Occupational hazards should not put you off
With company plans, it's simple: if your employer wants to give you money, take it. For those forced to go it alone, the decision is more complex
Lots of people in pensionable employment underestimate the value of their pension scheme. The greatest benefit of a company pension scheme is that most of the money is normally put in by someone else - the employer.
Insurance company research indicates that nearly a fifth of earnings needs to be saved throughout the working years to provide a realistic retirement. But the employee's personal commitment is often as little as a 20th of salary. Twice as much, and in many cases even more, is paid by the company.
The employer normally covers the costs of running the scheme, and commonly also offers other benefits, such as a payment for death-in-service (life insurance), health insurance and widow's pension benefits.
Steve Bee, head of pensions at Prudential, the UK's biggest personal pension company, says: "Anyone offered the chance to join a company scheme should grab it with both hands. A pension is effectively deferred income. No one would decline an offer of more income today, so why even think about not accepting it for tomorrow?"
In a typical scheme, around 5 per cent will be deducted from employees' salaries as a pension contribution, with the company paying another 10 per cent. From the fund accumulated, the Revenue allows a maximum pension of two-thirds pre-retirement earnings.
The employee can choose to commute (trade in) part of his or her pension entitlement for a lump sum of tax-free cash worth up to 150 per cent of salary. As a rule of thumb, your pension will be reduced by a pounds 1 for every pounds 9 you take as a lump sum. For example, earnings of pounds 36,000 would allow a maximum pension of pounds 24,000 a year.
By taking maximum cash of pounds 54,000 (pounds 36,000 multiplied by 150 per cent), the pension would be reduced by one-ninth, or pounds 6,000. This leaves a lifetime pension of pounds 18,000 a year.
Occupational pension scheme benefits are usually attributed on the basis of 60ths per year of service. Typically, 1/60th of the final salary is awarded for every year of work for a particular employer. In this case, 40 years' service is needed to automatically reach the two-thirds maximum.
Many government schemes, such as for teachers, work on 80ths. At first sight this may appear less attractive, with the same 40 years' service potentially accruing you a pension of just 50 per cent of salary. But a tax-free cash equivalent to 3/80ths for each year of service is paid on top, so the benefits of both schemes come out the same.
Despite the enormous benefit of company schemes, individuals may still harbour worries about security following scandals such as Robert Maxwell's pension fund plundering. In fact, the fall-out from Maxwell may have given rise to a disproportionate amount of concern. Company schemes are generally well run, and a new Pensions Act has been introduced to allay any remaining fears.
The provisions of the Act, most of which are implemented in April next year, place a heavy responsibility on those running schemes to ensure there is enough money in the pot to meet the promises made. Penalties for getting it wrong will be severe.
Yet, welcome as the protection is, it all costs money. The employee's deal under a salary-linked occupational pension scheme is generally superb, but it is matched by a theoretically unlimited commitment by the employer to pour in money when necessary. If the scheme is underfunded, or investment performance is poorer than envisaged, the company's finances can be hit for six.
Not surprisingly, then, employers are tending to move away from such schemes. Less of a liability to the employer are pension schemes where, instead of giving a guarantee of a pension related to final salary, the pension the employee draws on retirement is a result of the money put in, investment return and the time it has had to grow. The level of pension income is not guaranteed and poor performance will mean a lower pension. Such schemes are generally known as money-purchase.
Some employers have decided to avoid the commitment to a company scheme and the provisions of the Pensions Act altogether by opting for group personal pensions (GPPs).
These schemes can take employer contributions in the normal way, but all individuals effectively have a scheme with their own name on it - their own personal pension.
This type of scheme is very flexible, and many believe it issuitable for employees who switch jobs frequently or who work on contract.
The employee can carry the pension with him from job to job, and although the employee is subject to limits on annual contributions (calculated according to age and salary), there are no Revenue limits on the resulting pension income.
However, the biggest problem facing most employees is not theft or the exceeding of Revenue funding limits, but having enough pension at all. Ron Spill, Legal & General's pension spokesman, says: "With modern job mobility, the idea of doing 40 years in one company pension scheme is completely out of date. Only 1 per cent of all employees will receive the maximum benefits. People who start late or want to retire early from a company scheme face the sobering issue of how to make up the shortfall."
The gap can be enormous - retiring 10 years early can cost as much as 70 per cent of the fund build-up, and five years around 40 per cent.
The most tax-efficient solution to make up some of the potential shortfall is to pay additional voluntary contributions (AVCs), which attract relief against income tax in the same way as contributions to the normal pension plan.
An employee may contribute up to 15 per cent of his annual salary to the main pension scheme and AVC combined. AVCs are available both in-house or free-standing with an outside insurer.
Charges, flexibility and investment performance can vary with both. The charges of in-house schemes are normally subsidised by the employer, but one great advantage of the free-standing option is the ability to save aggressively towards a financial target for early retirement without alerting the boss to your plans.
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