Nowadays, most companies, both private and public, offer some type of pension scheme to their employees. In most cases, it makes sense to join such a scheme. The contributions to the pension scheme are automatically deducted from your pay packet, prior to income taxes.
Additionally, most companies will supplement your contributions with a contribution of their own – in most generous cases, they will match £1 for £1 what you contribute. Also, some company pension schemes will pay-out an annual bonus, based on the company’s performance. However, on average, pension schemes at public companies tend to be more generous than those in the private sector.
In the UK, there are two types of basic company pension schemes, which are known as defined benefit or final salary; and defined contribution or money purchase. Under the defined benefit pension scheme, the final pay-out is what determines how much the scheme is worth and this final pay-out amount is guaranteed. Normally, the final benefit is calculated as a portion of your final salary, i.e. the annual salary of your last year of work prior to retirement, although some schemes will give you the option of the final year or an average of your last three or five years’ salaries. At the point of your retirement, you will receive the guaranteed amount from the company’s scheme, regardless of whether the company’s pension scheme performed well or not.
Under a defined contribution scheme, the value of the pension is determined by what is contributed to it. Basically, the level of your pension at the time of your retirement is simply determined by how much you have contributed to the scheme and how well the pension fund has performed over the years. So, if the pension fund has done well, you will get more, if it has done badly, you will get less. In this type of pension scheme, it is the employee that takes the risk of the pension fund performance and not the employer.
Each company has differing regulations on what happens when you change jobs, so it is important to look at what your company’s rules are. In some cases, you will be able to take the pension fund with you as is and keep it, although you may not be able to contribute further to it. Other pension schemes will allow to you take the amount you contributed plus the company’s contribution, if you are fully vested and invest it into a new scheme. The vesting period is different from company to company, ranging form one to five years.