Types of UK Pensions
Types of UK Pensions
There are many different types of pension, which really means there are many different ways the pension providers invest your money.
To make it even more complex all kinds of different names are given to what are often the same thing.
When you sign up for a pension you will be given a choice of investment fund you want your savings to be invested in. How your money is invested and what returns you might receive will depend on the type of pension fund you choose.
The main types are company shares, property and government securities.
Your IFA or pension provider will explain the different approaches to you in detail. Because of the large variety available we’re only going to touch on the major categories of Pension Funds – unless enough users of Pensionsorter request us to, via Feedback.
The two major categories of pensions are either “With Profits pensions” or “Unit Linked Pensions”.
With profits pension fund or plan.
These funds invest in a mixture of UK and overseas shares, property, fixed interest and cash deposits.
At the end of each year you get a bonus depending on the performance of the fund and what the pension fund manager decides is reasonable bearing in mind past and future investment conditions.
The intention is to balance out the ups and downs in the stockmarket so pension providers are often quite cautious.
The advantage is that once these bonuses have been awarded they cannot be taken away, i.e. the value of your funds cannot fall. At retirement another final bonus may be added if investment conditions have been good. These funds are generally regarded as a medium risk option.
Unit linked funds or plans
There are a variety of unit linked investment funds available. They are usually more risky than “with profits pension funds” because their value will fluctuate in line with the underlying investments. However the returns can be better in the long term. The main types of unit linked funds are:
- Managed funds – These are popular unit linked funds because they invest in a mixture of UK and overseas shares, property, fixed interest securities and cash deposits. The job of the investment manager is to adjust the balance between these assets as investment conditions change. Some companies offer a choice of managed funds some of which are more risky (i.e. with a higher exposure to shares) than others.
- Specialist funds – Most companies offer a range of specialist funds which invest purely in one type of asset, such as UK or overseas shares, commercial property, fixed interest securities or cash. These cater for savers who like to make their own investment decisions.
- Tracker funds – These are “passive funds” which aim to follow the performance of a particular stockmarket index such as the FTSE 100 or FTSE All Share Index. They will rise and fall in value in line with share prices but the advantage is that investors avoid choosing a poor fund manager whose performance may lag behind these indices. They also tend to cost less than managed funds.
- Lifestyle funds – These are usually arrangements where savings are placed initially in a tracker fund, but as the investor approaches pension age the money is switched gradually – over a period of five to ten years – into a safer, fixed interest fund. This is to provide protection against a possible fall in the stockmarket just before retirement.
Equity Release Schemes
These are not pension schemes but a way of unlocking the value of your home in old age.
There are various types of equity release schemes. Typically you use the value of your house to raise money to pay for a regular income / annuity or to borrow a lump sum which you then invest to generate an income.
The idea is that the loan is repayable at some stage from the sale of your house, which could take place after your death.
Small self administered pension schemes. (SSAS).
Occupational Pension plans were really designed with large firms in mind so they are not totally suitable for small businesses.
SSASs enable small businesses to save in a more flexible way and are seen as a type of small company occupational scheme.
A particular attraction of an SSAS is that the pension fund can be used to help the business e.g. by providing loans and / or buying commercial property – which the company could then lease back. (All such arrangements have to be done on strictly commercial terms and are subject to detailed scrutiny by the Inland Revenue).
There is also great flexibility with when and how contributions can be made e.g. allowing for up to 70% of a director’s salary to be contributed into the pension fund by the company in any one year.
This means that in the years when the company cannot afford to make very large pension contributions they can be made up for in better years.
Each member is normally a trustee of the pension scheme. These schemes can be run “out of house” if the company does not want to administer them.
Group personal pensions
Some employers offer these as an alternative to their own company / occupational pension plan. They are subject to the rules governing personal pensions i.e. you can save more of your earnings than a company / occupational pension. (See Tax benefits for company / occupational pensions).
They would have an advantage over a personal pensions plan if the employer makes contributions and if they have negotiated special terms with the pension provider e.g. reduced charges and more flexibility.
If you don’t want to have your pension invested in companies engaged in activities you disapprove of e.g. arms dealing, tobacco, GM foods or hobnobbing with regimes that abuse human rights, etc, then a number of ethical funds have emerged in recent years which will cater for you.
While ethical funds are not seen as being particularly good for growth there are now some £2 billion invested in ethical funds.
Ethical fund managers buy and sell shares in exactly the same way as their non ethical colleagues. The difference is they evaluate companies they might invest in.
The thing you may need to look out for here is how tough are the criteria being used.
Dark green are those that take the toughest line i.e. they wouldn’t dream of investing in companies that have anything to do with animal testing, arms dealing, tobacco etc.
Light Green are those that will invest in companies who are still involved in “dodgy” areas but who are at least showing improvements in their ethics. While it’s good to reward steps in the right direction the “improvements” may only be window dressing. If in doubt you could monitor how the changes are progressing after a couple of years or more.
You could possibly ask Friends of the Earth or similar groups for advice, either about the specific companies being invested in or how they rate the ethical pension funds themselves.
Unit and Investment Trusts
A number of Unit and Investment Trust groups have started offering personal pensions linked to their investments in recent years. These may offer general UK and international trusts or more specialised funds e.g. investing in smaller companies.
Joining one of these would be similar to how a Unit Linked Pension Fund would work in that the value of your pension fund will go up or down in direct relation to the unit or investment trust’s performance.
They tend to be seen as riskier – with greater rewards possible – than unit linked funds and are normally recommended alongside other pension provision.
Other types of pensions you’ll come across will include:
- Self Invested Personal Pensions (SIPPs) – where you can decide where to invest your pension fund as opposed to leaving it to the pension fund managers. Whether or not you award yourself a seven figure salary for doing so is optional. See more on Self Invested Personal Pensions – SIPPs
- Executive Pension Schemes – intended for those who run their own businesses but considered by some IFA’s to be past their sell by date because of recent changes to the rules e.g. whereby you can’t make huge contributions in the early years any longer.
- Funded Unapproved Retirement Benefit Schemes – (FURBs, for the higher earners).
These tend not to be recommended these days and should be avoided. We’re including them because they were a fashionable buy in the early 90′s so may be relevant to you.
Your pension funds and mortgage are the largest two investments you are likely to make. The idea of a Pension Mortgage is to tie them together.
A Pension Mortgage is where you take out a loan to buy your house but, initially, you only pay interest on the loan and repay the capital later. Meanwhile you start a personal pension investing into it what you would have paid into your mortgage, on top of the pension savings you have been making.
When you retire you repay the capital from the cash lump sum i.e. up to 25% of your pension fund which you are allowed to take from it when retiring.
The major advantage of this scheme is that because your lump sum is tax free the Inland Revenue is effectively helping you repay the capital sum you brought your house with. If you want to move house you transfer the pension mortgage to the new property.
The disadvantages vary. You may end up paying more interest on your mortgage because the term may be longer.
If you join a occupational pension scheme you will have to change your method of payment e.g. you have to give your tax-free lump sum straight to your mortgage lender. While there may be money left over from this settling of your debt it could be that you won’t have enough to pay off the loan in full (i.e. because you can only take 25% of your final pension fund as a lump sum; if the performance of your pension fund has been disappointing you may not have enough money…)
Pensions for those working overseas
You cannot contribute to a personal pension scheme in the UK while you’re working overseas. Ask an IFA for the specifics on your situation.