Types of Pension
Defined Benefit and Defined Contribution
There is a wide range and different types of pension, these can be separated into those referred to as Defined Benefit schemes and the others refererred to as Defined Contribution Schemes.
Defined Benefit Pensions Schemes
The amount paid to you in retirement is set using a formula based on by how many years you've worked for your employer and the salary you've earned rather than the value of your investments or the level of contributions made.
If you work or have worked for a large employer or in the public sector (Local Government, NHS, Police, Fire Service, Education etc) you may have a defined benefit pension.
Defined benefit pensions pay out a secure income for life which increases each year. They also usually pay a pension to your spouse or 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 salary averaged over a career ('career average'), or some other formula
- The proportion of those earnings you receive as a pension for each year of membership - this is called the accrual rate and some commonly used rates are 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.
Defined Contribution Pensions Schemes
You build up a pot of money that you can then use to provide an income in retirement. Unlike defined benefit schemes, which promise a specific income, the income you might get from a defined contribution scheme depends upon factors including the amount you pay in, the fund's investment performance and the choices you make at retirement.
Most private employers will offer some form of defined contribution pension. Other pension schemes which are also subject to the level of contributions made, the fund performance and the age at which you retire include: Personal Pensions, Group Personal Pensions, Stakeholder Pensions, Self Invested Personal Plans, NEST Pensions, Multi Employer Pensions.
The fund (your money) is usually invested in stocks and shares, along with other investments, with the aim of growing it over the years before you retire. You can usually choose from a range of funds to invest in. Remember though that the value of investments can go up or down.
The pension or income you receive in retirement from any form for defined contribution pension will be subject to how much you invested, how the funds have performed and that age at which you retire, so unlike a defined benefit pension scheme all of these factors are variable and therefore are not guaranteed.
* Tax Information given is based on the 2020/21 tax year, and may be subject to change in the future. Any contributions in excess of you annual allowances will be taxed at your marginal rate.
THE VALUE OF A PENSION IS NOT GUARANTEED AND CAN GO UP AND DOWN DEPENDING ON INVESTMENT PERFORMANCE. YOU COULD GET BACK LESS THAN YOU'VE PAID IN.
