The 3 types of work-based pension scheme

A work-based pension scheme is set up by an employer to provide a way for employees to save for their retirement. Both the employer and the employee may contribute to the scheme. The employee’s contributions are usually collected directly from their salary or wages.

There are 3 main types of work-based pension scheme:

• Defined benefit (also known as DB, final salary or salary-related) - benefits are calculated based on how much a member earns and how long they are an employed member of the pension scheme
• Defined contribution (also known as DC or money purchase) – benefits are based on how much the member and employer pay into the scheme, and also on the performance of the investments made with that money. The income the member gets at retirement will depend on the amount of money in their fund, the age at which they retire and also the cost of buying a pension (the annuity rate) at the time
• Hybrid – a mixture of DB and DC

Pension schemes can be trust-based or contract-based, or a mixture of the two.

In a trust-based scheme (also known as an occupational scheme) a board of trustees is set up to run the scheme. This can be either a DB or a DC scheme. Trustees are accountable for making decisions about the way the scheme is run, although they may delegate some of the everyday tasks to a third party.

In a contract-based scheme (also known as a group personal pension) an employer appoints a pension provider, often an insurance company, to run the scheme. Employees take out a contract (also known as a policy) with the provider. In these schemes the provider makes the decisions about the way the scheme is run. However the employer can play an important role in helping the provider to design a scheme that meets the needs of the employees. Contract-based schemes are sometimes set up as stakeholder or self-invested personal pensions.

Contract-based schemes are usually DC.

The choice of which scheme to offer is an employer’s. The regulator’s role is to ensure that all work-based schemes are well run and provide protection for their members’ benefits.