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Moneybox Wednesday, 3 July, 2002, 10:02 GMT 11:02 UK
Pension schemes: An introduction
Money Box explains pension schemes
Many people are worried about their pensions

There has been much debate in recent months about the closure of final salary pensions schemes and their replacement - the 'money purchase' option.

This guide looks at the pros and cons of both.

Final salary pension schemes

Final salary schemes have traditionally been considered the gold standard of pensions.

They guarantee to pay you a percentage of your salary in retirement every year for the rest of your life.

The figure is based on how long you have spent working for your employer and how much you were earning at the time you gave up work.

The sum is usually between a half and a third of your pay packet.

Money purchase pension schemes

Over recent years some of the country's biggest employers have abandoned 'final salary' in favour of money purchase schemes.

'Money purchase' operates very differently.

Employers and their bosses each pay a percentage of the salary into a fund.

Typically workers put in around three to five per cent and employers put in anything up to seven per cent.

This is invested as an account directly in the stock market.

If the stock market rises, so does the pot of cash that has been invested, but if the market falls, as it has been doing for the last two years, so does the retirement fund.

Annuities

When an employee gives up work the cash that has been saved is used to buy an annuity, the policy which buys a retiree an income every year for the rest of their life.

The pitfall of this scheme is that because the money is at the mercy of the stock markets, all the risk is transferred from the employers to the worker.

Your income in retirement depends completely on how the market is performing at the time you plan to give up work.

The Association of Consulting Actuaries has estimated for people to retire under money purchase scheme at current pensions levels, about 20% per cent of the salary needs to be saved.

No obligation

Some generous employers may contribute enough, but under 'money purchase', employers are under no legal obligation to make any contribution at all.

Unions say companies have used the closure of final salary schemes as an opportunity to cut costs.

Many firms who have converted to 'money purchase' are now only putting in about half what they were before.

A survey by the Association of Consulting Actuaries carried in June 2002 found only four out of 10 companies they spoke to still offer the final salary scheme to new members.

Of that number, half again are considering closing the scheme.

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