It's Time to Retire

Workplace pensions fall into two categories: defined benefit schemes and defined contribution schemes.

  • Defined contribution pension – a type of pension that requires you to save a certain percentage of your monthly salary towards your retirement.

  • Your company can also pay into your pension

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:

  1. 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

  2. stakeholder pensions - these are similar to a personal pension