Pension types

The State Pension is a payment from the government most citizens can claim when they reach the required State Pension age, which is currently 66 and will rise to 67 between 2026 and 2028. Not everyone gets the same amount as it depends on your National Insurance record. For many people in the UK, the State Pension is their only retirement income.

The new State Pension introduced in April 2016 stipulated the need for 35 qualifying years of National Insurance contributions to get the full amount. If you’re unlikely to reach this requirement before you retire, you can purchase additional credits for any years you missed between 2006 and 2016. The deadline for doing so is 5 April 2025, after which you will only be able to plug gaps in the last six tax years.  More information on this is available on the government website - Voluntary National Insurance: Gaps in your National Insurance record - GOV.UK (www.gov.uk)

The new State Pension rules ensure that the amount you receive for your contributions prior to 6 April 2016 is no less under the new State Pension, as long as you meet the 10-year minimum qualifying period.

Advantages of the State Pension include:

• A reliable source of income for the rest of your life
• You will receive some level of State Pension if you have at least 10 qualifying years of National Insurance contributions
• Your State Pension will increase every year by whichever is highest of average earnings growth, CPI inflation or 2.5% (known as the 'triple lock')

The State Pension alone is unlikely to be enough to support a comfortable retirement.   The Pensions and Lifetime Savings Association provide some helpful information in this regard - Home - PLSA - Retirement Living Standards. The best thing you can do to supplement this income is invest in a workplace or personal pension during your working life.

If you have a Defined Contribution pension, then your money will accumulate over time, increasing your overall pension fund that you can use during retirement. How big that pot is depends on how much you and your employer(s) contribute to the fund and its investment performance. If you are self- employed then unfortunately you won’t benefit from the boost of an employer funded contribution.

Defined Contribution pensions (also known as money purchase pensions) can either be a personal pension arranged by you directly with a pension provider or a workplace pension arranged by your employer.

If your Defined Contribution pension is set up through your employer, then your employer usually deducts your contributions from your salary before it is taxed.

Benefits of a Defined Contribution pension include:

• Greater flexibility over your contributions and investments
• Tax relief on the contributions you pay into your pension
• Access to your money in a number of different ways
• Option to take a 25% tax-free lump sum from age 55 (rising to 57 in 2028)
• Can be inherited tax free in some circumstances

The main downside of a defined contribution pension is that, because your money is invested, it is subject to stock market performance and therefore can go down as well as up.

Important - Investment involves risk. The value of investments can fall as well as rise. You may get back less than you originally invested.

A Defined Benefit pension (otherwise known as ‘final salary’ pension) is a type of workplace and employee pension scheme. Instead of building a pension over an amount of time, a Defined Benefit pension provides you with a guaranteed annual income for life – depending on your final average salary.

You can think of this type of pension as a contract with your employer where they agree to pay you a fixed income from a set date until you pass away.

Advantages of a Defined Benefit pension include:

• A stable income stream
• Often the income will be inflation-linked to some degree, meaning it increases over time
• As the income is guaranteed, there’s no risk you will run out of money
• There is often a spouses pension paid for their lifetime if you predecease
• The costs of running the scheme are effectively paid by the sponsoring employer
• You don’t have to worry about investments or market performance
• The pension protection fund is in place should the scheme fail
• As an active member you may have the opportunity to buy added years or make additional money purchase additional voluntary contributions

Disadvantages could include:

• Not having control over the investments
• Not having full control over its beneficiaries
• Less flexible income and tax free cash options
• Being at risk of receiving less if your employer suffers financial troubles

A self-invested personal pension (also known as a SIPP) is a personal pension ‘wrapper’ that allows you to save, invest and build up a retirement fund. A tax wrapper is a type of tax break you can wrap around your investments. ’Full SIPPs’ offer the widest investment choice including such investments into  commercial property, and direct bonds or stocks (equities/shares).  Most people do not need schemes that allow commercial property and direct equities and bonds,  and find sufficient investment choice and flexibility with those that just offer a wide selection of investment funds. A financial adviser can assist you in selecting a provider and managing your SIPP.

Advantages of this type of pension includes:

• Having more control over your retirement savings
• More control over who benefits from your pension after your death
• Receiving tax relief on contributions worth up to 100% of your annual earnings

Disadvantages include:

• Higher management fees
• Having to navigate complex markets
• Investment risk and having to manage your investments as you get older
• Greater need for advice