The new law means that millions of people will for the first time have access to a pension scheme and be forced to save for their retirement. Your employer will typically offer you defined benefit or defined contribution pension arrangement, which we describe below.
You will either be placed into your employer’s own scheme or one run by the government, known as Nest.
According to the Department for Work and Pensions (DWP), around 4.3 million will be part of pensions scheme by May 2015.
You can opt out, but it is essential that you save for your retirement – so think very carefully before you say no. A workplace pension means that you will also get contributions from your employer as well as tax relief from the government – so opting out simply means you are saying no to free money.
The reason why the government has pushed for a pensions saving scheme that automatically enrols people is because people are living for longer, making pensions more expensive; so everyone should start planning for retirement as early as possible.
Under new regulations, as long as you haven’t opted out, then the minimum that must be paid into a pension scheme is 2% of qualified earnings, which is between £5,772 and £41,865. This is until 2017, after which the minimum contribution level will go up to 5% after October 2017 and then 8% from October 2018.
Your employer will pay part of these minimums – so until 2017, the minimum you pay is 0.8%, with the employer paying 1%, and the rest being made up in tax relief. From October 2017, the minimum you pay is 2.4% and your employer must pay at least 2%, with the rest being made up by tax relief, and then from October 2018, your minimum will be 4% of qualified earning and your employers minimum contribution will be 3% with the rest again being made up by tax relief.
Large employers have already started auto enrolling their employees into pension schemes, and other firms are due to follow – your employer can tell you the exact date they intend to implement ‘auto enrolment’, as there is a staged process, with some employers being given up to six years to implement auto enrolment.
If you already have a workplace pension scheme, then the changes are unlikely to affect you.
When you join your workplace pension scheme, your employer will probably offer you access to what is known as a defined contribution scheme or a defined benefit scheme. The different types are explained below.
The different types of workplace schemes
A defined contribution scheme
This is the most common type of scheme most employers now offer and the type you are very likely to be in.
A defined contribution (DC) scheme, also known as a money purchase pension scheme, invests the money you put in plus your employer’s contribution to help accumulate a retirement pot.
The government’s Nest scheme also works in this way.
You the use that pot to buy yourself an income for your retirement, this is usually done by buying what is called an annuity – although new rules from 6 April 2015 means you do not have to buy an annuity and can cash in your pension from age 55 (more below).
You can buy an annuity for life or a set period from annuity providers – these are normally insurance companies.
Think very carefully before you buy an annuity, because once you’ve bought it, you cannot change your mind. The annuity rates vary significantly and change frequently between providers, so be careful not to buy a poor deal, which if you do, you will be stuck with it for life!
Getting the best annuities deal
To make sure you do not get locked into a poor deal, you are entitled to shop around and are not obliged to go with the company that looked after your pension.
Your legal right to shop around is known as the ‘open market option’ and it is your best chance of getting the best annuity rate.
The majority of people do not exercise this right and assume that their provider is offering them the best rate – this is not the case. So when your time comes, be wise and look for the best deals before handing over your pension pot – you could be losing out on as much as 30% more pension income with the best provider.
By shopping around, you may even find that you are entitled to an enhanced annuity, normally available if you are in poor health. Different providers have a different criteria – so once again, shop around.
It is important that you disclose any health problems when buying any annuity as many annuity providers offer enhanced annuity payments for people who smoke, have high blood pressure, or are suffering from other conditions.
You could miss out on hundreds of pounds worth of extra income by not being honest.
You can use a financial adviser to help you find the best rates. They will help you shop around. You can find independent financial advisers See Unbiased.co.uk to help you find a local financial adviser.
Your annuity provider is obliged to tell you about the open market option and cannot charge you for using it.
If you choose not to buy an annuity or cash in your pension pot, you can use income drawdown as an alternative.
Income drawdown means you take out a taxable income each year and leave the rest invested – the aim is that you make more money with the invested cash, so that your income will get bigger over your retirement years – but bear in mind, investments can be risky and may not always work in your favour.
Income drawdown is usually suitable for those with large pension pots of around £200,000 – £300,000. But from 6 April, income drawdown will be made suitable for those with modest retirement savings with the introduction of flex-access drawdown products. You can take out as much as you like with no minimum income requirement.
If you are already in an income drawdown arrangement, then talk to your provider.
Cashing in your pension – new rules from 6 April 2015
From 6 April 2015, instead of buying an annuity or using income drawdown, you will be able cash in your pension anytime from age 55 (57 from 2028). But anyone looking to take advantage of the new pensions freedom, must seek advice, as it is important to save for retirement and you should think carefully before cashing in your nest egg. The government said it wants people to have more freedom over what they choose to do with their pension savings, but people are expected to be sensible.
Currently, people that have already cashed in their pension are excluded from the new pension freedom rules, but this is under review and more details will be revealed in the upcoming budget 2015.
If you are considering cashing in your pension savings, you can get guidance from a new government service known as Pension Wise. Pension Wise is available from April 2015, but you can register your interest online.
Defined benefit schemes
These are the crème de la crème of pensions – but, unless you are lucky enough to already be in one, it is unlikely that any employer will be offering it to new workers today. If you have one, hold on to it.
A defined benefit scheme, also known as final salary, is linked to your final (or average) salary and the number of years you have worked with your employer.
The benefits are often accrued at either 1/60th or 1/80th salary.
The scheme is looked after by trustees, who are responsible for making sure there is enough money in the scheme to pay all the workers in the pension scheme when they retire.
Most employers have stopped running these types of schemes for new employees because they are simply too expensive. If you joined your employer some years ago, then you may have a defined benefit scheme. The main reason behind the expense is because people are living longer.
In fact, the expense of these types of schemes has directly resulted in companies going bust, leaving employees without pension benefits or jobs. Only strong companies have managed to survive the turmoil and to continue running these schemes for existing members.
For those lucky few that managed to enrol into one, you should try and keep hold of this valuable benefit, especially if you are with a financially stable employer.
Some employers have been known to offer their employees cash alternatives to move out of the defined benefit schemes into cheaper alternatives – but there is now a new code of conduct in place which means employers cannot offer cash incentives to make people leave and must instead offer better deals whereby the employee does not lose out on valuable pension benefits.
If you joined a defined benefit scheme in the past with a previous employer and if you were in that scheme for over two years, then it’s likely that you have a deferred pension with your past employer unless you transferred the benefits to another employer’s scheme.
A deferred pension will be held for you until you retire and it will pay a pension when you do retire. It is important therefore that you advise the pension scheme of any change in details, so they know how to contact you when your pension payment is due.
There are thousands of unclaimed pension assets, simply because people have forgotten about them and pension providers have no way of getting in touch with beneficiaries.
It’s your money, so don’t lose out.
If your employer goes bust, then there is some protection available from the Pension Protection Fund (PPF). The PPF provides compensation to eligible defined benefit pension scheme members when an employer becomes insolvent and there insufficient assets to meet pension obligations.
If you are not joining a workplace scheme and wish to make your own arrangement, then you can take out a personal pension.
Personal pensions will work in the same way as a defined contribution scheme – you chose the provider and make regular payments.
There will be charges associated with your pension provider, and you should check the ‘key facts’ document given by your provider to see what the charges are.
Pension charges are not as high as they used to be, but it is nonetheless a hit on your retirement fund, so check that you are not paying over the odds.
You will still benefit from tax relief – your provider will claim the tax relief on your part and add it to your fund, although higher rate tax payers will have to take a step further and claim the additional rebate through their tax return.
Your pension provider will have a number of funds for you to choose from regarding the investment of your contributions.
Your retirement income will depends how much you contribute, how long you contribute for and how your investments perform.
You have to buy an annuity when you reach retirement age and it is vital that you shop around for the best rates, as your provider will not necessarily have the best deal for you.
Group personal pension
Some employers offer personal pensions to their workers by what is known as a group personal pension (GPP).
They also work in the same way as defined contribution schemes, where workers build up a fund which they then use to buy a pension, in the form of an annuity, when they reach retirement age.
In a GPP, your employer chooses the provider, but the contact is simply between you and the provider, and not with your employer.
Stakeholder pensions are sometimes offered by employers, but you can also start one for yourself.
The key features are low charges with minimum contributions. There are also default funds you can invest in if you don’t want to have to choose where to invest your contributions.
If you transfer to another pension arrangement, then stakeholders will not charge you a transfer fee.
Again, they also work in the same way as defined contribution schemes, and you will have to buy a pension income, known as an annuity, when you reach retirement age.
You can start your stakeholder pension with as little as £20 a month and they are available from banks and large insurance firms.
Self-invested personal pensions
Another way of building your own retirement fund is by using a self-invested personal pension, commonly known as sipps.
It works in a similar way to a standard personal pension, but with a sipp you can take charge of your investments by choosing how and where you invest – or pay a provider to make the decisions for you.
A sipp allows you to invest almost anywhere you like, and they are often targeted at people who are experienced in investing and want to take control of their funds.
There are a number of specialist providers out there; many, such as Hargreves Lansdown, even allow you to control your investments online 24/7.
Remember however, sipps too are subject to charges and they can often be higher than the standard personal pensions or stakeholder pensions.
If you are self-employed, then it is still important that you try and save for your retirement, even though it can be more difficult, especially as you will not benefit from employer contributions and your income patterns may not be as regular as getting a monthly pay cheque.
But you will benefit from a generous tax relief – for every £100 you put in, the government will add £25 to it.
You can overcome the irregular pay pattern by paying in a lump sum, rather than committing to a monthly contribution.
Stakeholder pensions, such as Virgin Money for example, allow you to stop and start payments to suit your needs, and come with low charges.
You can also look at other personal pension options, such as sipps.
You may also be able to join the government Nest scheme, which opened its doors to self-employed in October 2012.
More people are beginning to realise that they need to start saving for a pension and that the younger the better. But how much you should stash away for old age can be difficult to work out and very much depends on your age, your employment situation and affordability.
What if you die?
If you die and are in an income drawdown arrangement described above, new rules also mean that beneficieries can take a lump sum or income tax-free if you die before age 75 or at their marginal rate if you die after 75.
If you have an annuity, your partner, spouse or named benficiaries will receive payments from a joint life, guaranteed or value-protected annuity tax free if you pass away before age 75, and after age 75, payments will be taxed at the beneficiary’s marginal rate.