Understanding pensions could make all the difference to your hard-earned retirement!
The UK pensions system is a little complex, but basically consists of a State Pension which most people are entitled to, with workplace and private pensions as extra sources of income in retirement for some people.
There are several regulators that oversee the various areas of pensions, investments and advice in the UK, including the Pensions Regulator and the Financial Conduct Authority. These guys set many of the rules about how pension companies are supposed to conduct themselves.
In the UK we have the State Pension. This is a pension that is paid out to eligible UK citizens once they reach pensionable age.
We say eligible citizens because each person much tick a few boxes first, including (usually) at least 10 qualifying years of paying National Insurance contributions, (around 35 qualifying years for full state pension benefits).
Claimants of the State Pension (or New State Pension for those born after the designated dates) will receive an annual allowance, paid proportionally every four weeks.
Providing you are eligible, the state pension will pay you a different amount on retirement depending on your NI contributions and your age.
To find out how much you are likely to receive in retirement, check the government website here.
Despite being eligible for the state pension, most people are aware that the State Pension alone may not be enough to sustain a healthy and comfortable lifestyle in retirement, and therefore pay into personal or occupational pensions.
Personal Pensions are those that are just for one individual member – a private pension just for them. There are many different kinds, but they are almost always Defined Contribution pensions, but we’ll get to that bit later.
Occupational pensions are those pensions connected to a current or previous employer. In most cases, both the employee and the company will have paid into the pension. When the individual leaves the company, the pension usually does not automatically follow them, and will remain behind with preserved benefits.
In recent years, it has become a mandatory requirement to offer employees a pension (although they are not obligated to accept).
In either case, most money that is inside pension schemes in invested in something. This is how the money grows inside the pension fund.
The difference between a defined contribution scheme (DC) and a defined benefit scheme (DB) can be a big one when it comes to retirement.
The benefits of a defined contribution scheme depend on how much is paid into the pension funds, and later, how well those pension funds perform (how much the money has grown or shrunk by due to investments/inflation etc). In short, the amount of money they pay in retirement is not known until much closer to the time, only what is paid in is known for sure.
The benefits of a defined benefit scheme are guaranteed. For instance, in a Final Salary pension scheme, how much it will promise to pay out in retirement depends on how many years the member has worked for the company (pensionable service), how much money they earned in their final year of pensionable service (final salary), and their accrual rate.
Defined Benefits pensions are protected by the Pension Protection Fund up to 90% of their value, so in the event of a pension fund collapsing, members still receive the vast majority of their benefits.
With most defined contribution pensions, this may not be the case, however the FSCS may cover some investments and funds, but limits may apply.
While it is sometimes suitable to transfer from a defined benefits scheme to a defined contribution schemes, these situations are rare. Many pension transfers turn out to be the result of negligent financial advice, and some people go on to make mis-sold final salary pension transfer claims to try to regain their losses.
Putting aside that Defined Benefits pension schemes are generally considered to be the safest pensions, the risk between different defined contribution schemes, especially personal pension, can be different too.
Most pensions will have the money inside invested in some sort of asset(s) – investments such as stocks and shares.
But assets are not risk-free. Factors like investment strategy, the person making the decisions, the investments themselves and the diversity of the investment portfolio, all contribute to how much risk a pension fund is exposed to.
Not all pension situations are suitable for everyone, as different people have different attitudes and tolerances to risk:
It is usually the job of a financial adviser to assess an individual’s attitude to and tolerance for risk, and to advise on suitable pensions and investments. When they get this wrong, such as recommending a SIPP pension full of unsuitably high-risk investments, this may be considered to be negligent financial advice. In some cases, mis-sold pensions like these have the ability to ruin peoples’ retirement funds.
Many people later realise they have been affected by pension mis-selling and go on to make a mis-sold pension claim against their old financial adviser.
Workplace pensions have been quite common for years. Usually, they involve both the employer and the employee both paying into the scheme, although the outcomes of different pension schemes may be very different depending on whether they are defined benefits or defined contribution schemes.
While for years many employers offered a workplace pension scheme, others didn’t, and others may be been selective about who was offered a pension and who wasn’t.
Now, it’s compulsory for employers to enroll any eligible staff into a company pension scheme, which the employer must pay into.
Roll-out of auto-enrolment began back in 2012, by Feb 2018 all companies had to do it.
While companies HAVE to offer a pension to any eligible employees, those employees are not obligated to take them up on the offer, and they may opt-out if they wish.
Some workplace pensions are Defined Benefit pensions schemes, which are generally considered to be valuable, and which you can read about in the above section.