Types of pension schemes

There are different types of pension schemes and arrangements that you can belong to. Find out about the relationship between pension arrangements and schemes and how this affects the way you can take your pension pot and the way it's taxed.

On this page:

Pension schemes and arrangements

There are lots of different types of pension schemes but the most common types are:

  • occupational pensions - also known as company pensions
  • personal pensions
  • stakeholder pensions

Each pension scheme is made up of individual pension pots for each member - called pension arrangements. It's important that you know what type of pension arrangement(s) you belong to because it affects how:

  • you can take your pension
  • your pension pot is taxed

When you joined your pension scheme you should have been given information telling you what type of benefits the scheme provides. Your pension scheme administrator can give you this information.

Top

Pension arrangement types

You can be in any number of arrangements in the same scheme. An arrangement can only pay you one type of benefit, so if you're getting more than one type of benefit you must have more than one arrangement in the scheme.

There are four different types of pension arrangements:

  • money purchase
  • defined benefits
  • cash balance
  • hybrid

Money purchase arrangements

These are also called 'defined contribution' arrangements. With a money purchase arrangement you won't know in advance how much pension you'll get when you retire. You build up a pension pot that you use to provide you with your pension.

The value of your pot will depend on how much money you contribute and how well the funds are invested. This means the value of your pension will depend on how much pension your pension pot can 'buy'.

Any type of pension scheme (occupational or personal pension) can have money purchase arrangements. The following types of pension schemes are normally money purchase arrangements:

  • personal pensions (PP)
  • stakeholder pensions (SHP)
  • retirement annuity contracts (RAC)
  • small self administered schemes (SSAS)
  • free standing additional voluntary contribution schemes (FSAVC)
  • self invested personal pensions (SIPP)

Defined benefits arrangements

With this arrangement the amount of pension you'll get when you retire doesn't depend on the size of your pension pot. Under this arrangement you're promised a certain amount of pension at retirement. The amount of your pension is usually based on your pay and length of service. Usually you can work out in advance how much pension you'll get when you retire.

Defined benefits arrangements are normally only found under occupational pension schemes. Examples of a defined benefits arrangement are:

  • final salary - where your pension is based on your final salary and number of years with that employer
  • a career average scheme where your pension is based on the average of your earnings over your period of employment
  • lump sum only schemes that don't provide a pension but only a lump sum - say 3/80ths (3.75 per cent) of your final pay for each year of employment or scheme membership

Cash balance arrangements

These are less common than money purchase or defined benefit arrangements. You'll be promised a pension pot of a guaranteed amount when you retire. The amount of pension you'll get will depend on how much your promised pension pot can buy when you start to take your pension.

For example, if you've been promised that your pension savings will be £20,000 for each year of employment, your promised pension savings will be £100,000 after five years.

Hybrid arrangements

In a hybrid arrangement you won't know before you take your pension which type of benefit you'll get.

For example, you and your employer pay money into a pension scheme and the money is invested. You're promised a pension of at least £15,000 a year. However if your pension pot can give a bigger pension than that, the bigger pension will be paid to you. So the pension promised to you is either:

  • a defined benefit of £15,000
  • a bigger money purchase pension

More than one type of benefit under a scheme

A pension arrangement can only pay out one type of benefit. It's possible to get more than one type of benefit from the same scheme. For example if you have benefits promised on a final salary (defined benefits) basis, but you've also paid additional voluntary contributions (AVCs) to build up extra benefits under a money purchase basis. Here you would be a member of a defined benefit arrangement and a member of a money purchase arrangement under the same scheme.

Top

Pension scheme types

There are many different types of pension scheme that you can join to save for retirement. Information on the most common types is given below.

Occupational pension schemes

These schemes are also called company pension schemes. It's a scheme set up by an employer to provide pension or death benefits for its employees. An occupational pension can provide pension benefits on a money purchase, defined benefits, cash balance or hybrid arrangement basis. The two most common arrangements for occupational schemes are:

  • defined benefits
  • money purchase

If you leave your job you'll normally have to stop building up pension savings in your employer's scheme.

Your employer doesn't have to let you join their scheme. However from October 2012 employers will have to start enrolling their employees into a workplace pension.

Enrolling into a pension at work - GOV.UK website (Opens new window)

Personal Pension schemes

A personal pension scheme is set up and run by a regulated financial organisation such as a bank or insurance company. You can pay regular or lump sum contributions to the scheme, who will invest it on your behalf.

Anyone can start paying into a personal pension scheme - you don't have to be in employment. If you're an employee your employer may pay into your personal pension scheme - but they don't have to.

Personal pensions are money purchase arrangements so the amount of pension you'll get depends on:

  • the amount of money paid into the scheme
  • how well the investment funds perform
  • the 'annuity rate' at the date of retirement - an annuity rate is the factor used to convert the 'pot of money' into a pension

Your personal pension scheme provider should send you a statement each year telling you how much your pension pot is worth.

Stakeholder Pension

Stakeholder pensions are really a type of personal pension. The only difference is they have to meet a number of standards which include:

  • a 1.5 per cent limit on annual management charges
  • they have to accept contributions as low as £20
  • you can stop, start and change your contributions whenever you like

Retirement annuity contracts

These work in the same way as personal pension schemes. They're mainly aimed at the self employed and could only be taken out before July 1988.

Other pension types

There are other types of pension scheme that come under the occupational or personal pensions umbrella and the most common are:

  • National Employment Savings Trust (NEST)
  • group personal pension (GPP)
  • self invested personal pension (SIPP)
  • free standing additional voluntary contribution scheme (FSAVC)
  • buy out policy - also known as deferred annuity contract or section 32 policy
  • small self administered schemes - SSAS
  • employer finance retirement benefit scheme (EFERBS)

Find out more about NEST (Opens new window)

Types of UK registered pension schemes - The Pensions Advisory Service website (Opens new window)

Top

More useful links

Options when you take your pension

Understanding the lifetime allowance for pension schemes

Understanding the annual allowance for pension schemes

Top