“So what do I do with my money?”
There are two main types of occupational workplace pension schemes:
Defined contribution pension schemes
A defined contribution (DC) or money purchase pension scheme is one that invests the money you pay into it, together with any employer’s contribution and gives you an accumulated sum on retirement, with which you can secure a pension income, either by buying an annuity or using income drawdown.
Occupational pension schemes are increasingly a DC, rather than defined benefit (DB), where the pension you receive is linked to salary and the number of years worked. As an alternative to a company pension scheme, some employers offer their workforce access to a Group Personal Pension (GPP) or stakeholder pension scheme.
External pension provider
In either case, this is run by an external pension provider (typically an insurance firm) and joined by members on an individual basis. It’s just like taking out a personal pension, although your employer may negotiate reduced management fees. They may also make a contribution on your behalf. GPPs are run on a DC basis, with each member building up an individual pension ‘pot’.
The amount you receive depends on the performance of the funds in which the money has been invested and what charges have been deducted.
Degree of choice
Although your total pension pot usually increases each year you continue to pay into the scheme, there’s no way of accurately predicting what the final total will be and how much pension income this will provide. Unlike those who belong to a DB pension scheme, members of DC pension schemes have a degree of choice as to where their pension contributions are invested.
Many opt to put their money in the scheme’s ‘default fund’, but some will want to be more cautious, investing in cash funds and corporate bonds, while others may prefer a more ‘adventurous’ mix, with equity and overseas growth funds. GPPs also offer investment choice, often between funds run by the pension provider.
During your retirement
Defined contribution pension schemes allow you to build up a personal fund, which is then used to provide a pension income during your retirement. The usual way of doing this is to buy a lifetime annuity. The alternative is to leave your pension pot invested and draw a regular income from it each year.
Lifetime annuities are essentially a form of insurance, which removes individual risk by paying out a set amount each year for the rest of your life. How much you get depends on your age, your health and the prevailing annuity rates at the time you come to convert your fund.
Open market option
A workplace fund will usually negotiate a rate on your behalf, but you’re not obliged to take this and can opt instead, to shop around, comparing rates from other providers, by exercising the open market option. For those with poor health, it can be particularly advantageous.
Drawdown schemes are less predictable. They continue to depend on investment performance to maintain your pension pot. If the investments do badly, or you deplete your capital too early, there’s a risk of your income declining significantly
before you die.
Before buying an annuity, you can, on retirement, take up to 25 per cent of your pension savings as a tax-free lump sum. This reduces the pension income you can secure by buying an annuity, but may be worthwhile if you need the money (to pay off outstanding debts, for example) or decide to invest it independently. The earliest you can draw a pension or take a lump sum is from the age of 55.