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Types of Private Pension Plans

This page explains the two different types of private pension plans and how they work. Check what you can get from 'defined contribution' and 'defined benefit' pension schemes.

PRIVATE PENSION TYPES: These schemes are methods of planning for retirement in later life.

Either you, your employer, or you and your employer can use private pensions to save money for old age.

So, what are the two types of private pensions?

  • Defined Contribution: This is a pension pot based on how much money gets paid into it over the years.
  • Defined Benefit: This is a pension pot based on salary and how many years you have worked for your employer.

Defined Contribution Pension

The rules of personal pensions and your rights apply to both types of ‘money purchase’ pension schemes. Often, they are workplace pensions arranged by your employer. But, you can also set up a private pension away from the workplace and arrange it yourself.

A pension provider invests the money paid in by you (or your employer) – often as investment shares. The value of these types of pension pots is not guaranteed. The fluctuation can go up and it can go down – depending on the performance of the investments.

How Much Money Will You Get?

The money that accrues in a personal pension (the fund) depends most on three basic factors:

  1. How much money gets paid into the fund.
  2. How you take money from a personal pension (e.g. in part payments or in full).
  3. The performance of the investments (shares). Note: Investments such as these can go up or they can go down.

As you near retirement age, some schemes will move the funds to lower-risk investments. As a rule, this is an automatic process. But, your employer or pension provider can give further clarification on this service.

In most cases, the first 25% of a pension pot is tax free. Pension providers charge a nominal fee for managing private pensions.

The amount is usually a small percentage of your annual funds. These charges are often declared in retirement documents given by your employer.

Note: As a rule, the value of private pensions increase positively over the long term – compared to a regular savings account. But, be aware that fund values can go up or down in the short term.

Defined Benefit Pension Plan

These types of pension schemes are often called ‘career average‘ or ‘final salary‘ plans. They are workplace pensions arranged by an employer.

How Much Money Will You Get?

Defined benefit pensions schemes do not depend on fund investments. Instead, they get based on several factors such as salary and length of employment.

A pension provider guarantees a certain amount of money each year after retirement. As a rule, you will get 25% tax free and the rest as regular payments.

Note: The particular scheme rules dictate when you can take your pension pot. In most cases early retirement will not be before you reach 55 years old – at the earliest.

Different Types of Private Pensions in the United Kingdom