What Types of Pensions Can you Invest in?

There are many different types of pension schemes in which you can invest. All of them have certain standard elements, but will work in different ways.

Types of Pensions Available to you:

Defined Contribution v Defined Benefit

All pension schemes operate on either a defined contribution or defined benefit basis. Defined contribution schemes are the most common, and the benefits payable depend upon how much you have invested in the scheme and how well the investments within your pension fund have done. A defined benefit scheme, however, will give a fixed and known return in retirement. They are more expensive to administer and run, and are being faded out due to their cost. Predominantly defined benefits schemes are occupational pensions, and even those run by the government are being scaled back.

Here we take a look at the similarities and differences between the various types of defined contribution pension schemes, so that you can more easily decide which one is the best option for you.

Standard practice

• All contributions up to the annual limit (currently £50,000) and within the lifetime limit attract tax relief at 20%. For every £80 invested, £100 is invested on your behalf. Higher rate taxpayers can claim back tax at the marginal rate through the tax return.
• Investment choice is up to the pension scheme holder.
• The amount available to create an income will depend on how much has been invested and how well the unvested money has performed, as well as the charges applied within the scheme and the length of time the pension scheme is held.
• You may take up to 25% of the entire pension fund as a tax free cash lump sum when retirement benefits are taken.

Personal pensions

Investment can be made as regular payments or annual lump sums. Many personal pensions will offer a default fund, or you can choose other funds to match your risk profile. Some providers will offer lifestyle funds that seek to cut risk on investments the closer you move toward your retirement date. You may be able to select other benefits, such as death before retirement, a form of life insurance that returns the accumulated fund to your spouse or beneficiaries should you die before retirement.

Group personal pension schemes

Like a personal pension scheme, but set up by your employer. It is run by a pension provider selected by the employer, though the pension itself is an individual contract between you and the pension provider. Your employer is likely to make contributions into the scheme to add to your contributions. You will have the choice of selection of funds. This type of pension can be commuted to a personal pension should you change jobs.

Stakeholder schemes

These are designed especially for lower income pension savers. They have low minimum contributions, penalty free transfers between funds, and, although you will be able to choose from a range of investment funds, a stakeholder scheme must offer a default fund for those savers that do not want the responsibility of investment choice. They also will allow flexible contributions and stakeholder schemes have low internal charges. Many employers offer stakeholder schemes, and may make contributions on your behalf to add to your own contributions.

NEST pensions

The National Employment Savings Trust has been set up to provide for the new pensions required to be offered by most employers by 2018.  Employers will enrol employees automatically into a pension scheme, and it may be that your workplace pension will be a NEST scheme. However, self-employed persons will also be able to open a NEST pension.

There will be six funds to choose from, including a default fund that will operate like a lifestyle fund. Other funds will cater for different investment risk profiles and investing styles, including an ethical fund and a sharia fund.

There will be a limit of total contributions each year (starting at £4,400 in 2012/ 13) with charges of 0.3% on the fund value and 1.8% on new contributions into the fund. There are restrictions on transferring NEST funds into other schemes.

Self-invested personal pension (SIPP)

SIPPs are designed to give the individual maximum investment choice for his pension funds. Often suffering higher charges than other personal pension schemes, SIPPs are specifically aimed at those investors with larger funds or who are experienced at managing their own funds.

A wider range of investments can be invested within a SIPP wrapper, including commercial property, stocks and shares, unit trusts, government securities, investment trusts and life funds. Different SIPP providers will allow different investment instruments to be invested within their SIPPs.

SIPP pension holders may take income by purchasing an annuity, but are more likely to consider an income drawdown facility, which allows income to be taken while the remaining fund is still invested for growth.

In summary

There are a number of different pension schemes that work under the umbrella title of defined contribution schemes. The type that you choose will depend upon your individual circumstances, your earnings, and your employment. Those employees who are offered the opportunity to contribute to an employer scheme to which the employer contributes should seriously consider doing so.

You can have as many pensions as you want providing you don’t break annual and lifetime limits on investment for tax purposes. However, you cannot pay into more than one occupational pension at a time

If you have an occupational scheme and change employers, then you will either have to arrange for the previous scheme to be converted to a personal pension, or transferred to your new employer’s scheme if the rules of the schemes allow it. If neither of these options is possible, then the previous scheme will be ‘frozen’ and only become available when you retire. However, at that time it would be possible to amalgamate many schemes into a single annuity if you so wished.