A workplace pension is one of the most common methods of saving for retirement. Workplace pensions are not a mere employee benefit, but a critical element of national economic policy (auto-enrolment) and corporate compensation strategy.
In the UK, the vast majority of modern workplace pensions are Defined Contribution (DC) schemes, particularly those set up under auto-enrolment. Unless otherwise stated, references to workplace pensions in this article relate to DC arrangements, as these are now the most common form offered by employers.
Let’s take an in-depth look at the types of workplace pensions available, the differences and benefits to each type, and the legal obligation behind a pension scheme.
What is a workplace pension?
Typically arranged by your employer, a workplace pension is a scheme in which you pay contributions directly from your wages each month. Your employer will usually add contributions to your pension scheme as well as additional government contributions in the form of tax relief.
If you have automatically been enrolled into a pension scheme, your employer must write to you to let you know. They will inform you of:
- The date you were added to the pension scheme
- The type of pension scheme
- Who runs the pension scheme
- Agreement on the percentage you’ll pay in and their contribution
- How you can leave the scheme
- How tax relief will apply to you
Understanding auto enrolment
The Pensions Act 2008 mandates automatic enrolment for eligible staff. This legislation was brought about to combat under-saving for retirement.
It stipulates that every employer in the UK must automatically enrol certain employees – currently those aged between 22 and State Pension age who earn over £10,000 a year – into a workplace pension scheme and contribute towards it.
Opting out
Employees have the option of opting out of any pension scheme, but it’s widely agreed that pensions are worth paying into. Opting out of a pension scheme will mean forfeiting the contributions from your employer and the government, which may have a critical financial impact on your pension savings down the line.
Who is eligible for a workplace pension?
Employers are required to provide a workplace pension scheme, which is known as auto-enrolment. You will be eligible for a workplace pension scheme if:
- You are aged between 22 and State Pension age
- You are classed as a ‘worker’
- You earn at least £10,000 per year
You can opt out of a workplace pension if you want, but it’s highly recommended that you pay into it if you can afford to. While a State Pension will cover basic living costs, having a workplace pension allows you to enjoy a decent standard of living. In practice, eligibility for auto-enrolment means being enrolled into a DC workplace pension, as Defined Benefit schemes are now rarely offered to new employees.
What types of workplace Pensions are available?
There are several workplace pension schemes available. Each scheme is governed differently and has different terms, so it’s a good idea to have a full understanding of your pension options before opting in or out of one.
Defined Contribution (DC) Pension Scheme
Defined contribution pension schemes are usually personal or stakeholder pensions. They are also referred to as “money purchase” pension schemes.
Defined contribution schemes can be a workplace pension arranged by your employer or a private pension arranged by you. The amount you receive when you retire depends on how much is contributed, for how long, and how well the investments have performed.
Money paid into the scheme is put into investments (usually a mix of stocks, shares, and other investments) by the pension provider. It’s typical for the value of your pension pot to increase and decrease depending on how the investments perform.
Some schemes automatically move your money into lower-risk investments as you get closer to retirement age. You’re also able to manually opt for this if it doesn’t take place automatically.
Defined Benefit (DB) Schemes
Defined Benefit (DB) pension schemes are far less common in today’s workplace, particularly for new employees, and are now mainly found in the public sector or in legacy employer schemes.
Defined benefit pension schemes are based on a member’s salary and are also referred to as “final salary” schemes.
DB schemes are dependent on a range of factors, including your salary, the circumstances under which income is taken from the scheme, and how long you’ve worked for your employer. The pension provider promises to give you a set amount each year when you retire, so the amount isn’t based on stock market performance.
This type of pension may not be what most people expect, as many are more familiar with defined contribution schemes. Pension trustees play an impartial role in supporting members, helping them understand how the scheme works and what it means for their retirement benefits. This might include maintaining and relaying knowledge and understanding to employees when they are first enrolled in this style of pension.
In addition, the sponsoring employer is the one who underwrites the financial risk of this type of pension scheme. They have an ongoing obligation to ensure the scheme continues to meet the expectations of members.
Group Personal Pensions
Group personal pensions are a type of defined contribution pension run by a pension provider. Employees have a personal pension account with a pension provider, managed through the group arrangement, meaning employees have a direct contract with the pension provider despite the employer arranging the scheme.
State Pension
State Pension is a regular payment people can claim once they reach State Pension age. Your State Pension age depends on when you were born, in which you can find this information via the GOV.UK calculator.
The amount of State Pension you will receive depends on how many “qualifying” years of National Insurance payments you have, including National Insurance contributions you pay when you’re working and contributions that are credited to you when you are unable to work.
A State Pension Statement is an estimate of how much State Pension you could receive. If you are over State Pension age, you may be able to get Pension Credit, which gives you extra support for heating and housing costs.
How workplace pension contributions are made?
Employee contributions
Once you have opted into a pension scheme, you will make a direct contribution from your salary. The legal minimum contribution to your salary is 8%. 5% of this will be deducted from your annual salary, with an additional 3% from your employer, plus government tax relief.
Employer contributions
The mandatory legal minimum that your employer pays to your pension is 3% of earnings, but it can be higher depending on your employer. Some employers may even choose to match your pension contributions; check with your employer how much will be paid into your pension scheme.
Government contributions
Government contributions to pension schemes are also known as tax relief. This means the government adds money to your pension pot that would otherwise be paid as income tax. This is dependent on:
- You paying income tax
- You pay into a personal pension or workplace pension
The amount you receive depends on your income tax bracket, so if you are a basic rate taxpayer, you will get a top-up of 25% on your pension contributions, up to an annual limit.
What are the financial benefits of a workplace pension scheme?
Compounding is a powerful force for saving or investing and can be a useful tool for building wealth over the years. It works through small amounts growing over time; a popular visual example is to imagine the effect of a snowball rolling down a hill and steadily growing.
The financial benefits of pension savings include:
- The government tax relief on the contributions
- The tax-exempt growth within the fund
- The possibility of taking a tax-free lump sum (25%) at retirement.
By starting early, contributing regularly, and being patient, your retirement savings have the opportunity to return more money than you invested. Employer contributions are also an immediate, guaranteed return on investment for the employee.
When can I access my pension?
The earliest you can access a workplace pension is usually 55 (57 from April 2028), but it is usually designed to pay out around age 65 or older. The longer you leave your pension savings, the more time you give the money invested to compound and grow larger.
When you change jobs, you may lose track of your pensions. There are several online services that allow you to search and collate old pensions for a more consolidated approach to retirement planning.
How can I access a workplace pension?
There are a few options for how you take a workplace pension. You can take some as a lump sum, by buying an annuity, or using income drawdown.
A common approach is to take 25% of your pension pot as a tax-free lump sum and then use the rest to purchase an annuity.
An annuity provides a guaranteed income for life, or set period. The way it’s paid out is absolutely set, so there’s no change in value.
A drawdown, on the other hand, means your money will remain invested with the potential to increase or decrease in value as the stock markets change.
Are you a sponsor?
Sponsors are responsible for determining the pension scheme on offer to employees. From paying contributions to ensuring compliance with legal frameworks and regulations, sponsors need to ensure that they act in the best interests of their charges.
Start a conversation with our experts today, and ensure all sponsors and trustees in your organisation understand what is required of them. When it comes to planning your financial future and workplace pensions, you need to ensure you have all the right information on your side.
