Pension Schemes: A Basic Guide

With people living longer, and a growing percentage of the population looking to retire earlier to enjoy the fruits of their labour, it’s important to understand how to fund this increased requirement in income. As the pension remains the most popular method of retirement funding, we take a look at the different types of pension schemes available.

The basic state pension paid by the Government is based on National Insurance Contributions (NICs) and the number of years contributions made. The maximum is currently 30 years and anything less will result in a reduced pension from the 2007/08 maximum of £87.30 per week.

The basic state pension is paid at normal retirement age. There is a phased increase in the age when a person becomes eligible to draw the pension. For example, those born between 06 April 1969 and 05 April 1977 retirement age will be 67, whilst those born from 06 April 1978 will have to wait until age 68.

The Government also operates a second state pension for employed people (S2P), previously known as the State Earnings Related Pension Scheme (SERPS). This is also funded through NICs and is based on earnings, and hence the level of NICs paid over your working life. The amount payable from this pension is in addition to the basic state pension.

If you’re employed and are lucky enough to have an employer that contributes to a pension scheme on your behalf it will either be a final salary (defined benefit) scheme, or now more commonly, a money purchase (defined contribution) scheme.

A defined benefit scheme is based on your final salary at, or close to, retirement together with the number of years you’ve been a member of the scheme. The best scheme is a 60^th scheme, which will pay up to two-thirds of your final salary for 40 years membership in the scheme.

With a defined contribution scheme, it is the level of contribution that is specified, rather than the amount of pension. The fund at retirement depends on the performance of the underlying investment. Employers contributions into this type of scheme are generally less than for a defined benefit scheme.

A defined contribution scheme (personal pension) is also available to the self-employed and to those employees whose employers do not operate a pension scheme. Again, the fund size is based on investment performance.

For those who like more freedom to invest their monies as they choose, for example by selecting their own shares or investing in property then a Self Invested Personal Pension (SIPP) offers this flexibility. As a result minimum investment levels tend to be higher as do the administration charges.

At the opposite end to this the stakeholder pension was established to encourage people to start saving for retirement and so will allow smaller premiums and charges are restricted. However, investment choice may be restricted as a result.