A pension is essentially a long-term savings scheme that helps you build up your savings for retirement. It allows you to put money aside now in a tax-efficient way to live off later in life when you want to start working less or retire completely.
You may be entitled to a small pension from the government when you reach a certain age. This is known as a state pension and as a general rule, is only available if you have been paying National Insurance contributions over the years. However, it is unlikely to be enough to retire on. As a result, most people also join a workplace pension or take out a private pension.
What is a Workplace Pension Scheme?
A workplace pension, also known as an occupational pension scheme, is a savings scheme arranged by your employer. Since 2018, all employers are legally required to set up and contribute to a pension scheme for their staff.
How Does a Workplace Pension Work?
Your employer will deduct a proportion of your salary every payday, which will automatically go directly into your pension pot. In most cases, they will also make contributions to your pension through the scheme.
It is possible to make additional payments if you want to top up your pension savings. To encourage people to save and contribute to their pensions, the government will also contribute to pensions in the form of tax relief.
When you can start taking money from your pension, you will usually be able to withdraw up to 25% of your pension pot as a tax-free lump sum and the remaining amount will be taxable.
You can make contributions to as many pensions as you want. Contributing to a workplace pension scheme will not mean that you lose your entitlement to a state pension — this is paid on top of your state pension and contributions are separate from the national insurance contributions you pay for the state pension.
Benefits of an Occupational Pension
One of the main advantages of an occupational pension is the fact that your employer makes contributions, which can greatly increase the amount that goes into your pension pot. Such pensions are also convenient as you don’t have to bother about setting up a personal pension and they are taken care of by your provider. Furthermore, your workplace pension will be protected even if your employer goes out of business.
As well as providing a pension on retirement, most occupational pension schemes will also provide other benefits such as financial support for a partner if you die while still employed and a pension in the event of early retirement because of ill health.
Types of Occupational Pensions
There are two main types of occupational pensions;
- defined benefit pensions schemes
- defined contribution scheme
Defined Benefit Pension Schemes
Defined benefit pension schemes are also referred to as final salary schemes. In this type of scheme, your pension is linked to your salary while you are working, so it will automatically increase as your pay rises. In most defined benefit pension schemes, you contribute a set percentage of your salary toward your pension fund and your employer pays the rest.
Under a defined benefit scheme, your pension pot does not depend on the performance of the stock market or other investments. Instead, it will be based on your salary and the number of years you have been in the scheme.
Defined benefit pension schemes offer a more stable pension than a defined contribution pension scheme as your provider will give you a guaranteed annual income which increases in line with inflation. As a result, defined benefit pension schemes are considered an attractive workplace benefit. However, such schemes are increasingly rare; with the exception of the public sector, most employers no longer offer them.
Defined Contribution Pension Schemes
Defined contribution schemes are also known as money purchase schemes and are the more common type of workplace pension scheme these days.
Money contributed by you and where relevant, your employer is put into investments such as shares or bonds so the amount you have on retirement will depend on how the investments have performed. You will usually pay a percentage of your wages into the scheme and your employer may also pay a regular amount, but this isn’t always the case. However, if your employer has to offer you automatic enrolment (see below) into a workplace pension, they will be obliged to make contributions.
You can choose more risky investments to maximise your growth depending on your circumstances. However, as you move closer to retirement, you are likely to want to be more cautious. Some schemes may move your money into lower-risk investments as you get close to retirement age. If this doesn’t happen automatically, you can normally ask your provider to do this for you.
Defined contribution pension schemes do not guarantee how much pension will be paid on retirement.
Group Personal Pensions and Stakeholder Pensions
It is possible to have a group personal pension or stakeholder pension arranged for you through work. These are a type of defined contribution pension scheme and work in a similar way to the ones you can arrange for yourself.
Your employer will select the pension provider but you will have an individual contract with the pension provider. As with other workplace pensions, you pay contributions into your pension fund directly from your wages and you should receive some tax relief on contributions. Your employer will also usually make contributions. The money is then invested to grow your fund which will provide you with a pension when you retire.
The main distinction between organising a group personal or stakeholder pension yourself and joining one through work is the level of control you have over how much you must contribute to your fund. With a workplace scheme, the employer will set contribution amounts and will usually also make investment choices for you.
Automatic Enrolment into a Workplace Pension
Your employer is required to enrol you into their workplace pension if you are an eligible employee. This is known as automatic enrolment and was created by the government to encourage people to save additional money for retirement.
To be eligible you will need to be:
- aged between 22 and state pension age
- not already in a workplace pension
- earning more than £10,000 a year
- working in the UK
If you are eligible, pension contributions will automatically be taken from your wages each time you are paid and your employer will also have to make regular contributions to your pension pot. Previously, the onus was on the employee to join a workplace pension scheme if they wanted to.
Since April 2019, the total minimum contributions made by you and your employer into a workplace pension scheme is 8% of your basic pay, of which your employer must pay at least 3%. If your employer decides to pay the minimum of 3%, you must pay the remaining amount to make this up to at least 8%. Your employer can, however, choose to contribute more.
How to Opt Out of Workplace Pensions?
You can opt out of the workplace scheme if you want to, but it is a good idea to pay into it if you can afford to as you will benefit from your employer’s contributions, which is essentially ‘free’ money. There is also tax relief on the contributions you make to the scheme.
Even if you chose to opt out of your workplace pension, your employer must still automatically re-enrol you every three years as long as you are still eligible.
The law governing pensions is complex and constantly evolving. At Witans solicitors, we can offer you clear practical legal advice in relation to any pension scheme, helping you to understand how workplace pensions work. If you have an issue or query, contact us today.
For more advice on any of your employment-related queries, reach out to us today.
FAQ
When can I start drawing a pension?
You can usually start drawing a pension from most schemes from the age of sixty or sixty-five, which is well before you can get your state pension. If the scheme allows it, it is even possible for you to start taking benefits from the normal minimum pension age, which is currently fifty-five. However, this will be increasing to fifty-seven from 6 April 2028 for most people.
The increase to age fifty-seven will not apply to those retiring due to ill health. Special rules also apply if your life expectancy is less than a year.
It is best to contact your pension provider for more details if you are unsure about the rules of your workplace pension scheme.
What if I already have a pension?
There are no limits on the number of different pension schemes to which you can belong. However, there are restrictions on the total amounts that can be contributed across all schemes each year if you want to receive tax relief on contributions.
What happens if I change jobs?
If you decide to change jobs in the future, your work pension pot still belongs to you. Depending on the type of pension scheme you have joined, you can:
- leave your pension behind in your old employer’s scheme and access it once you reach the schemes’ pension age
- transfer your money to your new workplace pension scheme
- transfer your money to a personal pension
