What types of occupational pension scheme are there?

There are two main types of scheme.

Salary-related schemes (also known as ‘defined-benefit’ schemes).

The pension you get in a salary-related scheme is based on:

• the number of years you belong to the scheme as an employee; and
• how much you earn (usually, your earnings when you retire or leave the scheme).

You usually have to pay contributions into the scheme on top of those that your employer pays.

In a contracted-out salary-related scheme (COSRS), you and your employer will pay lower National Insurance contributions. The difference between the full rate and the lower rate of contributions is known as the rebate. However, where your earnings fall below the level at which you have to pay National Insurance contributions, any rebate payable will go to your employer.

For a salary-related scheme to be able to contract out of the additional State Pension, it must pass a test of overall scheme quality. The scheme actuary (a professional who works out the costs of different possible events) must issue a certificate to show that the scheme meets this standard.

Money purchase schemes (also known as ‘defined contribution’ schemes).

In a money purchase scheme, your contributions (together with your employer’s) are invested. The pension you get is based on the total payments into the pension fund, and how well these investments have done. In general, the longer your payments have been invested, the larger the pension you will get when you retire. Most money purchase schemes operate by allowing you to use the money you have built up in the scheme to buy an ‘annuity’ from an insurance company – an agreement to pay you a pension for life – when you retire. This annuity may also give payments to your husband or wife if you die before they do.

In a contracted-out money purchase scheme (COMPS), you and your employer pay lower rate National Insurance contributions. As with a COSRS, the difference between the full rate and the lower rate is known as the rebate. Where your earnings fall below the level at which you have to pay National Insurance contributions, any rebate payable will go to your employer. Your employer must also pay into the scheme an amount at least as much as the total of the National Insurance contribution rebate. Once a year, the Inland Revenue will add an age-related payment to your pension, based on your earnings. Older people get a higher age related payment than younger people, so that they can build up a pension that reflects the additional State Pension they have given up.