Waiting for pension money to finally arrive can take a long time – often decades. And so, quite naturally, many people play with the idea of reducing or stopping payments, allowing them to live the life that they want right now. Others wonder what will happen to their pensions if they leave their current employer.
In this post, therefore, we discuss what happens when you cancel different types of pensions and how it may affect you financially in the long-run.
Types of Pensions
In the UK, there are two main types of pension schemes that you may be a part of through your employer. Financial experts classify these as:
- Defined contribution pensions – a pot based on how much you put in
- Defined benefit pensions – a workplace scheme that specifies how much money you’ll get paid, regardless of how your investments perform.
Under a defined contribution scheme, you pay a sum of money into your pension pot (usually monthly) and your employer tops it up by a certain percentage, increasing your total contributions.
In most cases, employers will then send this money to a firm that manages the pension. They take the money and invest it in assets likely to yield steady returns over the long-term. For instance, they may buy shares in stable companies or bonds. As you approach retirement, some schemes allow you to switch your investments to lower-risk assets, reducing the likelihood of sudden losses as you reach pensionable age.
How much you get paid depends on:
- The performance of the investments themselves (how much they returned annually)
- How much you paid in during your working life
- How you get paid – either in a lump sum or a regular income payments
A defined benefit pension scheme is different. Here, what you get paid depends on the rules of the scheme set out by the employer. Usually, employers base what you get on your salary and how long you’ve worked for them. Some schemes are “final salary,” which pay you what you were earning in your final year for your retirement. Others pay a “career average” income.
Cancelling A Defined Contribution Pension
As an employee, you have the option of stopping payments into your defined contribution pension scheme. This facility is called “opting out.”
Employers will automatically enrol you on a defined contribution pension plan. This means that they take a set amount of money from your paycheck each month and put it into your pension pot. However, you can decide to cancel your contributions or reduce them to a lower level if you want more money available today.
Employers must automatically re-enrol you every three years from the date you join their schemes. So you’ll need to opt out again in order to cancel your payments.
If you have been paying into a workplace pension scheme long-term, you will not be able to access any of the money that you previously paid in. For that, you must wait for the retirement date. However, if you are still within a month of being enrolled, you can apply to get your money back.
The Consequences Of Leaving A Defined Contribution Pension Scheme
If you leave your current employer or opt out of their pension scheme, you will stop building up pension benefits. However, any benefits that you have already accrued will remain yours and you will be able to access them when you reach retirement age.
Many people entertain the idea of leaving a defined contribution pension scheme because it releases money today. This impulse is understandable, but there are costs.
Stopping or reducing your payments could mean that you:
- Receive a lower pension income when you reach retirement age
- Be disqualified from other benefits that your pension provider offers as an incentive to stick with their scheme (such as life insurance)
- Won’t receive matching pension contributions from your employer
If you’d like a little more money today (at the expense of a higher pension income in the future), then you could lower your monthly contributions (instead of canceling your pension outright).
To do this, you will need to ask your employer to reduce your pension payments. You are allowed to reduce the amount you pay into the scheme below minimum contribution levels set by law. Employers are not allowed to suggest, encourage or induce you to do so.
If you do reduce your pension contributions below the legal minimum levels, you will no longer be classified as eligible for auto-enrolment. However, your employer should re-enrol you every three years to your pension scheme, giving you an opportunity to meet the total minimum contributions again.
Again, please note that contributing less today will likely mean lower pension payments in the future.
Cancelling A Defined Benefit Pension
Most defined benefit schemes do not ask you to make contributions directly out of your monthly pay packet. Instead, they are run on behalf of your employer by a Board of Trustees. Typically, they invest company profits in assets that will enable them to grow their capital to meet their obligations to you (some fixed sum, agreed upon when you became an employee). They then distribute this money to you in chunks according to the rules of the scheme when you reach retirement.
If you are on a defined benefit scheme with a company but want to leave, you may be able to keep the benefits. The person administering the scheme should give you a statement showing you how much your pension is worth at the time of leaving, and what you’re still entitled to in the future. If you leave a company early, you won’t get the full amount you would have received had you stayed, so always speak with a pension adviser before making major financial decisions. They will be able to help you with pension consolidation.
The Bottom Line
Pension cancellation comes with costs if you spend the money on things you want today, such as holidays. However, you may be able to offset these losses if you reinvest money elsewhere. Please note, though, that if you invest outside of a defined pension scheme, your employer is not obligated to top up your payments with contributions of their own.