Since 2012, employers in the UK have been required to provide a workplace pension for their qualifying workers. The scheme is likely to be categorised in one of two ways:

  • Defined benefit pension
  • Defined contribution pension

Defined benefit pension

A defined benefit pension scheme (sometimes called a final salary or occupational pension scheme) provides a specific benefit, usually based on your pensionable earnings and the length of time that you have been a member of the scheme. Each pension scheme is likely to define what is meant by your pensionable earnings, as this may not be the same amount as shown on your pay slip. Your employer will contribute to the scheme, and is responsible for ensuring the scheme is sufficient to provide you with an income upon retirement.

You may also be required to contribute to the scheme, and be able to make additional voluntary contributions, too. These contributions may provide extra years of service, or a separate fund that adds further benefits to the already defined benefits. These schemes will provide tax relief at your marginal rate by reducing your taxable income through the pay-as-you-earn (PAYE) system.

Defined contribution pension

A defined contribution pension scheme (also known as a money purchase scheme) will invest the contributions made by you and your employer into a range of different investments. You may be offered a choice about how your contributions are invested, but when you are enrolled, a default fund will generally be selected for you by your employer.

The benefits available at retirement under this scheme will depend on how much you and your employer have contributed over the term of the scheme. However, as the funds are likely to be invested for many years, the benefits you receive will also be impacted by how the investments have performed over this period. It’s important to be very clear about the investments you select, or to ensure that the default fund is right for you.

Your employer is required to make monthly minimum payments into the pension, and if they choose to do so then you will also be required to make minimum payments. The payments you make qualify for income tax relief at your highest marginal rate. If you’re a higher (40%) or highest rate (45%) taxpayer, you may need to complete a self-assessment to claim additional relief.

If you opt out of this scheme then you may lose the value of the employer contribution, and it may not be offered through your salary as an alternative. Therefore, it can be viewed as a valuable personal benefit, which once paid, is yours and cannot be taken back.

Tax reliefs are dependent upon personal circumstances, and pension and tax rules are subject to change by the government.

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