If you work as an employee for a company then the chances are that you will be able to join the company pension scheme. In most cases this is a good option, as it will be the best way of boosting your income in retirement .Regardless of which country you live in, company pension schemes tend to fall into two categories:
Defined Benefits or Final Salary Schemes
This type of scheme is typically offered by public sector employers and some larger private companies. With this type of scheme your pension is calculated by a formula, as a proportion of your final salary and is dependent upon the number of years you have worked for the company.
The advantages of this type of scheme is that there are certainties:
• You know that if you work for so many years, you will be entitled to a certain level of pension.
• You do not have to worry about stock market movements, because you will obtain the promised pension irrespective of how well the pension fund is invested.
• You will generally have to pay a percentage of your salary into the scheme (typically 5%), which is taken from your gross salary. In return your employer will bear all the investment risk.
Take time to read your company scheme booklet which will outline the maximum retirement benefits payable and any entitlements to a tax free lump sum, life cover etc…
The bad news with this type of scheme is that for many women they are unable to build up enough years of service to get adequate benefits in retirement. The costs of running a defined benefits scheme have blown out of all proportion in the last decade, because retirees are living to older ages. The various stock market down turns over the years have exposed huge funding black holes at major multi national companies. Because of the increased funding costs, many companies are changing from defined benefit schemes to defined contribution schemes.
Defined Contributions or Money Purchase Schemes
With this type of scheme, your final benefits will be determined by the amount of money paid in by you and your employer and the investment earnings of the fund. The performance of the underlying fund is critical to what you end up getting. It is therefore very important that you take an interest in the investment funds on offer and select funds appropriate to your risk profile and time horizon.
Watch our Investment Risk Pyramid Video to help you with this...
This type of scheme is becoming increasingly common, they are easier to understand and more flexible than defined benefits schemes, however, your end benefits are less predictable. What you get out will largely depend on investment performance.
Watch our video specifically about UK Company Pensions here..
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