Pensions For Beginners: Part Two

Do you know what your pensions options are? Part Two of our beginners' guide explains what you're entitled to - in plain English.

In Part One, I explained what a pension is, the pros and cons of having one, and what the main alternatives to a pension are.

I'm now going to outline the different types of pension you can get, so you get a clearer idea of what your options are.                                             

THE STATE PENSION

This is provided by the government. At the moment, it provides just over half of all the income received by pensioners.

Over recent years, State Pension provision has decreased substantially. As we'll see, you shouldn't rely on it when you make your retirement plans.

It comes in three main parts:

1) The Basic State Pension

Am I eligible? You need to build up enough 'qualifying years'. These are tax years in which you have received enough income to pay National Insurance contributions.

At the moment, men normally need 44 qualifying years, and women 39 to get the full basic State Pension. If you reach retirement age from 2010 onwards you will only need 30 qualifying years.

Once you have built up enough qualifying years, you are entitled to this benefit, no matter how high or low your income is in retirement.

You can get a State Pension forecast from Direct.gov.uk to check if you're up to date with your NI contributions.

How much will I get? The full basic State Pension is currently £87.30 a week for a single person and £139.60 a week for a couple.

When can I claim? Those entitled to it can claim from State Pension age, which is currently 65 for men and 60 for women. From 2010 these ages are set to increase.

Good to know: You can claim the basic State Pension even if you receive a personal pension or other sort of retirement fund, such as a salary-related pension (see below).

Find out more about the basic State Pension here.

2) Pension Credit

What is it? Pension Credits are means-tested benefits designed to help combat pension poverty. They are used to ensure all pensioners have a minimum amount to live on in retirement.

Am I eligible? If the basic State Pension is all you have to live on in retirement, you should qualify for some additional money.

There are two elements of Pension Credit you might be eligible for when you retire: `Guarantee Credit' and `Savings Credit'.

Good to know: Taken together, a full basic State Pension and Pension Credit for a married couple is only about £9,450 a year. This is why many people, if they are able, choose to make other provisions for their old age as well.

Find out more about Pension Credit here.

And if you want to investigate further, read Pension Credits: What Are They And Are They Any Good?

3) S2P

What is it? S2P (confusingly, also known as the State Second Pension or the additional State Pension) allows you to build up a state pension in addition to the basic State Pension and Pension Credit.

Am I eligible? S2P calculations are based on how much you've paid in Class 1 National Insurance contributions - which means they are based on what your annual salary has been.

Where does money from the S2P come from? S2P contributions will be taken from the National Insurance payments you make on earnings of between £4,524 and £34,840.

Good to know: Self-employed workers don't pay Class One National Insurance - and are therefore not entitled to S2P.

Find out more about the State Second Pension here.

SALARY-RELATED PENSIONS

The second main type of pension is the salary-related, or `defined benefit' pension. You can receive this type of pension and the Basic State Pension.

What is it? Salary-related pensions are based on your final salary - or an average of your salary for the last few years of your employment.

Generally speaking, the longer you've been a member of this sort of scheme, the bigger your pension will be. You may get up to two-thirds of your final salary as an annual pension when you retire.

The benefits: This sort of scheme is attractive because it is the employer who takes the risk in investing the funds.

They have to decide how much to invest and where to put it - and if their choice fails to make money, they take the hit.

In other words, your income in retirement is set in stone, and won't be affected if your employer makes bad investment decisions. Hurrah!

What happens if the company goes bankrupt? In 2005, the government set up a Pension Protection Fund to partially protect members of salary-related schemes should this happen, by offering some compensation. So you won't lose everything if the worst happens.

Am I eligible? Sadly, this depends entirely on whether the company you work for operates such a scheme. If it doesn't, you can't get one.

Good to know: Here's the catch. Because the risk with these schemes lies mostly with the employer, fewer and fewer companies offer final-salary pension schemes nowadays. Many such schemes have now been closed to new members. 

Find out more about salary-related pensions here.

MONEY-PURCHASE PENSIONS

The third main type of pension is a MONEY-PURCHASE PENSION (also known as a personal pension/defined contribution pension).

This is the one you have the most control over, and there are several, rather complicated options available.

To find out more, keep an eye out for Part Three: coming soon...