FOOL SCHOOL
Company Pensions

September 5, 2003

Picture the scene. Forty years on the shop floor at Harding & Sedgewick ends with a handshake, a carriage clock and a generous pension to reflect the hard work and faithful service of a lifetime. Your final grovelling words to the boss are along the lines of: "It has been such an honour to work my fingers to the bone fourteen hours a day for a pittance of a weekly wage and a five shilling bonus every other Christmas. The outstanding growth in your personal wealth over that time and the way in which I was allowed to shine your shoes on my birthday have been a source of great pride to me. Truly a privilege, sir. Thank 'ee."

Yes, those were the days, the days of Mrs Miniver and Morris Eights, of the Movietone News and good old British honesty and pluck and people jolly well knowing their place. Those days, though, are largely gone. While occupational, aka company, pensions can provide a sound retirement income and should generally be opted for rather than against, the picture is not quite so clear as it was back then, when the sun always shone in June and we knew with such certainty who the baddies were.

The big plus for this type of scheme is that your employer will often contribute some money to the scheme for you -- or even fund it entirely. Of course this isn't out of the goodness of their heart (you'll probably be paid a little less to account for your generous pension benefits), but for most people it's a simple case of you lose out if you don't opt in.

The big minus, increasingly so, is that people rarely stay in the same job for their entire working lives as they did in the world of Harding & Sedgewick. In fact, the average person changes jobs around five times, these days, and you can end up with a collection of small pensions not paying out very much. Although they can be moved around, you can often lose out on the 'transfer values'.

The best occupational pensions are generally to be found in the public sector. If you are in the police force, for example, your pension will be generous indeed and will be paid for out of the organization's budget, not a separate investment fund. Elsewhere, though, and especially in the private sector, pensions are paid out of an investment fund into which both employee and employer contribute.

These funds are held separately from the actual company, by a board of trustees who will take the money and invest it in a variety of things, predominantly shares. So the fund should still be there even if your company goes bust. However, a bust company will no longer be there to top-up the fund if needs be, which may be the case, from time to time, with a 'defined benefit' or 'final salary' scheme where the employer carries the investment risk. We'll say more about these schemes in a moment.

The important point to carry in your head for the moment is that, while company schemes should generally be opted for rather than against, you shouldn't rely on them providing an all-encompassing, complete, solution to your retirement needs.

Anyway, getting back to the point, there are two basic types of occupational pension scheme: defined benefit (also known as final salary) and defined contribution (also known as money purchase).

With a defined benefit pension scheme, the final 'benefit' is what defines how much the policy is worth. In effect, the final benefit -- aka 'how much you get' -- is guaranteed by your employer, so they take on the risk of things not working out on the investment front.

With a defined contribution pension, the value of the policy, and what you stand to get out of it in the end, is defined by what gets put into it and how well the investments do over the years. In this case, it's you that takes that risk, not your employer.

The difference between these two types of fund is absolutely crucial as it tells you how the risks get shared out between you and your employer. If you've got a company pension, it's the first thing you need to know. We'll look at these in next week's articles.

Find out more in our pension centre.