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Pensions are a tax efficient way in which to build up capital, with the intention of providing an income in retirement.  There are two main types of pensions:

  1. Money Purchase
  2. Defined benefit (or final salary)

With money purchase schemes, the level of pension received in retirement depends on the size of the pension fund (and other factors such as annuity rates and gender) at retirement.  As such the emphasis is on the individual to ensure they have sufficient funds at retirement to provide the right level of income.

Defined benefit schemes (run by some employers) provide a guaranteed income in retirement, usually based on the employee’s length of service and salary at retirement.  The employer will decide what level of contribution is required by both themselves and the employee.  Therefore the risk lies with the employer to ensure that they have enough funds in the pension to meet their obligations.  Defined benefit schemes have become increasingly costly to run, and most have either been closed or are no longer available to new employees.

As such there is an increasing onus on the individual to ensure that they have adequate provision for their retirement.

Pensions benefit from tax concessions that are not available with most other forms of investment.  For example, tax relief is available at the highest marginal rate of tax paid i.e. a basic rate tax payer will receive tax relief at 20% and a higher rate tax payer at 40%.  This means that a £100 gross contribution will only cost a basic rate tax payer £80, and a higher rate tax payer £60.  The tax on the growth of a pension fund is also tax efficient in that no capital gains tax is paid on growth.  Prior to 1997 pension funds could also reclaim the tax paid on dividends received, but one of the first things the new Labour Government did when it came in to power was to abolish this tax incentive.

However, pensions remain an integral part of retirement planning for most people, and it is important to review existing arrangements on a regular basis to ensure they are on track to meet retirement needs

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