Understanding Pensions

Get To Know Your Options When It Comes To Pensions

You can perceive pensions to be a complicated financial instrument. Most of us just simply do not want to think about until we have to! But we at IEP Financial can help. Allow us to provide you with a simple walkthrough to Pensions.

By the end we hope to ensure that both individuals and businesses have the knowledge to  a secure financial future.

Which type of pension do you have?

There are two main types of pensions; Defined Benefit and Defined Contribution.

A defined benefit scheme (known as a final salary pension) is set up by an employer and is a guarantee of future benefits. This is based on factors such as length of service, final salary or career average salary. Due to the nature of the guaranteed benefits, the level of pension you receive is not linked to investment performance.

A defined contribution scheme relies on how much you (and an employer) have contributed into the scheme. You will build up an invested pot of savings over time. The level of pension you receive will be affected by the overall growth within your pension.

You can download our free guide to Defined Benefit here ➜ Click To Download

Defined Contribution Schemes

This type of scheme can be set up by an employer for an individual upon them joining the company or directly by an individual (if self employed for example). Whether it is a workplace pension or a private pension scheme the value will be based upon the contributions made into the plan. These contributions are then invested which means that the size of the final pot in retirement can be affected by market fluctuations.

There are a few other factors that also affect the size of your pot:

  • Level of contributions (you and/or employer)
  • Any charges deducted by the provider
  • Length of time you save for

From April 2015 the Pensions Freedom Act gave individuals the flexibility of accessing their defined contribution pot at the age of 55. You can also take out 25% of the pot as a tax free lump sum.

Prior to this purchasing an annuity would have been the most popular option; however this type of arrangement will take into consideration your health and whether or not you wish to include a spouse’s pension.

Income drawdown may be the more popular option but one can run the risk of depleting their pension pot too early on if not managed sensibly.

Defined benefit schemes

The income received in retirement is based on three main factors:

  • Length of service
  • Your salary at retirement/career average salary
  • Your accrual rate. What proportion of your earnings you’ll get for each year spent in the scheme. This is usually represented as a fraction e.g. 1/80th

Can I switch between the two types of pensions?

You can in certain circumstances transfer a DB scheme into a DC scheme – but not the other way around.

There are benefits to transferring your DB pension into a DC scheme which include possible attractive transfer values for DB pensions depending on the market and an ability to invest the pot to take advantage of further gains.

Control – you don’t need to worry about your employer’s DB pension scheme going insolvent and being unable to pay you what was promised. This type of transaction isn’t suitable for everyone and careful consideration around your overall circumstances need to be factored in before such a decision becomes final.

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