Pensions
For most people pensions form a central part of their retirement planning and are designed to provide an income in retirement as well as, often, a tax free cash lump sum.
Most people will have accrued a number of different pension plans during their working life and understanding what these are, the options available and what level of income they can provide in retirement is critical.
There are two main types of pension plans although, with the exception of the statutory schemes e.g. the NHS, Civil Service, Teachers’, Armed Forces, Police, Fire Service and Local Authority Pension Schemes, etc. the first of these, Defined Benefit Plans are becoming far less common.
Defined benefit
A defined benefit pension scheme provides a guaranteed income in retirement based on a formula, which takes into account your salary and years of service. The employer usually bears the investment risk, meaning that they ensure the promised benefit is paid, even if the underlying investments underperform. In other words, it provides a guaranteed income for life and potentially an income for your spouse or partner if you pass away first.
Defined contribution
The other type of pension, and far more common these days, is a Defined Contribution scheme. This relies on contributions made including potentially from an employer to build a fund that can be used in retirement. The income received depends on how much has been contributed and how well the underlying investments have performed. The investment risk is borne by you, as the value of the pension can fluctuate based on market conditions. Therefore, for this type of plan ensuring the investment strategy being employed both before retirement, and in retirement, is important and should be monitored on an ongoing basis.
Tax efficiency
Saving through a pension can be very tax efficient, in fact, saving through pensions is often used to manage income tax liabilities for individuals and corporation tax for small companies.