Company or occupational pensions are set up by employers for their employees. Employers are obliged to enrol you into a pension subject to you meeting the conditions of the scheme.
You’ll most likely have to match the contribution made by your employer, but what the company puts in will be in addition to what you take home from your salary. It’s as good as a pay rise.
How much your employer pays in can vary. The minimum amounts are currently 1% of your ‘qualifying earnings’ from your employer, with 0.8% from you and 0.2% tax relief, but both you and your employer can pay in more. (Your employer will work out your ‘qualifying earnings’, which are your earnings (before tax and National Insurance are deducted) that fall between a lower and upper earnings limit set by the government). Take a careful look at the pension scheme that your employer offers.
Contributions paid into a pension scheme are free of tax but, unless it is a company pension scheme where payments are structured as a salary sacrifice, you do pay National Insurance on your contributions.
While admittedly this saving arrangement is not going to put more money in your pocket right now, it’s certainly money you’ll be glad to have in the future.
Two types of company pension scheme
There are two types of company pension scheme:
- Defined benefit schemes – also known as final salary schemes or average salary schemes.
- Defined contribution schemes – also known as money-purchase schemes.
Defined benefit / final salary schemes
Defined benefit schemes are becoming increasingly rare. They promise to pay you a set retirement income based on how much you earned as an employee. Under this scheme, the employee’s retirement benefits are set out or ‘defined’ in advance by the pension scheme. This means that the income you’ll receive from your pension is guaranteed depending only on your income during your membership of the scheme.
Not surprisingly, they’re generally considered (by employees) to be the best form of company pension. But they are very expensive (for the employer) to provide, and only tend to be offered to most public sector workers, including civil servants, local authority employees, teachers, nurses and the police. In the past, many larger private sector companies offered these kinds of schemes, but they’re few and far between these days. While there are many people who have preserved rights in defined benefit schemes, most such schemes have been closed to new members and provide no further accrual of benefits for members (beyond, usually, inflation increases).
If you’re lucky enough to be in a defined benefit scheme, you should usually hang on to it. While you might have heard there are benefits to consolidating a number of different pension pots into one, when it comes to this sort of scheme that’s not generally the case. In fact, it is now a legal requirement to have financial advice before you transfer out from one of these schemes, and even with advice some providers may not accept them as a transfer in.
Defined contribution / money purchase schemes or group personal pensions
Due to the cost, many defined benefit schemes have now closed and instead company employees are more likely to be offered a defined contribution scheme.
With these schemes there’s no such guarantee – indeed, no guarantee at all - of the income you’ll receive when you come to retire. The retirement benefits won’t be known until an employee reaches the stage when the benefits are taken. It’s only the contributions that are ‘defined’ in advance. These contributions, along with any from your employer, are invested with the aim of growing your retirement pot as much as possible.
Key benefits of company pension schemes
Where an employer offers a company pension scheme, they must make contributions to the scheme on behalf of their employees. Many employers will contribute at least as much as their employees’ contributions, and sometimes a lot more. The statutory minimum is currently 1% of the employee’s income. The amounts payable by the employer and employee are usually shown as a percentage of basic salary. In rare cases, the employee doesn’t make any contributions – these are known as ‘non-contributory’ schemes.
Tax relief on employee contributions
Where the employee is required to contribute a percentage of their basic salary, the amount is deducted through payroll before tax. This means the employee will benefit from tax relief at their marginal income tax rate, up to certain limits. Tax rules can change and their benefit to you will depend on your individual circumstances.
Death in service
In the event of death whilst still an employee, a lump sum of a multiple of annual salary is usually paid (for example, two times or four times your salary). Some schemes can also provide a dependant’s pension in the event of death before retirement age.
Ill health pension
If, while still employed and an active scheme member, your employment comes to a premature end due to long-term sickness or injury, company pension schemes can provide an ill-health early retirement pension scheme. Depending on the scheme type, this may match what the pension might have been at normal retirement if the employee had stayed with the company, or maybe what the accumulated fund can purchase.
Additional voluntary contributions
Employees can contribute over and above any required contribution. Where this payment is used to enhance the company scheme it is called an Additional Voluntary Contribution (AVC). These are deducted from payroll and tax relief is gained in the same way as with normal employee contributions. If this is effected via what is called salary sacrifice, then employee national insurance contributions are also not charged. One benefit of AVCs is that the cost of running the pension scheme is usually met by the employer so employees face so no additional charges.
AVCs aren’t the only way of supplementing a company pension. Since 2001, members of company pension plans have been able to contribute to personal pensions (including stakeholder pensions and SIPPs. This is known as concurrency.
Automatic enrolment, also known as Auto Enrolment
This new approach to workplace pension savings was introduced by the government in October 2012 and is being phased in over a period of six years.
Auto enrolment aims to encourage all workers – and particularly part-time employees and those on lower incomes– to start saving for their own retirement.
Under the auto-enrolment scheme, employers will automatically enrol all eligible employees into a qualifying pension scheme and make contributions on their behalf.
By the time the full system has been rolled out, pretty much every employee will be enrolled in a pension scheme, with regular contributions made to their pension through payroll.
As part of the scheme, employers will have to make a contribution to each employee’s pension and there will be tax relief on employee contributions; making it a simple and cost-effective way to save for retirement.
By February 2018 every company with more than one employee will have to have enrolled their staff in a qualifying pension scheme. Employers who already have a qualifying pension scheme can use it to comply with the new laws or they can choose to start another scheme.