Pensions can be confusing for both small business employers and employees. Be aware that with the new auto-enrolment regulations, by 2018 all businesses, big and small, will have to organize a pension scheme for employees. When you pay into a workplace pension, your employer and the government also contribute. The amount paid depends on your employer’s pension scheme. Your employer must contribute, provided that your earnings are over £5, 772 per year.
There are two types of workplace pension schemes:
1. Defined contribution
These are often referred to as 'money purchase schemes'. In a defined contribution pension scheme, the amount you pay in is usually an agreed percentage of salary to be paid into a pension pot. Your pension pot is invested in stocks and shares along with other investments with the aim of giving you an amount of money when you retire. Of course, the value of the investments can go either up or down.
The pension is based upon the amount that is contributed, how long you have contributed and the performance of the investments. Generally the earlier you start, the more you, your employer and the government contribute and hence the greater sum of money you are likely to have when you retire. With a defined contribution scheme, the level of retirement income for the member is not guaranteed.
2. Defined benefit
These are often referred to as 'final salary' or 'salary related' pensions. In this scheme your pension is linked to your salary while you are working and so it automatically increases as your pay rises. Therefore, unlike a defined contribution pension, it does not depend on stock market performance or other investments.
In most cases you pay a set percentage of your wages towards the fund and your employer contributes the rest. The amount of money that you receive on retirement is based upon how long you have been contributing to the scheme and your earnings.
Defined benefit schemes are also protected by the Pension Protection Fund. This pays some contribution to members whose employers become insolvent and where the scheme does not have enough funds to pay members benefits. The compensation may not be the full amount and the level of protection varies between members who are already drawing benefits, those who are still contributing to the scheme, and deferred members who have already left the scheme but have built up an entitlement.
Since October 2012, employers are now required to automatically enrol eligible workers into a qualifying pension scheme. It started with employees who work for the biggest businesses and with the others due to be signed up by 2018. Both workers and employers pay into the scheme and the government also contributes by way of tax relief. You will be eligible for the scheme if you are:
- Not already in a workplace pension
- Aged 22 or over
- Under state pension age
- Earning more than £9440 a year
- Working in the UK
Your employer will take your contributions directly from your wages. It is possible however to opt out of the scheme. Those who opt out will automatically be enrolled again every three years or after three months if they change employer. In this case, if the employee wishes to opt out again, they are required to repeat the process.