Pensions

What are the main types of Pension?

Basic State Pension

This a pension that is paid to people above State Retirement Age. The amount of income payable is based on a person’s National Insurance contribution history.

Additional State Pension

This pension is additional pension income provided by the state and is based on a person’s income throughout their working lives. Additional State Pension comes in three forms:

• Graduated Pension
• SERPS (State Earnings Related Pension)
• S2P (State Second Pension)
• Defined Benefit Pension
• These pensions are provided by the public sector, some private sector companies and other organisations and provide set pension benefits such as defined incomes and/or lump sums. They can be based on salaried incomes and can often be referred to as Final Salary or Average Salary pension schemes.

Defined Contribution Pension

These pensions are contributed into by individuals, companies and other organisations to build up a pension fund for use in retirement. These pensions can often be subject to investment risk and usually do not offer any guarantees as to the level of pension income they would provide in retirement.

Annuity

This is a pension income that is provided by an insurance company or pension company after pension fund crystallisation. A pension fund is sold and the proceeds used to provide a set income for an individual in retirement. The income offered by an annuity can be level or can increase by inflation or by set amounts each year. Some annuities can include an element of investment risk in them (examples include unit-linked annuities, with profits annuities etc)

Drawdown Pension

This is another pension income option available to an individual after pension fund crystallisation. A drawdown pension will often continue to be invested with the pensioner drawing an income down from the invested funds. Drawdown pensions tend to offer a higher degree of investment risk than annuities.

Scheme Pension

This is the term for the pension income that is provided by a defined benefit pension scheme.

Tax Free Cash/ Pension Commencement Lump Sum

Some pensions offer the ability to take a lump sum cash payment on retirement. This may be in addition to any pension income offered but usually it will take the form of commuting entitlement to pension income. Often the maximum amount of Tax Free Cash available from a pension fund would be 25% of the fund value although some pension schemes may offer tax free cash lump sums greater than 25% of the fund value.

Some ways that pensions can be advantageous to people with a life limiting illness:

• Releasing pension monies as a tax free lump sum under the special HMRC rules can provide a person with money when they need it most. Under few other circumstances such as the death of a pension holder can a pension fund be released tax free in its entirety.
• Pension monies can be used to provide an income to a person with a life limiting illness and possibly their spouse and any dependents. How income is released to a person from a pension depends upon the rules applying to the particular pension.
• Contributing into a pension can offset tax paid on a person’s income. Individuals can contribute the equivalent of their gross salaried earnings into a pension scheme in a tax year up to a maximum of £40,000. Individuals earning in excess can possibly make use of Carry Forward to make contributions in excess of £40,000.
• Pension funds in defined contribution schemes can often be paid tax free to beneficiaries of a person’s estate – spouses, children etc.
• Pension funds bequested to charities can often be paid tax free on death. Drawdown pension funds bequested to charity would also be paid tax free on the death of the pension holder.

It’s important to seek advice before making any pension commitments or changes.

We have outlined above the main types of pension around however there are other pensions and pension options. We have only highlighted the main types of pension available in order to keep the information above brief and concise.

Seeking Independent Financial advice is important to help ensure that you choose the options most appropriate for your needs and requirements. Please note that Independent Financial Advisers may charge fees for providing their advice. Other sources of information about pensions include the Department for Work & Pensions, the Money Advice Service, the Pensions Regulator (regarding the new Workplace Pensions).