7th April 2023
general
Since auto-enrolment was introduced in 2012, more people have joined employer pension schemes to save for their retirement. As of 2020, 88% of eligible employees were members of a workplace pension scheme1.
Workplace schemes operate in a similar way to private pensions, but have been streamlined to accommodate large numbers of employees, many of whom will be making fairly small contributions. Additionally the schemes need to be accessible to people who may not be financially literate or have access to advice.
Private pensions offer more choice and more flexibility, but often at a higher cost. For anyone who is not working for an employer, they are the only option. Many employees have private pensions in addition to their workplace schemes.
Below, we explain the main differences between the two scheme types to help you decide which option is best for you.
Eligibility
Employees may fall into three main categories:
Eligible jobholders must be automatically enrolled in a workplace pension scheme. Non-eligible jobholders can join if they wish, and will also receive employer contributions. Entitled workers have the option to join the scheme, but no automatic right to employer contributions.
Contractors and self-employed people are not eligible to join a workplace scheme.
Private pensions, on the other hand, are open to anyone who is tax resident in the UK, regardless of age or employment situation.
Setting Up Your Plan
If you join a workplace scheme, the plan will be set up for you by your employer. If you are an eligible jobholder, you don’t need to take any action, as you will be automatically enrolled. This has been a key factor in increasing participation in workplace schemes as people tend to go with the default option.
Setting up a private pension takes a bit more effort, as you will need to choose a provider and go through their application process. You might even need to send in additional information, such as ID. Online applications are usually fairly quick and simple, but you can also seek financial advice if you need any help setting up your plan.
Contributions and Tax
Typically in a workplace scheme, your employer will contribute 3% of your qualifying earnings, you will contribute 4%, and 1% is credited in tax relief. This takes your total contribution to 8%.
Qualifying earnings include salary, overtime, commission, and bonuses, as well as any sick pay or income arising from parental leave. However, your employer only needs to include earnings between £6,240 and £50,270 in this calculation. Many employers will base contributions on your full earnings.
There are three main ways in which you can pay pension contributions:
A workplace scheme may use any of these methods. Generally, relief at source is preferable for lower earners, while higher earners will benefit more from salary sacrifice.
Private pension contributions can only be paid via the relief at source method.
Your contributions are limited by earnings and by the Annual Allowance. You can find out more about contribution limits and tax here.
Investment Choice
Workplace schemes normally offer a limited investment choice, although this can range from a handful of risk-rated funds to over 100 options from different sectors. Some providers will customise their offering depending on what the employer requires. This can simplify things for members, as they don’t have the whole market to choose from.
Most schemes also offer a lifestyling option, which means that you invest in higher risk assets in the early years, and will be automatically phased into lower risk investments as you approach retirement.
Private pensions can offer anything from a few hundred to a few thousand investment choices. This means that you have more flexibility, but the choice can be overwhelming. Many providers offer tools or ready-made portfolios to choose from. Alternatively, a financial adviser can help.
Workplace pension funds are normally lower cost than private pension funds, although this is not always the case.
In both types of scheme, your pension pot grows free of income tax and capital gains tax.
Future-Proofing
If you are a member of a workplace scheme, each time you move employer a new plan will be set up for you. You can move your old pensions into your new pension, or you can consolidate all of your old plans into a personal pension.
As a personal pension is not linked to any one employer, providing you choose the right plan, it can stay with you for life. Of course, you can still move it if your circumstances change or another provider offers better options.
Both types of scheme are normally flexible over retirement options, which means that you can buy an annuity, opt for drawdown, or leave the plan invested. It’s a good idea to seek advice when you are approaching retirement to make sure your funds are in the most suitable place.
Which Pension is Right for You?
If you work for an employer, joining the pension scheme is usually a no-brainer. You will benefit from tax relief as well as employer contributions. Additionally, most of the work is done for you.
If you earn over £240,000 or have taken taxable benefits from a previous pension, you may have a lower contribution allowance. Advice is recommended in these situations to ensure that you don’t pay excessive amounts of tax.
If you feel that the basic level of contributions won’t be enough to support your retirement, you can easily increase your contributions, or even set up a personal pension in addition to your workplace scheme.
If you are self-employed, or if you are not working but can afford to save, it’s a good idea to set up a personal pension. This can provide security in retirement, as well as significant tax benefits.
If you work for a small company, you may have the option to have your employer contributions paid into a pension of your choice. This offers the best of both worlds, as you will receive enhanced contributions, full tax relief, and a wide range of investment options.
Workplace and private pensions both have an important place in retirement planning depending on your circumstances, goals, and life stage.
Please don’t hesitate to contact a member of the team to find out more about retirement planning.
