Pensions Explained

Final salary scheme

If you are in a salary related scheme, such as a final salary scheme, either the income you receive in retirement will be based on the length of time you have worked for your employer, or been a member of the scheme, as well as your salary. You can only join these schemes if your employer provides one – you cannot pay into one privately. The scheme's trustees and manager make all the investment decisions for you.

Final salary schemes are most common in the public sector for example teachers, nurses and local government employees usually benefit from these schemes. Some private sector employers also provide final salary schemes but recently many have closed due to the high cost of the guaranteed benefits. These schemes provide a defined amount of pension that is independent of market performance and usually adjusted for inflation. They also provide tax-free lump sums that are related to your salary and the number of years in the scheme.

Workplace pensions

You are in a workplace defined contribution scheme if you join your employer's trust-based money purchase scheme or a group personal pension arrangement (such as a group stakeholder scheme).

• You make regular payments during your working life.
• Your payments are then invested in your choice of one or more of a range of professionally managed funds and remain invested until you retire.
• The investment performance of the fund(s) will determine how much money you may have available when you are ready to retire. Charges and investment performance will affect the fund value. However, the value of your investment can go down as well as up and the value of the pension fund may be worth less than has been invested.
• The money built up is used to buy an annuity or another product which provides you with an income in your retirement. Your pension income will be taxed as earned income.
• You can usually take up to 25% of your pension fund as a tax-free lump sum, which means you will receive a smaller pension income. Tax rules may change in the future.

Usually, your employer also pays into the scheme. If you can join your employer's scheme it's usually a good idea to do so, particularly if the employer pays towards your pension fund – some schemes are very generous. You can still take out a personal pension if you need to top up your pension fund.

Unfortunately, no one can know how much your fund will be worth when you retire or how much income you will receive each month. Although saving in a bank has its advantages (you have access to the money, you will at least get back the amount you paid in and any interest, once earned, is guaranteed), it is generally accepted that investing in a pension is a more effective way of planning for your retirement. A pension scheme lets you invest in a range of funds, so your money has a chance to achieve better growth than it would in a savings account. You need to understand more about the funds to make the best choices about where to invest your pension payments. You should also talk to a financial adviser.