What are the different types of pensions?

Summary 

  • Pension schemes are the best long-term investment tools to secure your future and have a comfortable life post-retirement.
  • They can be classified into personal, workplace, and state pension schemes.
  • It is better to start investing early to reap the maximum benefits out of pension schemes.

When people retire, they face a major reduction in income that has an inevitable impact on their lifestyle. Maintaining a comfortable lifestyle and the same standard of living after retirement can be achieved if one either receives a large inheritance or plans his retirement years by investing into an appropriate pension scheme. The key to a good life after retirement is to choose the right pension plan today to reap the maximum benefits in the future.

But what are the different types of pension plans in the UK, let’s closely watch the options available.

Types of pension plans 

Different pension plans work in different ways. The pension plans can be classified into state pension and private pension, which include workplace pension and personal pension. Personal pensions are the most flexible pension schemes, as you have the freedom to choose your provider and the amount you are willing to invest. In case of workplace pensions, the government has made it compulsory for employers to provide you with an automatic enrollment, unless you willfully opt-out.

Also read: What is the over 80s Pension?

 

Let’s first take a brief look at the types of private pensions.

Private pension schemes

There are two main types of private pensions, which are defined contribution pension schemes and defined benefit pension schemes. The defined contribution pension schemes are also known as money purchase pension schemes, include the workplace pensions which are arranged by your employer, and the personal pensions which you arrange yourself. The pension provider puts the money received by you and your employer into investments, like shares, and thus the value of your investment pot can fluctuate depending upon the performance of your investments.

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As you get closer to your retirement age, some pension schemes may also move your money towards lower-risk investments, and if it doesn’t happen automatically then the pension provider can be asked to do so. When you finally get your pension pot, the amount you receive will depend on several factors, such as the amount paid in the pot, the performance of your investments, as well as the way you take the money, for example as regular payments, smaller sums, or a lump sum payment. Generally, 25% of your pension pot is free from taxes. Though, a small percentage is taken by the pension provider as a management fee.

Also read: Roth IRA: Is it the best way to invest money for your retirement years?

The defined benefit pension schemes, also known as ‘final salary’ or ‘career average’ pension schemes, are generally workplace pensions which are arranged by your employer. The amount of money you get from this pension pot doesn’t depend on how much you’ve paid in or your investments, but on the rules of your pension scheme. Workplace schemes take several factors into account, such as your salary and the time you’ve worked for your employer. A commitment is made by the pension provider to give you a certain amount per year after your retirement. Generally, up to 25% of it is free from taxes, and the rest of the money is received as regular payments. Your pension scheme’s rules define when you can get access to your pension pot, but it is 55 at the earliest in general.

State pension schemes

The State Pension is the pension you receive from the UK Government after attaining the defined State Pension age. The amount you receive depends on your contribution towards the National Insurance. The state pension has changed for people who reach the state pension age on 6 April 2016 or after, which includes men born on or after 6 April 1951 and for women it is on and after 6 April 1953. The change has been made to simplify the old complex rules, based on basic State Pension and Additional State Pension, which made it difficult to calculate the amount you’d get when you reach the state pension age. The new State Pension will provide a closer and early estimate of the amount you’d receive post-retirement, which will in turn help you to plan your savings in a better way.

Also read: Which Investments Have the Best Return?

State pension may only form a part of the retirement income, as people may have a workplace pension, or any other pension or earnings as well. Every person may get a different amount as per their National Insurance records. People who want to get the full amount of new State Pension, but have no National Insurance record before 6 April 2016, will require 35 qualifying years to get it, when they reach State Pension age. Generally, most people have made National Insurance contributions or have received National Insurance credits before 6 April 2016, and mostly the new State Pension considers their National Insurance record, both before and after 6 April 2016 when they reach the state pension age.

 

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If you meet the 10-year minimum qualifying period, the new rules ensure that the amount you get is not less than what you’d get under the old rules. The qualifying years on your National Insurance record are not required to be 10 years in a row, and they can be before or after 6 April 2016. The full amount one can receive from the new State Pension is £179.60 per week (2021 to 2022 rate), but not everyone receives the full amount, depending on their National Insurance records.

Some people may work even after attaining the state pension age, and they don’t need to pay National Insurance contributions anymore. If one chooses to retire at 65, and not 55, there can be a 60% increase in their average earnings from their pension pot.

Conclusion

Investing in a pension scheme is one of the most beneficial long-term investments you can make to secure your future and build up a cushion of money to face a reduction in income post-retirement. But it is very important to analyse the costs and benefits of all pension schemes, such as tax deductions, risks, and accessibility to funds, before investing in a scheme. One or more suitable schemes should be chosen as per your financial condition and future expectations. It is always advisable to start investing in a pension scheme as early as possible, to reap the maximum benefits. 

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