Workplace pensions are pension schemes you enrol in through your company/ place of employment. They are also known as occupational pension schemes.
Workplace pensions fall into two categories: defined benefit schemes and defined contribution schemes.
Defined Benefit Schemes
Defined benefit – is also known as a final salary scheme. This type of scheme is where your company promises you to give you a certain amount of money when you retire, based on things such as:
1. the total amount you earned when you worked for them, hence the name final salary;
2. the number of years you worked for them, how old you are when you retire;
The money your company promises you goes up as your salary goes up; if you’re getting promotions and working your way up through the company, receiving pay rises along the way.
Defined benefit pension schemes used to be the main type of pensions in the past, especially if you worked in the civil service or public sector. They were quite popular, and you can understand why, because they guaranteed you a certain amount of income when you retired. But these schemes have been phased out/not open to new people, because of this reason: they are incredibly expensive for companies!
Scenario: Imagine you promise to give someone a certain amount of money every month. It means you have to live up to that promise no matter what situation you’re going through, even if you lose your job or your salary, you become sick and can’t work, or whatever.
This is essentially the same thing as final salary, because the company has to pay you an agreed amount, which means they have to go look for the money no matter what. So even if the company stops doing well, or the investments they invest you pension in lose money/don’t perform well, they are still responsible.
Defined Contribution Schemes
The second type of workplace pension is called a defined contribution scheme, and is also known as a money purchase scheme. This is because you contribute/pay a certain amount of money from your monthly salary into a ‘pension pot’, which you save towards retirement. You can decide how much of your monthly salary you save (e.g. 3%, 4%, 5%, or more).
Your employer may also pay into this pot, which may be based on how much you personally contribute i.e. they may decide to match the amount you pay in, or if you work for a generous employer, contribute more.
This ‘pension pot’ provides you with a sum of money in retirement. The pot of money is taken and invested for you with the aim of building and growing that pot as much as possible, hopefully meaning more money in retirement. The money is invested in the stock market, for example. The income you then receive from this pot once you retire depends on:
how well these investments have performed;
how many years you’ve saved for; and
how much you’ve save each month during your career, amongst a few other things.
So you can see why defined contribution schemes are now more commonplace and have replaced defined benefit schemes: they do not guarantee you a certain amount of money for retirement like defined benefit schemes, which makes it cheaper for your employer.
Aside from workplace pensions, defined contributions schemes are also available through two other types of pensions:
personal pension – this is where you take out a private pension e.g. if you are self-employed/ sole-trader (a bit like going to a private doctor rather than the NHS). It is also available to those in employment and unemployed
stakeholder pensions - these are similar to a personal pension
In 2012, the government made it compulsory for you to save for retirement through a workplace pension – known as auto-enrolment. Your company has to provide one by April 2017.
You will be auto-enrolled if you meet certain criteria, that criteria being:
you’re not already in your company’s pension scheme;
you are over the age of 22;
you earn more than £10,000 per year; and
you work in the UK.
A certain percentage of your salary (which you decide) is saved each month. The money is taken directly from your salary before you receive it, and paid into the ‘pension pot’, which is then invested for you, along with the contributions of your other colleagues.
If you do not want to be auto-enrolled, you have to say so; you have to opt-out. Otherwise it will happen automatically by the date your company is required to provide you with a pension. This is because the government wants to encourage you to save for retirement. We are living longer, and life is also becoming increasingly expensive. So the more you save towards your retirement, the better you should be able to live when you retire, and not rely as much on government (welfare)… at least in theory.
If you are older (and fortunate) enough, then your workplace pension might be a defined benefit pension, which we discussed last time. These schemes are expensive for your company (or the state if you’re a civil servant) as they promise to pay you a certain percentage of your final salary regardless of economic conditions, so they were phased them out some years ago.
Investment of your pension
This pot of money is given to a professional company to invest for you. They are called investment managers or money managers. You have access to information on who they are, and usually also what they have invested your money into. Depending on the type of occupational pension scheme (which we will cover in the next article) your company provides, you can actually instruct the money managers on the investment products to choose for your pension!
Questions to ask yourself:
Does your employer have a workplace pension?
Do you meet the criteria for auto-enrolment?
How much are your monthly contributions? (This will be a percentage of your monthly salary, and can be determined by you)
Will your company also contribute to your pension? If so, how much will they contribute? If you are auto-enrolled, they have to contribute up to a minimum level.
How will the money you contribute be invested.
If you would like more information, go to www.gov.uk or the website for the Department of Work and Pensions, which is www.dwp.gov.uk. You can also visit other sources like www.citizensadvice.org.uk