Company Pensions
Employer's pension schemes, superannuation, occupational schemes, defined benefit schemes, company pensions. All these names refer to the same thing. Many of the UK 's working population are members of a company pension scheme, and it often represents the most important benefit an employer offers.
The reason is simple. A good company scheme can offer the best retirement benefits available, at the lowest cost to the employee. Though it should be pointed out that, a poor scheme offers little more than the employee would have received from the state.
Eligibility
Eligibility to join a company scheme varies form company to company. Either some allow their employees to join straight away or very soon after joining the company, whilst others put in place conditions before an employee can join, such as a minimum 2 years service, or upon reaching a certain age. These conditions are usually applied by companies who are susceptible to high turnover of staff, such as firms with many young employees.
There are two main types
There are two main types of company scheme:
- Final Salary
- Money Purchase
They differ greatly in what they offer and how they work. At present final salary, schemes are the most common in terms of number of members, but many large firms are now switching over to the money purchase type because they are cheaper for the employer to fund.
Final Salary Schemes
With a final salary scheme, the pension you receive at retirement is directly related to your final salary before retirement. This is a benefit because it means you will have a very good idea of what your pension income will be before you actually retire.
A final salary scheme can pay up to two thirds of your final salary when you retire, up to a maximum of £105,600. It can also provide a tax-free lump sum at retirement, again up to a maximum of one and a half times your final salary. Taking the lump sum will normally reduce your pension.
Benefits included
Many final salary schemes have a host of additional benefits such as death in service benefits of up to four times annual salary. Widows & dependent children's pensions, known as death in retirement benefits & often long-term disability benefits all in addition to the salary related pension already mentioned.
Many companies increase the actual pension payments by approximately 3-5% per annum. This very valuable benefit would be costly with a money purchase type scheme.
Money Purchase Schemes
How they Work
Unlike final salary, money purchase schemes do not give any guarantees about level of income. In other words, they do not provide a pension that is linked to your final earnings before retirement. Contributions made by you & your employer (if it's contributory) are invested and allowed to grow. The resultant fund is 'allocated' to you & upon reaching retirement age; you use the money that has built up in your pension to purchase an annuity within Inland Revenue limits. It's the annuity, which then provides you with income in your retirement. Therefore, it follows that the value of the pension at retirement, is dependent upon:
- How much money has been paid in over the life of the plan,
- How well the money has grown
- What annuity rates your pension fund purchases when you retire?
In other words a money purchase pension is just a long term savings plan (albeit a very tax efficient one) that has designed to produce a lump sum at retirement. This then purchases an annuity, which in turn provides the retirement income. It follows that unlike a final salary scheme, you are unable to predict with any accuracy, what pension you will receive before your retirement date.
The benefits
The benefits that come with money purchase company pensions tend to be not as good as the ones associated with final salary schemes. Widows & dependent children's pensions, death & disability benefits are all quite rare in money purchase schemes. However, some employers offer them as options you can pay towards.
