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Company Pensions Guide

Introduction

If all we had to live on in retirement were the basic state pension, even one topped up by various means-tested schemes on offer, the vast majority would find it hard to make ends meet.

Thankfully for many us planning for our retirement, the good news is that up to 12 million people in the UK are eligible for an additional company pension from our employers. Five million current pensioners receive a retirement income from a company scheme.

The bad news is that many of the more generous company pension schemes are being closed, or amended so they will pay out less.

What types of schemes are there?

There are two main types of company scheme:

• “Final salary” or “defined benefits” pensions
• “Money purchase” or “defined contributions” pensions

Final salary

These schemes are also described as “defined benefits”, because what staff may receive is agreed at the outset.

Employees pay a fixed amount of their salary into the pension scheme every month.

At retirement, the pension they receive is based on their final salary and linked to their years of service with the company.

Final salary schemes are good for:

• Staff, in that their contributions are fixed, while the employer guarantees any shortfall in their pensions

• Employees who may spend most or all their careers with one employer. Promotion should mean their salary rises faster than inflation, boosting their pensions at retirement

• Employers – if stock markets are rising. They can take “contribution holidays” and, in some cases, even raid their pension funds (subject to trustees’ approval) if the fund is in surplus

They are bad for:

• Those who change jobs often: they are unable to accumulate enough years of service and have to start all over again with each employer

• Employers – if stock markets are falling. They have to fund the guaranteed pension out of their turnover, which means bills can rise exponentially. If pensioners live longer, as they are, companies have to pay them pensions for longer too. Also new accounting rules mean under-funding becomes more evident

Risks of final salary schemes

Final salary schemes rely on a combination of future stock market returns and ongoing company contributions to meet their guarantees to those coming up to retirement.

If a company goes bust, existing pensioners are protected but those still in work may receive less than their assumed entitlement. The government has set up an industry-wide insurance-type levy – the Pensions Protection Fund – that will protect the pensions of those whose companies go bust.

Money purchase

These are also known as “defined contributions”, because the employer knows in advance how much it will pay into the fund.

Both employer and employee pay an agreed amount into a fund each month.

The money is invested in stocks and shares, as well as bonds and other assets. At retirement, the employee’s pot of money is used to buy an “annuity”, an annual income for life.

Money purchase schemes are good for:

• Companies, who can predict how much they must pay per employee every year, rather than relying on the vagaries of the stock market

• Staff who switch jobs regularly: they build up much more transparent retirement funds and sometimes have a greater choice over how their money is invested

They are bad for:

• Staff whose employers don’t make generous contributions into their pension pots. Surveys show that most companies don’t

• Bad for staff if stock markets fall

More pages

Page 1: Introduction
Page 2: Risks of money purchase scheme

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