Occupational Pensions

Your pension is linked to your salary and the number of years you've belonged to the scheme. This is a great option because it's your employer who must shoulder the investment risk to deliver your pension, not you.

These pensions, sometimes called 'defined benefit' or 'superannuation' schemes, normally pay you a fraction ('accrual rate') of your salary at retirement ('pensionable salary') for each year you've served in the scheme ('pensionable service'). This income might also increase with inflation each year during your retirement (i.e. it's 'index-linked')

Mr Fortunate works for XYZ and has been a member of their final salary 1/60th pension scheme for 30 years. At retirement his salary is £50,000 a year. His pension is therefore 1/60th x 30 years x £50,000, equal to £25,000 a year.

The 'pensionable salary' used to calculate your pension varies between schemes, so it's important to check if not sure. It can range from the salary in your year before retirement to an average over your whole career within the scheme - potentially a significant difference.

These schemes usually require employees to contribute a percentage of their salary, around 5% is common.

Final salary schemes are a great deal for employees, but can cost employers a fortune. Because of this they're becoming increasingly rare, with most employers having closed these schemes for new employees and/or reduced the benefits for existing members. The Government is one of few big employers to still offer these schemes.

Your pension is dependent on how much income for life your pension fund can purchase at retirement This in turn depends on how much money is contributed during your career, investment performance and annuity rates when you retire.

These schemes, sometimes called 'defined contribution', require employers and often employees to contribute money into a pension fund. Employees can usually choose from several investment fund options, ranging from safe to risky, with the option to change in future.

Unlike final salary pensions, money purchase schemes shift all the investment risk onto employees. If stockmarkets crash, it's the employees who get hurt, not employers.

Although less attractive than final salary schemes, money purchase pensions can still be a worthwhile perk, especially when the employer makes a generous contribution. Contribution levels vary widely, but a 3% - 5% employee contribution matched by the employer is typical.

These pensions are really just another type of money purchase scheme. However, rather than being a single scheme that is run by trustees, group personal pension and stakeholder pensions are individual policies administered and run by insurance companies. By grouping a large number of polices together (i.e. buying in bulk) your employer should be able to negotiate reduced costs compared to a standard personal or stakeholder pension. You might also enjoy a wider choice of investment funds to choose from than a conventional money purchase scheme.

All employers with five or more employees must offer their employees a stakeholder pension. However, employers are not obliged to contribute any money so in many cases it's a pretty pointless exercise.

If you're fortunate enough to be offered one of these you should probably bite off your employer's hand in your eagerness to join. Nonetheless, always check what you'll expect to get, including the fraction of your salary you'll receive for each year's service (e.g. 1/60th is better than 1/80th etc.) as well as how your pensionable salary is calculated. Also check what else is included, such as death benefit.

If your employer contributes some money then it's at least worth a serious look and very likely worth joining. Just ensure you understand what charges may be deducted and the investment options available.

If your employer doesn't contribute then there's no reason to join unless the scheme offers a better deal than others in the marketplace, e.g. the employer may have negotiated lower charges or will pay for you to receive advice.

This all depends on how generous the scheme is, your salary and how many years of service you've built up by retirement. However, after 30 years of service you might typically expect to receive an annual pension of around 30% - 50% of your salary at retirement.

Obviously, the bigger your pension fund at retirement the better. This will depend on how much is contributed and how successfully your pension fund grows. Use our 'How Much?' Retirement Calculator to estimate how much you might get in retirement.

You normally have three choices:

• Buy 'extra years' (of service) within the final salary pension.
• Invest in a money purchase type pension attached to your scheme, called an 'additional voluntary contribution' (AVC).
• Invest in a personal or stakeholder pension unrelated to your scheme.

Buying extra years is attractive provided your employer charges a reasonable price for doing so. Investing in a money purchase type scheme means taking on the investment risk yourself. If you take this route then the AVC scheme might have lower charges than an external scheme, but check whether the investment choice is satisfactory.

You have two choices:

• Invest in a money purchase type pension attached to your scheme, called an 'additional voluntary contribution' (AVC).
• Invest in a personal or stakeholder pension unrelated to your scheme.

Final salary schemes usually include a 'death in service' benefit, similar to life insurance. The typical level of cover is three to four times your salary and the sum is tax-free provided it doesn't exceed your available pension 'lifetime allowance' (see pension rules for more details). It's also usual for the scheme to refund your contributions and some schemes might also provide a spouse's pension at what would have been your retirement date.

Money purchase schemes simply pay the value of your pension fund to whoever you've named as the beneficiary. However, your employer might provide life cover as a separate benefit.

Final salary schemes normally pay a spouse's pension of between half and two-thirds of your pension.

For money purchase schemes it depends on whether you bought an annuity with your pension or left it invested to draw an income.

If an annuity any payment will depend on whether you included a spouse's pension or 'guaranteed period' option, e.g. if you die within five years of buying the insurer will payout the balance of what you would have received over the five years.

If you left the pension invested it will pass to your beneficiaries, either as a lump sum or as income. If you're under 75 when you die these paymenst will be tax-free, else taxable at the beneficiaries marginal income tax rate.

There's been a lot of press in recent years about companies going bankrupt and leaving their final salary pension funds with insufficient cash to pay member's their full pension benefits. This became such a concern that the Government introduced the Pension Protection Fund (PPF) in April 2005 with the aim of protecting employees in final salary schemes. It's basically an insurance pot funded by the pension schemes themselves. If you think your employer is in financial difficulty and/or has a big deficit in their pension fund then check carefully to what extent the PPF will protect you if the worst happens.

Once money has been contributed into your pension scheme it is, in theory, safe (ignoring underlying investment performance). Neither your employer nor the pension provider can touch the money.

Your pension will be preserved and paid at the scheme's retirement age. You'll have the option to transfer the pension either to your new employer's scheme or another pension, but this is usually a bad idea as you could end up taking on the investment risk (and not your ex-employer).

The funds remain invested and performance up until retirement will largely affect the value of your pension income. It's important you continue to monitor the pension and alter the fund(s) your money invests in if necessary.

You can transfer elsewhere, and this is likely to be a more viable option than under a final salary scheme. Nonetheless, tread carefully, as you'll need to analyse the transfer value from your ex-employer's scheme along with the costs and performance potential from any new scheme.

In theory you can take up to 25% of your pension fund as a tax-free lump sum. In practice, unlike money purchase pensions, your fund doesn't have an explicit value, so a formula is used instead. To use the formula you need to know your pension schemes 'commutation rate', the amount of tax-free cash you'll receive for each £1 of pension that you give up. You can then calculate your entitlement as follows:

Maximum tax-free lump sum = 20 x Your Annual Pension / (3 + 20 / Commutation Rate).

You'll then receive an income for the rest of your life. Check your scheme details to establish whether, and by how much, the income increases each year.

You can take up to 25% of your pension fund as a tax-free lump-sum. The balance is used to either purchase an income for life using an annuity or can be left invested for you to draw an income as required. To find out more read our taking income page.