Types of Pensions

Types of Pensions

What exactly is a pension?

A pension is a plan or long term investment that's primary aim is to build a financial fund, in a tax efficient way, for your retirement. When you finally retire your pension will provide you with an annual income when your monthly salary stops.

Pensions come in a number of shapes and sizes. There are three main types of pensions - state pensions, workplace pensions and personal or private pensions. If you are in employment then all three of these types of pensions are available to you.

State pensions

Easily forgotten because of the minimal amount you will receive, a statement pension is a small pension from the Government when you hit the state retirement age. State pension age is currently set between the ages of 61 - 65 years old for women and 65 years old for men. At the moment the basic state pension pays out £110.15 per week. You will have to pay national insurance contributions throughout your working life to qualify for this pension.

Workplace pensions

Unfortunately the stark reality of the situation is that a state pension will not be able to cover all the retirement income you will need. For this reason the majority of people will take out a pension with their employer. There are a number of tax advantages to this as well as simply investing for your retirement. The way a workplace pension will work will be in your employer will take a percentage of your salary each month, top it up and pay it into a pension scheme.

There are two types of workplace pensions - Defined benefit and Defined contribution:

Defined contribution and money purchase schemes - This is scheme made up of your own contributions, those from your employer and any tax relief offered from the government. A defined contribution scheme will provide you with an lump sum (accumulated during employment) which you can then use to buy an annuity to secure a pension income. The majority of company pension schemes are defined contribution.

Defined benefit and final salary pensions - Normally this type of pension is largely funded by employers, however staff can on occassion pay into them themselves. The way they work is that you get a percentage of your final salary before retirement or when you leave the company, as an annual income. The percentage of what you will receive depends on the length of time that you worked for that particular company.

Personal or private pensions

These type of pensions, on the most part, work by you paying money into a pension scheme and then receiving a sum of money at the end which you can use to buy an annuity. They all differ in the way your money is invested and/or the level of charges. These type of pension comes in three main categories:

Standard pensions - These are where your employer coupled with yourself contribute regularly (monthly). The money is invested by the pension company until you retire.

Stakeholder pensions - Very similar to a standard pension but differ in that they have have low and flexible minimum contributions, capped charges and a default investment choice. This means you do not have to decide where you put your money.

Self invested personal pensions - Otherwise known as SIPPS are great DIY pensions. They work in the same way but will allow you personally to choose your investments. If you are reasonably savvy and prepared to do a bit of research and legwork you can run a SIPP on the cheap yourself.