Pensions aren’t the most exciting topic of discussion, but they are one of the most important.
The type of pension you have determines how it’s invested, when you can access it and more.
There are 4 types of pensions: 2 of which are workplace accounts, and 2 of which are private.
- Defined Benefit: A pension for public sector workers that guarantees a set income for life.
- Defined Contribution: A pension for private employees that is based on their contributions.
- Self Invested Personal Pension: A private pension but without an employer contribution.
- Small Self Administered Scheme: A pension for people that want to use their pension early.
In this article, I go through each of these 4 different types of workplace and private pensions.
I discuss the pros, cons, when you can access them, what you can do with them, and more.
To know how much you could have in your pension, check out the MYB Pension Calculator.
What is a Defined Contribution Pension?
Let’s start with a Defined Contribution (DC) pension as this is what most UK employees have.
A DC pension is a workplace pension that is based on contributions and market performance.
What this means is that the employer is not guarantying how much you’ll have at retirement.
All that they are guarantying is that they will continue paying into your pension every month.
How much you will have at retirement will depend on fund performance and platform fees.
Apart from employer contributions, you don’t pay tax on the contributions that you make.
However, you do pay tax when you withdraw from your pension, which is quite unfortunate.
As well that that, you can only access your DC pension from age 55 – soon to be 57 from 2028.
The benefits of joining a DC pension is the free money that you can get from your employer.
The cons of a DC pension is your wealth is locked in an account with no access before age 55.
Let’s Move on to a Defined Benefit Pension
A Defined Benefit (DB) pension (Final Salary/Career Average) isn’t as popular as it used to be.
This type of pension is mainly found among the public sector: doctors, teachers, police, etc.
Like a DC pension, your employer contributes to your pension while you’re employed there.
However, unlike a DC pension, with a DB pension you are guaranteed a fixed income for life.
That’s right, regardless of how your funds perform, you will still get a predetermined amount.
You can see why this is a popular pension; and can see why most employers don’t use them.
Retirement income is calculated from your salary and how long you’ve worked for the firm.
The benefit of a DB pension is you’re guaranteed a certain amount each year at retirement.
The disadvantage is that this money is locked up until age 55 – soon to be age 57 from 2028.
The other con of DC pensions is that like DB pensions, you are still taxed when you withdraw.
Tell me about a Self Invested Personal Pension (SIPP)
Let’s say that you don’t like your workplace pension scheme and want to invest elsewhere.
You can decide to open a self invested personal pension (SIPP) with a platform of your choice.
SIPPs are traditionally for self employed people but nowadays anyone can open up a SIPP.
Why would someone open up a SIPP as opposed to a Stocks & Shares ISA? Because of taxes.
Like a DC pension, you don’t get taxed when you pay into a SIPP (in the form oftax relief).
However you do get taxed on the way out when you withdraw, and can’t access it before 55.
Unlike a DC pension, a SIPP has a lot more flexibility in terms of what you can invest in.
For example, you can use your SIPP to buy commercial property, which you can’t do with DC.
You can use your SIPP to invest in commercial property but the income is kept in the SIPP.
What this means is although you’ll get an income from tenants, you can’t access it before 55.
Let’s Talk about a Small Self Administered Scheme (SSAS)
SSAS pensions are probably one of the best kept secrets of the pension investment industry.
The are basically ‘pensions for entrepreneurs’ as they require you to have a limited company.
It is a scheme set up by the business so the owners have more control over their pensions.
One of the main reasons people open up a SSAS pension is to boost their property investing.
That’s because a SSAS pension allows you to borrow your pension money before age 55.
That means you essentially become a bank for yourself to fund projects on your own terms.
This also means you get to benefit from the cash flow now as opposed to storing it in a SIPP.
Unlike other types of pensions, there are certain criteria to be met to open a SSAS pension.
The first one being that you must be the owner of a limited company in the UK.
Another one is having existing pensions to transfer or contribute a minimum of £50k to start.
Which Pension is Right for You?
When it comes to choosing the best one for you, not everyone can have each type of pension.
For example, unless you are a public worker then unfortunately you can’t have a DB pension.
So depending on where you work will determine the type of workplace pension that you get.
The next question is should you contribute to a workplace pension or just a private pension?
If you get free contributions from the employer, you should enrol in your workplace pension.
The other question is should you also invest into a private pension such as a SIPP or SSAS?
This will determine on your goals – whether you want to retire early or invest in property.
If you’re looking to retire early, then I’d have an ISA instead as you can access it at any time.
If you’re looking to invest in property as a business, then a SSAS would be the way to proceed.
Therefore invest in your workplace pension but also in another tax advantaged account.
To find out more about early retirement, check out our articles on retirement and investing.
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