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Occupational Pensions


What are they?

Occupational pension schemes are those offered by employers to their employees. It's normal for the employer to put money into the scheme for employees' benefit and in many cases employees contribute too.

Although the schemes are set-up and usually funded (to some extent) by employers, the scheme itself is held independently of the company in a trust and is the responsibility of a board of trustees. It's their job to ensure the pension is run fairly and that you receive your pension during retirement.

Occupational pensions are usually a welcome perk for many employees, as you get 'something for nothing' if your employer makes contributions on your behalf.


What types are there?

Final SalaryMoney PurchaseGroup Personal Pension / Stakeholder

Your pension is linked to your salary and the number of years you've belonged to the scheme. This is a great option because it's your employer who must shoulder the investment risk to deliver your pension, not you.

These pensions, sometimes called 'defined benefit' or 'superannuation' schemes, normally pay you a fraction ('accrual rate') of your salary at retirement ('pensionable salary') for each year you've served in the scheme ('pensionable service'). This income might also increase with inflation each year during your retirement (i.e. it's 'index-linked')

Candid Example Mr Fortunate works for XYZ and has been a member of their final salary 1/60th pension scheme for 30 years. At retirement his salary is £50,000 a year. His pension is therefore 1/60th x 30 years x £50,000, equal to £25,000 a year.

The 'pensionable salary' used to calculate your pension varies between schemes, so it's important to check if not sure. It can range from the salary in your year before retirement to an average over your whole career within the scheme - potentially a significant difference.

These schemes usually require employees to contribute a percentage of their salary, around 5% is common.

Final salary schemes are a great deal for employees, but can cost employers a fortune. Because of this they're becoming increasingly rare, with most employers having closed these schemes for new employees and/or reduced the benefits for existing members. The Government is one of few big employers to still offer these schemes.


Should I join my employer's pension scheme?

Final SalaryMoney Purchase

If you're fortunate enough to be offered one of these you should probably bite off your employer's hand in your eagerness to join. Nonetheless, always check what you'll expect to get, including the fraction of your salary you'll receive for each year's service (e.g. 1/60th is better than 1/80th etc.) as well as how your pensionable salary is calculated. Also check what else is included, such as death benefit.


Which fund(s) should I choose in a money purchase scheme?

Investment choice can have a major impact on how much income you'll receive in retirement, so ignore at your peril. It needn't be confusing and an hour or two spent getting to grips with this could prove invaluable. Find out more in the Candid Money guide to pension investment choice.


How much will I get?

Final SalaryMoney Purchase

This all depends on how generous the scheme is, your salary and how many years of service you've built up by retirement. However, after 30 years of service you might typically expect to receive an annual pension of around 30% - 50% of your salary at retirement.


Can I add to my pension or contribute to another?

Final SalaryMoney Purchase

You normally have three choices:

  • Buy 'extra years' (of service) within the final salary pension.
  • Invest in a money purchase type pension attached to your scheme, called an 'additional voluntary contribution' (AVC).
  • Invest in a personal or stakeholder pension unrelated to your scheme.

Buying extra years is attractive provided your employer charges a reasonable price for doing so. Investing in a money purchase type scheme means taking on the investment risk yourself. If you take this route then the AVC scheme might have lower charges than an external scheme, but check whether the investment choice is satisfactory.

Whichever route you take, ensure you don't break the maximum annual contribution allowance. The find out more read our guide to pension rules.


What happens if I die?

If you're still working (i.e. haven't taken benefits)

Final SalaryMoney Purchase

Final salary schemes usually include a 'death in service' benefit, similar to life insurance. The typical level of cover is three to four times your salary and the sum is tax-free provided it doesn't exceed your available pension 'lifetime allowance' (see pension rules for more details). It's also usual for the scheme to refund your contributions and some schemes might also provide a spouse's pension at what would have been your retirement date.

If you've retired (i.e. taken benefits)

Final SalaryMoney Purchase

Final salary schemes normally pay a spouse's pension of between half and two-thirds of your pension.


How safe is it?

Final SalaryMoney Purchase

There's been a lot of press in recent years about companies going bankrupt and leaving their final salary pension funds with insufficient cash to pay member's their full pension benefits. This became such a concern that the Government introduced the Pension Protection Fund (PPF) in April 2005 with the aim of protecting employees in final salary schemes. It's basically an insurance pot funded by the pension schemes themselves. If you think your employer is in financial difficulty and/or has a big deficit in their pension fund then check carefully to what extent the PPF will protect you if the worst happens.

There are broadly two main levels of compensation:

  1. If you've reached the pension scheme retirement age, or already receive your pension, then your pension is 100% covered.
  2. If you're below the pension scheme retirement age then your pension is 90% covered, subject to an overall annual cap, currently £33,678 if benefits are taken at 65.

However, it's worth noting a few points/exceptions:

  • When compensation (i.e. your retirement income) is paid, no annual increase is paid on benefits earned from service before 6 April 1997. Benefits from service thereafter increase inline with the Retail Price Index (RPI) capped at 2.5% a year. This means the annual increase to your pension could be less than it would have been under your original scheme.
  • If the original scheme provided for a spouse's pension then the compensation will cover this too, subject to a limit of half your pension.
  • If you're below the scheme retirement age then compensation is calculated by revaluing your benefits up until retirement using RPI. This is subject a maximum increase by assuming RPI rose by 5% each year.
  • You can't transfer your pension elsewhere once it's in default and being assessed by the PPF (unless the scheme had accepted your request before).

In general, the PPF provides welcome protection for many. However, if your potential pension benefits are in excess of the annual cap and you have concerns over your employer's financial stability, there is an argument for carefully investigating whether transferring the pension elsewhere (in order to protect it) is worthwhile. While such transfers are normally a bad idea, they can make sense in this instance.


What if I leave my employer?

If you've less than two years of service you may be able to get a refund of your contributions (less tax to offset the tax relief on your contributions). Otherwise:

Final SalaryMoney Purchase

Your pension will be preserved and paid at the scheme's retirement age. You'll have the option to transfer the pension either to your new employer's scheme or another pension, but this is usually a bad idea as you could end up taking on the investment risk (and not your ex-employer).

In all situations, make sure you keep relevant paperwork and ensure the scheme administrators have your current contact details.


What happens when I retire?

Final SalaryMoney Purchase

In theory you can take up to 25% of your pension fund as a tax-free lump sum. In practice, unlike money purchase pensions, your fund doesn't have an explicit value, so a formula is used instead. To use the formula you need to know your pension schemes 'commutation rate', the amount of tax-free cash you'll receive for each £1 of pension that you give up. You can then calculate your entitlement as follows:

Maximum tax-free lump sum = 20 x Your Annual Pension / (3 + 20 / Commutation Rate).

You'll then receive an income for the rest of your life. Check your scheme details to establish whether, and by how much, the income increases each year.


Occupational Pension Jargon

Here's some of the more common occupational pension jargon you might come across:

JargonMeaning
AVCAdditional Voluntary Years, a way of increasing your potential occupational pension by contributing money into investment funds.
Death In SeviceA benefit, similar to life insurance, paid by occupational final salary pensions should you die while still working.
Final Salary SchemeAn occupational pension scheme where your pension is linked to your salary and the number of years you've belonged to the scheme.
Group Personal PensionA type of occupational money purchase pension scheme, where individual pension policies are administered by an insurance company.
Money Purchase SchemeAn occupational pension scheme where your pension depends on how much money is contributed during your career, investment performance and annuity rates when you retire.
Occupational PensionA pension scheme offered by employers to their employees.
Pension Protection FundIntroduced by the Government in 2005 with the aim of protecting employees in final salary schemes (against their employer becoming bankrupt).