Occupational Pensions
An occupational pension scheme is a pension scheme provided by an employer for its employees.
There are two main types of occupational pension schemes:
Final Salary Pension Scheme:
A 'final salary' scheme, technically a 'defined benefits' scheme, provides employees with pension benefits linked to the number of years of scheme membership and their 'final pensionable salary'.
Members of final salary pensions are not reliant upon pension fund performance, as their employer is obliged to put more money into the scheme if the fund will not be sufficient to pay all scheme benefits. It is probably for this reason that in recent years, employers have been closing final salary schemes.
A member of a final salary scheme may or may not be required to make contributions. If they are required to pay into the scheme, a typical contribution would be 6% of their gross salary. They will receive tax relief on their contribution at the highest rate at which they pay income tax.
For example, Ethel, who is just about to retire, has been a member of her final salary scheme for 40 years. Her final pensionable salary is £40,000. Her scheme provides her with a pension based on 1/80 of her 'final salary' for each year, plus a tax-free cash lump sum based on 3/80 of her final salary for each year. Her pension in payment will rise in line with the Retail Prices Index.
Ethel will therefore retire on a starting pension of £20,000 and will receive a tax-free sum of £60,000.
Money Purchase Pension Scheme:
A 'money purchase' scheme does not provide a pension based on the employee's years or service and final salary.
The employee's pension at retirement will depend upon the investment performance of the pension funds assets, (for example, 'stocks and shares') and annuity rates at retirement.
If the pension fund does not do as well as hoped, the employee's pension may be less than expected.
Unlike a final salary scheme, an employer does not have to put more money in the pension fund if it looks as though the benefits for the employees may be less than originally anticipated.
The employer and employee usually both contribute into the pension fund. The employee's pension is then provided by using the employee's pension fund entitlement to purchase an annuity.
