Pension planning can be a handful — but with workplace pensions, you can leave some of the hard work to your employers. As the name suggests, your employer provides you with a workplace pension to help you save for retirement.
Your employer must enrol you if you’re eligible.
You can have a Defined Contribution, Defined Benefit Schemes, and a mix of the two.
Choosing the right fund to invest in can bring thousands of pounds to your pension pot.
There are alternatives but workplace pensions usually are the best choice if available.
Types of Workplace Pensions
You can find three types of workplace pensions in the UK: defined benefit, defined contribution, and a cross between the first two, called hybrid pensions. Let’s break through the jargon:
Defined Benefit Pension Scheme
A defined benefit pension is specific in two aspects.
It offers greater security and predictability, as you get a guaranteed income depending on scheme rules rather than the market performance of your investments.
It’s usually only offered to people who’ve worked for large companies or in the public sector.
- It’s a secure and predictable pension income that increases in value with inflation
- Additional employee benefits
- The employer takes most of the risk to ensure you receive the agreed amount
- Many closed in recent years
- Only your employer can choose to enrol you in a DB pension scheme
A defined benefit pension provides you with an income determined by factors set by your pension scheme, such as your salary and length of service, rather than investment performance.
Defined benefit pensions are calculated depending on three factors:
the number of years you spent in the pension scheme,
accrual rate: the proportion of your salary used to build up your pension, e.g. 1/60th,
pensionable earnings: your final salary (at retirement age) or career average revalued earnings, also known as CARE.
For a decent pension cheque, you want the number of years you spent at work to be as high as possible, as well as the accrual rate.
But with final salary and career average schemes, there are more factors to consider. Here’s an overview:
Final salary | CARE | |
|---|---|---|
Pensionable earnings | Your salary at retirement | Your career average salary, revalued to keep value against inflation |
Who it’s good for | Usually suitable for everyone, but best for those who get pay raises later in their careers. | Suitable for people with shorter careers and career breaks. Also good for those who received similar salaries throughout their careers. |
Calculation | Accrual rate (varies from scheme to scheme, for example 1/60th) x years of service x salary at retirement | Accrual rate x each year’s salary revalued for inflation added together. Pay attention to both the revalue rate and the accrual rate to see if a scheme is favourable. |
An example: | 1/60th x 40 years x final salary = of 40/60ths or 2/3rds of the final annual salary. At an accrual rate of 1/60th and with forty years in a DB scheme, you would get 2/3rds of your final annual salary. | 1/60th of your salary in year 1 + 1/60th of your salary in year 2 + 1/60th of your salary in year 3… all the way to the final year. Pensionable pay is revalued for inflation. The final amount depends on the above factors. |
As with other workplace pensions, your employer is required to pay into your pension scheme, and you may also be required to make contributions. The contributions usually rise each year to adjust to inflation.
Dependents and spouses typically receive defined benefit pensions after the holder’s death. However, the amount they get depends on the scheme and may not be the full amount.
Defined Contribution Pension Scheme
While defined benefit pensions provide a predetermined income in retirement, defined contribution or money purchase workplace pensions grow your fund without a guaranteed final amount.
Your defined contribution pension income depends on the following:
how long you participate in the scheme,
the success of your fund’s investments,
the contributions you and your employer make + tax relief,
fees and charges.
- Automatic enrolment is legally required
- Employers are legally required to contribute
- You take more risk for investment performance compared to a DB pension
- Value can go down if investments fail
Your pension pot inflates depending on the amount of money you and your company paid into your fund. This means your pension income will depend on the height of your earnings, the contributions you made, and the amount of time you spent in the scheme.
Returns on investments will also affect the value of your pension pot. This is why your pension provider will invest your pension funds in diverse company shares, bonds, property, and other assets.
Since 2012, employers have been legally required to enrol their eligible employees into workplace pensions – called automatic enrolment. You don’t have to ask your employer to do so.
If you’ve been automatically enrolled in a DC workplace pension, then your employer has to contribute 3% of your earnings minimum. The minimum contribution is 5% for employees, but you can choose to invest more, and your employer might offer to match your contribution.
Hybrid Pensions
Providing both defined contribution and defined benefits sections, hybrid pensions offer the best of both worlds. A common example would be a defined benefit main scheme with defined contributions and additional voluntary contributions. AVCs are often offered to public sector employees and are useful for building additional pension funds.
Eligibility Criteria
To qualify for a workplace pension, a UK employee needs to meet the following criteria:
The holder must be classed as a worker.
They must earn a minimum of £10,000 per year.
They must be aged between 22 and 66 (State Pension age).
They must ordinarily work in the UK.
Opting Out of a Workplace Pension Scheme
It is strongly recommended to stay in a workplace pension to continue accumulating employer contributions and tax relief, which helps grow your pension pot. However, it is possible to opt out of a workplace pension if necessary.
You may need to do this if you are in significant debt and cannot afford the legally required employee contributions. However, it is also possible to reduce your contributions for a certain period, depending on your provider.
To opt out of a workplace pension, you need to contact your employer and pension provider for further instructions. If you choose to leave within one month of enrollment, you will receive a refund. However, if you opt-out after that period, the money will remain in your pension pot.
Employers are required to re-enrol employees every three years or sooner. If you choose to opt out a year before the three-year period, they aren’t required to re-enrol you at the three-year mark.
Managing Workplace Pensions
Managing workplace pensions in the UK is relatively simple. We will outline the basics every employee needs to know about management, investments, and regulation.
Investment
Once you’re enrolled in a workplace pension, your money will typically be invested for you in a default fund. A default fund is designed to satisfy the investment needs of the majority of its members. However, with most workplace pension schemes, you may choose different funds with the same provider.
While you don’t choose individual investments like you do with SIPP accounts, you still have some choice when it comes to the type of fund you want your money in. For example, lower-growth, lower-risk funds are suitable closer to retirement. And vice versa — people at the start of their career have more room to take risks and invest in a higher-growth, higher-risk fund.
You can also make a switch to low-risk funds as you approach your retirement, or your pension provider can offer to do it automatically. Managing your funds can make a massive difference to your pension pot, so take your time and research your options.
Management
Unlike personal pensions, workplace pensions are primarily managed by your employer and the pension provider, leaving you with more time to focus on other things. That is, your employer takes care of payments, and they are responsible for enrolling you and re-enrolling you. Another thing you should know is that you can have more than one pension, including a personal and a workplace pension. Moreover, since April 2023, you can save more each year before incurring tax, with the annual allowance increasing to £60,000.
Regulation
UK workplace pension schemes are regulated by several government bodies:
Pensions Regulator | Controls employers, ensuring they enrol their employees and pay their contributions. It also monitors workplace pensions providers. |
|---|---|
Financial Conduct Authority | Controls all institutions that provide financial services in the UK, including workplace pension providers. |
Pension Protection Fund | Takes over the defined benefit scheme in case your company cannot pay your pension. |
Prudential Regulation Authority | Ensures proper provider management and ensures protection against loss. |
Pensions Ombudsman | Helps people with complaints or disputes about workplace and personal pension schemes. |
Financial Ombudsman Service | Investigates complaints about the sale or marketing of individual pension arrangements. |
Withdrawal and Retirement
In the UK, employees can choose how to withdraw money from their workplace pension. Here are some options:
Delay your pension: Might increase your income but also lose your guaranteed income. Different rules for defined benefit and defined contribution schemes.
Buy different types of annuities: 25% is tax-free. A lifetime annuity is irreversible.
Lump sum payments (UFPLS): Take lump sums from your pension pot when you want to. On each lump sum you withdraw, 25% is tax-free, the rest is taxable with the rest of your income. Depending on your income, taking UFPLS can push you into a higher tax band.
Flexi-access drawdown: Get up to a quarter as a tax-free lump sum. Then choose between lump sums or a regular income.
Early medical retirement
Taking one lump sum: Usually risky. It can push you into a higher tax band as 75% of your pension will be taxable as income.
Alternatives to Workplace Pensions
The alternatives to workplace pensions are private pension plans, such as Lifetime ISAs, stakeholder pensions, and self-invested personal pensions (SIPPs). We will briefly cover and compare them to workplace pensions.
Lifetime ISAs
The government doesn’t recommend a Lifetime ISA as a replacement for pension. However, if you’re self-employed, it can be useful as a way to save more money to use after the age of 60 or buy a first home.
Stakeholder pensions
Stakeholder pensions are meant to be simple, affordable, and flexible. They are defined contribution pensions strictly controlled by the government to encourage saving for retirement.
Stakeholder pensions have a legal limit on charges, low minimum contributions, and a default investment strategy. They are helpful for self-employed individuals who need more flexibility with their pension plans.
Self-invested personal pensions
A SIPP is a type of personal pension that allows holders to manage their investments with significant independence. They are useful for people who have investing experience but also come with a higher risk compared to workplace pensions.
A Comparison of Pension Schemes
Minimum Access Age | Who qualifies? | Advantages | Disadvantages | |
|---|---|---|---|---|
Workplace Pension | DC: usually 55 (57 2028 onwards)DB: usually 60 or 65 | UK workers earning £10,000+ between 22 and State Pension age | Obligatory employer contribution, auto-enrolment, guaranteed income for life in case of DB pensions | Less investment choice, strict withdrawal rules |
Stakeholder Pension | usually 55 (57 2028 onwards) | Anyone | Simplicity and flexibility, suitable for self-employed and unemployed | No obligatory employer contribution, limited investment choices |
SIPP | usually 55 (57 2028 onwards) | Anyone under 75 | Wide choice of assets you can invest in | No obligatory employer contribution, higher risk, more effort |
Lifetime ISA | 60 | Anyone aged between 18 and 40 | Useful for self-employed people, best for buying a first home | No employer contribution, you can only pay in until the age of 50, money within a LISA is considered an asset for debt recovery, 25% loss if you withdraw earlier |
Discover Your Options In-Depth
The Bottom Line
Employers are obligated to provide workplace pensions for a reason. Whether they are defined benefit (DB) or defined contribution (DC) schemes, these pensions, along with the added contributions from employers, offer individuals greater financial security in retirement.
While alternative options are available, workplace pensions remain the safest and most tax-efficient method of saving for retirement. Therefore, unless absolutely necessary, it is strongly advised not to pass up on a workplace pension.
