribution (DC) or money purchase plans where the fortunes of the scheme are linked to investment market performance.1 With these schemes there’s no guarantee of the income you’ll receive when you come to retire. The retirement benefits won’t be known until an employee reaches the stage when the benefits are taken.

With company pensions when you pay in, your boss does too. Under legislation introduced in 2012, all companies must offer a workplace pension and automatically enrol eligible workers into it.

How much your employer pays in can vary. The minimum amounts (2018/19) are currently 5% of your ‘qualifying earnings’, with at least 2% paid by your employer. From April 2019, this rises to 8% of your qualifying earnings with at least 3% paid by your employer. Your employer will work out your ‘qualifying earnings’, which are your earnings (before tax and National Insurance are deducted) that fall between a lower and upper earnings limit set by the government.

Very few company schemes are now final salary, or Defined Benefit schemes. Under this type of scheme, the employee’s retirement benefits are set out or ‘defined’ in advance by the pension scheme. This means that the income you’ll receive from your pension is guaranteed depending only on your income during your membership of the scheme.

Personal pensions

A personal pension is another type of money purchase or DC scheme. You, or your financial adviser, choose which pension provider you’d like to administer your pension and where you want your contributions to be invested, from a range of funds offered by the provider. This should cover the full range of investment assets – shares, government bonds, corporate bonds, cash and commercial property. The aim is to grow the fund over the years before you retire. The amount of income your pension will pay you when you retire will chiefly depend on how much you save into it and the performance of your chosen funds over time, after taking account of the charges. Like DC company schemes, the value of your pension fund will depend on the performance of the investments held in it and these can fall in value as well as rise. You may get back less than you and your employer invest.

Stakeholder pensions

Stakeholder pensions are often viewed as the low-cost option in the world of pensions as they’re typically cheaper than other schemes and have very low and flexible minimum contributions. But compared to other plans they typically offer a narrow range of investment options. However, should you require wider choice at some point you can transfer stakeholder pensions to another type of pension plan, or to another stakeholder pension provider – and you won’t be hit with a charge for doing so. Like a personal pension, the success of your stakeholder pension will be down to how much you save and how markets perform.

Self-invested personal pensions (SIPPs)

A self-invested personal pension or SIPP is a type of personal pension but with added bells and whistles. Like all pensions, it’s a tax-efficient savings wrapper but you can invest in a much broader range of investments – including individual shares, in some schemes individual commercial properties and you won’t be restricted to pension funds offered by any single pension provider. SIPPs may appeal more to experienced investors who are happy to monitor and manage their pension themselves and want to take advantage of the wider range of assets available. Some plans offer investment management, with a specialist making investment decisions for you, but there’ll be additional charges for this type of service. If you’re considering investing in a SIPP, you need to be prepared to take a risk as you could lose the money you’ve invested and you could end up with insufficient savings in retirement.

Remember too that the favourable tax treatment associated with all pensions may change in the future and that the value of this tax treatment to you will depend on your individual circumstances, which can also change.

Again always bear in mind that the value of any personal or defined contribution (DC) pension scheme will depend on the performance of the investments held in it and these can fall in value as well as rise. You may get back less than you and your employer invest.

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