The State Pension is a regular income paid by the UK Government to people who have reached State Pension age.
The State Pension is intended to ensure that everyone has a foundation for their retirement income to support them in their old age. State Pensions are funded from National Insurance (NI) contributions. What you’ll receive doesn’t directly depend on how much you have earned but on your own NI record. For those who enter the NI system on or after 6 April 2016, in order to get the full State Pension you currently need to have 35 years’ worth of qualifying NI contributions or credits when you reach State Pension Age (SPA). For those who have an NI record before 6 April 2016, there are transitional arrangements.
Basic State Pension (SERPS)
SERPS ran from 6 April 1978 to 5 April 2002. As the name implies, the level of pension payable was related to earnings via the amount of National Insurance contributions. Qualification was based on band earnings above a Lower Earnings Limit (LEL) in each year. The LEL (£84 per week /£4368 pa in 2006/07) was usually set at the same level as the BSP (£84.25) and increased when BSP did. Band earnings were those between the LEL and an Upper Earnings Limit (UEL) at which National Insurance contributions ceased to be payable by the employee (this was £645 per week/£2,795 per month in 2006/07, although the UEL now refers to a threshold where reduced NI payments are made, as opposed to payment ceasing). The UEL is also adjusted annually.
State Second Pension (S2P)
S2P was introduced on 6 April 2002. As with SERPS, the level of pension payable is related to the recipients earnings via their National Insurance contributions. Qualification is based on earnings at, or above, the LEL, but no band earning calculation is made until earnings reach a higher base (£12,500 pa in 2006/07) called the Lower Earnings Threshold (LET). Earnings below the LET (but above the LEL) are credited up to the LET.
Occupational pension schemes are arrangements established by employers to provide pension and related benefits for their employees. These are created under the Pension Schemes Act 1993, the Pensions Act 1995 and the Pensions Act 2008.
Defined benefit/final salary schemes
A large number of UK employers offer their employees access to a defined benefit occupational pension scheme, often based on their final salary. In such an arrangement, the employee was typically promised a pension of a fixed proportion of their salary in the period leading up to retirement or as an average of earnings over their career. The proportion would depend on the number of years of service with the employer. Post retirement increases are typically partly discretionary, however, must comply with statutory minimums. The amounts payable are restricted by taxation rules, the maximum being typically either a pension of one-sixtieth of final salary for each year of membership or a pension of one eightieth of their salary per year of membership plus a tax free lump sum of three eightieths.
Defined contribution/money purchase schemes
The employer (and sometimes also the employee) makes regular payments (typically a percentage of salary) into a pension fund, and the fund is used to buy a pension when the employee retires. So the amount of pension depends on a number of factors including the accumulated amount of the fund, interest rates and projected mortality rates at the time the individual retires.
It is also possible for an individual to make contributions under an arrangement they themselves make with a provider. Similar tax advantages will usually be available as for occupational schemes. Contributions are typically invested during an individual’s working life, and then used to purchase a pension at or following retirement. Various names are given to different types of individual arrangement, but they are not fundamentally different in nature. The generic term personal pension is used to refer to arrangements established since the rules were changed in the 1980s (earlier arrangements are usually called retirement annuity contracts), but can be subdivided into other types (such as the self-invested personal pension, where the member is allowed to direct what their contributions should be invested in).
Stakeholder pensions (insured personal pensions, with charges capped at a low level) are a form of pension arrangement designed to be easily understandable and available. Stakeholder pensions are in effect personal pension schemes set up on terms which meet standards set by the government (for example there are restrictions on the charges the provider may make). Although a stakeholder pension is a personal pension, they can (and in some circumstances must) be offered by an employer as a cost-effective way of providing pension cover for their workforce.
Group personal pensions
Group personal pensions are another pension arrangement that are personal pensions, but are linked to an employer. A group personal pension plan (GPPP) can be established by an employer as a way of providing all of its employees with access to a pension plan run by a single provider. By grouping all the employees together in this way, it is normally possible for the employer to negotiate favourable terms with the provider, thus reducing the cost of pension provision to the employees. The employer will also normally contribute to the Group personal pension plan.
A self-invested personal pension (SIPP) is the name given to the type of UK government-approved personal pension scheme, which allows individuals to make their own investment decisions from the full range of investments approved by HM Revenue and Customs (HMRC).
SIPPs are “tax wrappers”, allowing tax rebates on contributions in exchange for limits on accessibility. The HMRC rules allow for a greater range of investments to be held than personal pension schemes, notably equities and property. Rules for contributions, benefit withdrawal etc. are the same as for other personal pension schemes.