What kind of pensions do employers provide?

Pensions provided by employers are called occupational pensions.

(Confusingly, employers can also provide a gateway to some kinds of personal pension – such as a stakeholder pension and a special kind of personal pension called a group personal pension scheme.  There is more about these in the question and answer section on personal pensions.)

There are two main families of occupational pension. This is where we start to hit pensions jargon, as the two types of scheme are known by different names and each has different variations. But the two broad types are easily understood.  

• The first family of pensions are called salary related, defined benefit or final salary schemes. This type of scheme makes a pensions promise – the defined benefit – to members. In other words you can work out in advance how much pension you will be paid. Normally this is based on your salary when you retire and how many years you have been a member of the pension scheme. This particular case is known as a final salary scheme, but other ways of working out your pension are used by some schemes such as your average salary over a number of years. (Although schemes make a pensions promise, this is not legally guaranteed. Some people have lost a great deal when employers have gone bust, although a new Pensions Protection Fund now offers some help.)
• The second family of pensions are called money purchase or defined contribution schemes. With this kind of scheme the amount of pension you will get cannot be known in advance as it depends on:
• how much you and your employer contribute – the defined contribution – to the pension fund
• how well the pension fund's investments perform, and
• annuity rates when you retire. (An annuity is a financial product. In return for handing over some or all of the pension fund you have built up, you get paid a pension.)

There are many variations on both these broad types of pension, and some hybrid schemes that take elements from both, but the important difference between them is that with defined benefit schemes your employer bears the risk (although if your employer goes bust then you can still lose out), and with defined contribution schemes you bear the risk.

If there is not enough money in a salary related scheme to meet the pensions promise, the employer will need to make up the gap. With a money purchase scheme there is no pensions promise, so if the investments do badly you end up with a lower pension (though if they do very well you can get a better pension).

This is one reason why many employers are closing salary related schemes and replacing them with money purchase schemes. This is not to say, however, that all money purchase schemes are worse than all salary related schemes. There are good and bad schemes of both types, and any occupational pension is usually better than none.

Both types of occupational pensions can also provide a lump sum payment (a big cheque) when you retire, and a death in service benefit (a big cheque for your dependents) if you die before retiring.

On top of your occupational pension, you can save more through schemes provided by your employer either through AVCs (additional voluntary contributions) or, as long as you do not earn too much, a stakeholder pension. These will be money purchase schemes, and are covered in more detail elsewhere. 

There is a general introduction to occupational pensions on the Pension Service website and you can download a pdf Occupational pensions – Your guide from http://www.thepensionservice.gov.uk/resourcecentre/downloads.asp#planning