Pensions

Final salary, money purchase, stakeholder; Pam Atherton unravels pension schemes.

Anyone joining a company with five or more employees is eligible to join a pension scheme provided by their employer - be it a stakeholder, group personal pension, group money purchase or a final salary scheme.

Final salary (also known as defined benefit) schemes are based on years of employment and salary at retirement, and pay a maximum of two thirds of your final salary. In practice, few people achieve this because it requires working for the same employer for around 40 years.

Final salary schemes offer members an accrual rate of 40ths (most generous), 60ths or 80ths (least generous). So, if you earn £100,000 and have done 40 years service in a 60ths scheme, your pension would be as follows:

40/60th x £100,000= £66,666 pa pension.

But with an 80ths accrual rate your pension would be as follows:

40/80ths x £100,000 = £50,000 pa pension

Employer-sponsored

It is usually in your interest to join an employer sponsored pension scheme as your employer will contribute (with the exception of stakeholder schemes) between 3% (the minimum for group personal pensions) and up to 20% or more of your salary to a final salary scheme.

You will be told how much you must contribute yourself. This can range from 3%-15% of your gross salary. A very few schemes do not require employee contributions and are called 'non contributory' schemes.

Final Salary

The maximum you can contribute to a final salary scheme is 15% pa of your gross salary, including top-up pension contributions. (See 'Top up your pension'.)

Final salary schemes have traditionally been considered to offer a 'copper bottomed' guarantee of a pension at retirement, but this is not always the case.

These schemes are only as strong as the sponsoring employer and the company's commitment to the scheme.

Group money purchase

Group money purchase (also known as defined contribution) schemes have the same contribution limits as final salary schemes (up to 15% pa of salary), but your contributions are invested in stock market linked funds, so the value of your pension pot will fluctuate in value.

At retirement, the maximum benefits available from a group money purchase scheme are the same as for a final salary scheme, but the pension is provided in the form of an annuity.

Group personal pensions

Group personal pensions (GPPs) are governed by personal pension rules so the contribution limits and benefits are completely different.

Contributions are based on your age and a percentage of salary, subject to an earnings cap of £102,000 in the current tax year:

Age at start of tax year % of net relevant earnings

Under 36    17.5
36-45     20.0
46-50     25.0
51-55     30.0
56-60     35.0
61-74     40.0

Earnings cap £102,000 (04-05)

The size of your pension fund at retirement will depend on the success of your investments and annuity rates, so the burden of making investment decisions rests with you.

At retirement, you can take up to 25% of the fund as tax free cash, but the balance must be used to purchase an annuity. (See 'Options at retirement' for alternatives to buying an annuity.)

Stakeholder

The same personal pension contribution and benefit rules apply to stakeholder pensions, but employers are not required to contribute. Stakeholders are simple, low cost, personal pensions and companies with five or more employees have to offer access to a plan if they have no other pension in place.

Tax relief

All personal pension contributions are now made net of 22% standard rate tax. Higher rate taxpayers have to claim the extra 18% tax relief via their self assessment tax returns.

From 6 April 2006, all pensions will be simplified under one set of rules with an annual contribution allowance of 100% of earnings up to £215,000 pa.