Company pensions

Occupational or company pensions are either described as 'defined contribution' or 'defined benefit' schemes.

Occupational 'defined contribution' pensions provided by some employers, stakeholder and group personal pensions and all pensions available to your privately are all defined contribution schemes, sometimes known as 'money purchase' schemes. These work by building up a pension fund using your contributions (and your employer's contributions if they make any), plus investment returns and tax relief. While you are working, the fund is invested, usually in stocks and shares and other investments with the aim of growing the fund over the years before you retire. You get tax relief on your contributions, your fund grows free of income tax and capital gains tax; you may be able to choose the funds to invest in and your employer may contribute if it is a work-based pension.

When you retire you can take a tax-free lump sum from your fund and use the rest of the fund to buy an annuity - an income for life. This is why they are called 'money purchase' - you are swapping your fund for a regular income for the rest of your life. The amount of pension you'll get at retirement will depend on how much you pay into the fund, how much your employer pays in (if anything), how well your invested contributions grow, the charges taken out of your fund by your pension provider, how much you take out as a tax-free lump sum, the 'annuity rates' at the time you retire and the type of annuity you choose.

A 'defined benefit' or 'final salary' pension is a scheme where the final benefit defines how much the policy is worth. The final benefit - your payout - is guaranteed. Typically, your eventual benefits from this type of scheme are defined as a proportion of your final salary. With this type of pension, your retirement income (and any lump sum that you stand to get) simply comes out of the total pension pot that your employer has been building up over the years for all employees. If the investments have performed badly and there is not enough money to pay your guaranteed sum then your employer has to make up the difference. If the investments have performed well and there is extra in the pot, then the employer often gets to keep the extra.

Additional contributions

Your company may give you the option of making an Additional Voluntary Contributions (AVCs) to your pension to secure additional benefits. You may want to top up your pension because you can afford to or if you are concerned that your pension pot will not be big enough. If your employer offers an occupational scheme and there is sufficient demand then they must also offer an AVC scheme. Alternatively, you can top-up your contributions independently of your employer in a free-standing AVC, or FSAVC, which can move with you between jobs. However, an employer's AVC scheme will usually have cheaper charges, making this a more cost-effective option.

Who to talk to about what

Talk to your current employer to find out if they offer an occupational pension scheme.

Different kinds of risk

Occupational pensions have been much in the news recently because of the number of defined benefit or final salary pensions that have been closed by employers. The reason they have been doing this is a combination of the stock market falling drastically a few years ago and the fact that employers are responsible for making up any shortfall in the pot of money from which they pay the pensions to staff when they retire. On top of this, companies going bankrupt have left staff without any of the pension they believed they were entitled to. To help ease the plight of those finding themselves in this situation, the Government has launched a Pension Protection Fund from which some compensation can be paid.

Overall, what we are seeing the UK is more and more employers moving away from defined benefit schemes to defined contribution pensions. Defined contribution pensions share more of the risks involved with the employees, because there is no guarantee as to the amount these pensions will pay out. So staff take on the risk of investment returns being poor, rather than being protected from this risk by their employer. But on the upside, if an employer does go bankrupt, there is no risk to defined contribution pensions - the funds accumulated are completely protected.