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What are the different types of pension plans?

If you live and work in the UK, there are different types of pension plans to help you save for retirement. Find out how they work so you can choose the best option for you. 

Summary

  • Defined benefit and defined contribution are the two main types of pension schemes in the UK.

  • In addition to your state pension, you may have a workplace pension and a self-invested personal pension (SIPP).

  • A financial adviser can help you find the best pension and fund for your circumstances.

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Why it’s vital to find the best pension

No matter where you are in your career, it’s important to think ahead to the days when that monthly cheque is no longer coming in.

In the UK, a pension is among the most tax-efficient ways to save for your retirement.

However, not all pensions and schemes are created equal. So, it is vital to find out about the different pension and scheme types and how they function.

This is the best way to ensure that you are doing everything in your power to secure a comfortable retirement for yourself.

What are the different types of pension schemes?

There are two main types of pension schemes in the UK:

Defined benefit pension schemes

Defined benefit pension schemes pay out based on your years of employment, salary, age, and the terms of your pension plan.

This type of pension scheme is also known as ‘final salary’ and is a type of workplace pension scheme.

Defined benefit pension schemes differ from defined contribution pensions in that they pay out a specific income for the rest of your life after you retire.

Your employer is responsible for setting up your defined benefit pension scheme and ensuring that enough money accrues to cover your pension upon your retirement.

 Your employer makes payments into your pension and may ask you to contribute as well. Any payments you make are eligible for tax benefits.

Defined contribution pension schemes

Defined contribution (DC) pension schemes are also known as “money purchase” pensions. 

You, your employer, or in some instances, a third party can set up a DC pension scheme on your behalf.

If you set up your defined contribution pension scheme on your own, it is referred to as a personal pension plan or scheme.

If your defined contribution pension is set up on your behalf by your workplace, both you and your employer make payments into the fund.

The money paid into your defined contribution pension is invested, which means your pension pot may grow or depreciate depending on investment performance.

In other words, the ultimate value of your total payouts at the time of retirement is not guaranteed. 

Other factors influencing the growth of your DC pension pot include how much money is paid into it and any charges associated with the particular scheme.

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What are the three main types of pensions?

There are three primary types of pension available to you if you live and work in the UK:

The state pension

All eligible UK citizens are provided a state pension from the age of 66, although this is set to increase to 68 in the future.

To be eligible, you need to accrue “qualifying years,” typically by contributing to your national insurance (NI) record out of your income.

Since the state pension is paid from taxes, you don’t build up a pension pot of money.

Your state pension payout depends on your number of qualifying years, with a maximum payout of roughly £10,600 annually, set to increase to around £11,502 in April 2024.

Workplace pension

By law, employers in the UK must enrol all eligible workers in a workplace pension scheme, and they must contribute at least 3% of eligible workers’ qualifying earnings to their pensions each year. 

Employees are then responsible for contributing the difference to make up the minimum contribution (typically 8%).

Many employers contribute more than the requisite 3% to their employees’ workplace pensions. In fact, some employers offer contribution matching, where they match each worker’s pension contribution up to a certain limit.

Workplace pension schemes generally come in one of two forms: defined contribution schemes or defined benefit schemes.

Self-invested personal pension (SIPP)

A self-invested personal pension (SIPP) is a modern take on the traditional personal pension.

With a SIPP, you gain greater control of how your pension contributions are invested.

Unlike more traditional personal pensions, such as stakeholder pensions, your involvement extends beyond simply paying your monthly contributions. 

You personally select the investments that make up your SIPP. In fact, you can even combine various existing pots into one to form your SIPP.

This allows you to enjoy pension tax relief on your chosen investment portfolio.

The larger potential returns and greater flexibility of SIPPs make them popular with high-income individuals and DIY investors who like to take a more hands-on approach to retirement planning.

While this option is more flexible and potentially more rewarding, it is also more complex and time-consuming. So it’s vital to get professional financial advice if you’re considering a SIPP.

You need to be under 75 to open or pay into a SIPP and receive tax relief (for yourself or on behalf of a dependent). Otherwise, the usual pension rules apply to SIPPs, and you can access your pot from age 55.

Seek expert financial advice

There’s no time like the present to begin planning for your retirement.

Knowing about the different types of pensions available to you is an excellent starting point for selecting the right option to secure your financial future. 

If you want to learn more about pensions and need expert financial advice, let Unbiased match you with a financial adviser who can offer guidance based on your unique circumstances. 

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About the author
Our team of writers, who have decades of experience writing about personal finance, including investing, retirement and pensions, are here to help you find out what you must know about life’s biggest financial decisions.