Being able to comfortably retire from working life is a milestone that many people look forward to. But how exactly do you get there? Understanding how workplace pensions work now will set you in good stead for the future, and help you to make the most of your retirement.
What is a workplace pension?
A workplace pension is a scheme set up by your employer that allows you to save for your retirement. They can also be called occupational or company pensions.
Workplace pension schemes fall into two main categories:
1. Defined benefit schemes
Defined benefit schemes do not require you to contribute to the scheme. Instead, your employer will simply pay you a pension when you retire. The amount you get is based on your salary, how long you’ve been employed with the company and the scheme's 'accrual rate' (a percentage of your final salary that's set by the scheme).
These types of pension scheme are very costly for employers, so they’re becoming increasingly rare.
2. Defined contribution schemes
This is by far the most common type of workplace pension scheme. Your retirement fund is built up from contributions from both you and your employer.
The contributions are then invested, usually in stocks and shares, by people working for the pension scheme company. The aim is to grow your contributions enough to give you a suitable income when you retire.
Once you reach retirement age, you can start drawing on the funds you’ve saved up to pay for your living expenses.
Workplace pension funds: the rules
Employers must automatically enrol eligible employees
By 2018 every employer in the UK must automatically enrol eligible employees into a workplace pension scheme. This includes people being paid by an agency or on fixed-term contracts. You're classed as eligible if you satisfy these three criteria:
you work in the UK
you earn more than £10,000 a year
you’re over 22 but under the state pension age
If your salary is less than £10,000 a year you can still ask to be enrolled as long as you earn more than £5,876. From 2018 your employer cannot refuse this request.
Both you and your employer have to contribute to your pension pot.
Currently, your employer must pay in an amount equivalent to at least 1% of your salary. The minimum amount will increase to 2% in April 2018 and to 3% in April 2019.
Your contribution will be deducted automatically from your salary each month. At the moment, the minimum you can contribute to your workplace pension is 0.8% of your salary. This will increase to 2.4% in 2018 and to 4% in 2019.
Of course, nothing stops your employer from contributing more to your pension fund. Many employers offer higher contributions as part of their package to attract the best employees. You can also opt to contribute more than the minimum amount if you want to.
Some employers also offer an option known as salary sacrifice. This involves giving up some of your salary and in exchange your employer makes contributions directly to your pension fund, rather than taking them out of your larger salary. The advantage here is that you won’t have to pay tax on the portion of your salary that you're 'losing'.
If you take leave from work, but remain employed by your company, then it can change how you and your employer contribute to your fund. If your leave is unpaid, maybe you're taking a sabbatical for example, then your employer doesn’t have to make contributions. However, you may still be able to keep making contributions. It’s best to check this with your employer. However, if you're taking unpaid maternity leave your employer must pay pension contributions for at least the first 26 weeks.
If you take paid leave, including paid parental leave, both you and your employer keep making contributions as normal. The contributions will be calculated as a percentage of the pay you receive over your period of leave.
How much of my salary should I put into my pension?
This depends on what your plans are for your retirement and how much you can afford to contribute each month.
A rule of thumb is to put away a percentage of your income that’s equal to half the age you start saving at. If you start saving at 26 you could put 13% of your pre-tax salary aside every year. If you're unable to do this, start with what you can and gradually increase it.
If you can, it's worth starting your retirement fund as early as possible, so your money has longer to grow. This is due to something called compound interest. This is where you earn interest on the money you put into the fund and also on any interest you've already earned. You can calculate how much you could earn in compound interest using a
What if I change jobs?
If you decide to change jobs, become self-employed or unemployed, your pension is still yours. You usually have three options:
Keep making contributions to your old pension.
Leave your old pension alone and start contributing to your new one. What you’ve invested in your old pension will keep earning interest and you’ll be able to use it when you retire.
Transfer your old pension to your new one.
If you’ve worked at your old workplace for less than two years, you may be able to have your contributions refunded.
A defined benefit pension can be switched to a defined contribution pension. However, you’ll need to speak to a financial adviser if it’s worth more than £30,000. There are some defined benefit pensions that cannot be transferred, called “unfunded” public sector pensions. Examples of these include the teachers’ pension scheme and the NHS workers’ pension scheme.