Posted on: 28th September 2016 in PensionsThere are two main types of workplace pension:
|DEFINED BENEFIT SCHEME(also known as FINAL SALARY)
|DEFINED CONTRIBUTION SCHEME(also known as MONEY PURCHASE)
|Employer takes the risk The employer is responsible for providing the guaranteed pension sum (your “Pension Pot”) and also for making the investment choices. Guaranteed Sum You’ll know for certain what you’re getting in advance, and a monthly sum will be paid for the rest of your life. Protected Most employees with Defined Benefit schemes are protected by the UK Pension Protection Fund: “the PPF was set up in April 2005 to protect you if your employer goes bust and its pension scheme can no longer afford to pay your promised pension.” (PPF) Five categories of compensation apply. 100% compensation will be paid if you were already retired when your scheme went bust. 90% compensation will be paid if you retired early, or had yet to retire when your scheme went bust. Deferral, caps and annual price rises apply variously. The PPF has this year changed its insolvency modelling from Dun and Bradstreet to Experian.
|Cheaper to run for employers Contribution-based schemes are cheaper for employers to run. Defined benefit schemes involve high administration costs in assessing individual pay-outs. A further drain on cost for pension chiefs of benefit schemes is that people are generally living longer, which makes it more expensive to pay employees for a lifetime. Employee chooses investments Some choice is available to employees of where their pension is invested. A good thing or a bad thing? Depends on how you look at it.
|ANNUAL PRICE INCREASE?
DB schemes enjoy a compulsory increase each year.How much your DB pension goes up each year depends on what money was put down by you when:§ For money laid down after 6 April 1997, there is an annual increase of 5%, or of CPI — whichever is lower.
As with Defined Benefit schemes, DC schemes enjoy a mandatory hike in value each year.How much your DC pension goes up each year depends on what money was put down by you when.It is important to note that:”There is no legal requirement for increases to be paid on:
|WHO DECIDES WHERE THE MONEY IS INVESTED?
|The employer (or rather the pension professionals advising the employer). All contributions are invested as part of a collective pool.
|With some schemes, the employee is given some choice as to where to invest the money. Often there is a default fund which employees can opt for if they are not adventurous.
|ENTITLEMENT SUM PAID HOW?
|The employee can take 25% tax-free of total entitlement as a lump sum. A fixed sum is then paid for life every month.
|As with DB schemes, the employee can take 25% tax-free of total entitlement as a lump sum. With a DS scheme, you can take 100% of the pot in one go,or a proportion, in which case a decision then needs to be made about the rest of your pension pot: A common choice is to buy an annuity which converts into a lifelong fixed income. Buying an annuity was compulsory until 6 April 2015. Or you can opt for income drawdown. With this option, the asset base of your pension pot (i.e. the stocks and shares investments) is left on the stock market and you draw down an on-going income from it.
|CALCULATION OF YOUR ENTITLEMENT
|The calculation of your pension pot sum usually depends on three factors:
|The calculation of your pension pot sum usually depends on five factors:
|Can be taken aged 55+.
|Can be taken aged 55+.
|WHAT TYPES OF SCHEME EXIST?
|Defined Benefit schemes are divided by how they use your salary to calculate your entitlement: “Final Salary” vs. “Career-Average Revalued Earnings.” (CARE).
|Defined Contribution schemes are divided by who looks after the money: “Trust-based” vs. “Contract-based”:
|WHO MAKES THE CONTRIBUTIONS?
|An agreed percentage is taken out of your salary before you are paid. Your employer makes a contribution, and the Government gives you tax relief on your contribution.
|An agreed percentage is taken out of your salary before you are paid. You can adjust this percentage as you go. Your employer makes a contribution, and the Government gives you tax relief on your contribution.
|In March 2016 the Pensions and Lifetimes Savings Association launched the DB Taskforce with a mandate to review the challenges currently facing DB pension schemes and report to the Government.
|No such taskforce is envisaged for DC pensions. But the rule change of April 2015 that widened the way employees can access their Pension Pot continues to be influencing the market.
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