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Which Pension is Best for Me?

There are two main types of pensions in the UK: defined benefit and defined contribution. Within these two categories, however, there are several different kinds of pensions available so it can be hard to decide which pension type is best for you.

Most of these options on how you build your benefits up, will be dependant on what your employers offered during your career. Recent pension legislation seeks to give members more flexibility than ever before, and it may be appropriate for you to consider whether your pension plans are in the most suitable place.

With this in mind, there are a number of important points for anyone thinking of starting a pension or changing their current scheme.

Below is a general guide to the pros and cons associated with certain pension schemes, including an explanation of how they work, this should help you decide which pension type is for you.

Defined benefit

Defined benefit pensions, also known as final salary schemes, are generally not available to new employees. They are now largely synonymous with older, more established organisations.

DB schemes work in the following manner. The pension income amount is determined by the following factors:

  • How long a member has been active within the scheme
  • Your final salary amount, or salary average, depending on your scheme rules
  • The accrual rate – as stipulated by the proportion of your earnings received when you retire, according to the length of your membership

Here is a quick calculation to show how a defined benefit schemes may work:

A woman retires at the age of 65 with a salary of £25,000 per year. She has been enrolled into the scheme for 15 years and has an accrual rate of 1/60th.

Her pension will be £6,250 a year (15 X £25,000 divided by 60).

Overall, defined benefit schemes are a very good option for many pension holders. They provide increased financial security, with the peace of mind that is not dependant upon investment returns.

Defined contribution

There are several different types of defined contribution schemes available in the UK, such as:

  • Self-invested personal pensions (SIPPs)
  • Money purchase occupational pensions
  • Stakeholder pensions

Defined contributions are relatively simple. The pension member builds up a pot and uses the money to sustain themselves through retirement. However, the pension income is not determined; it is subject to how much money is contributed to the pot and the overall investment performance.

Depending on the scheme, the member will make regular contributions to their pension and so will an employer. If it is a workplace scheme, for example, an employer will automatically deduct contributions from a monthly wage.

Alternatively, those who have established their own defined contribution scheme will arrange their own payments.

The contributions to a DC scheme will be placed into other investment options – such as stocks and shares. The purpose behind this is to ensure maximum return on your contributions. However, there is also the risk that the pension pot will deplete in value in accordance with a changing financial market.

Once DC members reach the age of 55, they will be able to access their pension and do whatever they see fit. In these circumstances, it will be possible to:

    • Withdraw 25% of your pension pot tax-free
    • Withdraw the other 75% as a taxable lump sum
    • Purchase an annuity
    • Take flexible benefits
    • Take no Action
    • Use a combination of the above.

If you have a defined contribution scheme and wish to consider your options, we will be happy to help you.

How do you choose a pension scheme?

Choosing a pension scheme can be a complex decision. When you are building your pension up, the scheme that you are in is usually dictated by your employer. With the advent of auto enrolment and Workplace pension schemes, it is more likely that this is the type of scheme that new employees will enter. If you have an old scheme, you do have the choice of where that is invested, and whether pension transfer or final salary pension transfer is suitable for you.

We specialise in providing pension advice to a range of individuals, particularly those affected by April 2015’s changes in pension legislation.

If you would like to learn more about your pension, then please contact us today.

Disclaimer: Final Salary Pensions are suitable for the vast majority of members. Transferring from a final salary pension scheme is an irreversible decision and it could have a detrimental effect on your retirement planning. The detail on this website is for information purposes only and is not to be taken as a personal recommendation. Before taking any action, you should take financial advice from a suitably qualified independent financial adviser. Any potential advantages of transferring from a defined benefit scheme to a defined contribution scheme are often outweighed by the costs, risks and loss of benefits involved.

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