Private pensions have a number of similarities and differences. This guide will explain the differences between pension types, as well as some similarities. There are two main types of private pension:
- Defined contribution
- Defined benefit
Differences Between Pension Types
Defined Contribution Pensions
Defined contribution pensions (also referred to as money purchase schemes) are a type of personal pension. They can be workplace pensions provided by your employer or private pensions, which you would need to arrange yourself or through a financial advisor.
Money paid into the pension is put into investments (such as stocks and shares) by the chosen pension provider. The value of your pension pot can therefore go up or down depending on how the investments perform.
These pensions offer a variety of funds to invest in, which represent different levels of risk. Some schemes automatically move you into a low-risk fund as you approach retirement, often described as lifestyle switching.
What you receive from the pension at retirement is not guaranteed. This depends on how much was paid in, and how well the investments have performed.
Defined Benefit Pensions
Defined benefit pensions are workplace pension provided by employers. They are also known as final salary pensions.
Unlike defined contribution pensions, how much you receive from your pension at retirement is not dependent on investment performance, or how much you have paid in. Defined benefit pensions are based on your salary and how long you have worked for your employer.
Defined benefit schemes also differ for defined contribution schemes in that the pension provider will guarantee to pay you a certain amount each year when you retire. The amount you receive year on year often increases in line with inflation.
Differences Between Other Pension Types
Self Invested Personal Pensions (SIPPs)
Self-invested personal pensions (SIPPs) are a pension ‘wrapper’ that allow you to save, invest and build up a pot of money for when you retire. It is a type of defined contribution personal pension and works in a similar way. The main difference is that with a SIPP, you have more flexibility with the investments you can choose, which you manage yourself or with the help of a financial adviser.
As you’re in control, you can make changes and additions to your investments as often as you want. SIPPs can offer much wider investment options than other pension types.
Small Self-Administered Schemes (SSAS)
Small self-administered pension schemes (SSAS) are generally set up to allow a small number of senior staff in a company to build up a pot of money. They differ from other occupational pension schemes in that they limit the membership to usually no more than 11 members. These are often company directors or senior executives. However, they can be open to other workers and even family members.
The value of a member’s entitlement from a SSAS when they retire depends on:
- The amount of money that’s been paid in
- The length of time that each contribution has been invested
- investment growth over this period and the level of charges (if applicable).
SSAS pensions function like most other workplace pensions, with a few key differences. Like most defined contribution schemes, the employer and/or its members pay contributions, which are all eligible for tax relief. Members can start withdrawing benefits from the age of 55 in the standard way.
However, unlike other schemes, there’s often no pension provider involved. All the members, or trustees, decide what happens with the monies, thus gaining greater flexibility and control. Another key difference is that you can pass down the benefits of the scheme to future generations.
How we Can Help with Differences Between Pension Types
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