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Know what a defined contribution scheme is? How about the FRS17 accounting rule? Wading through the wealth of information about pensions can be a confusing business - Kieran Wyatt sorts the fact from the fiction

Know your pension

The headline news isn't good - the stock market's in freefall, our pensions are practically worthless and we'll be lucky to be living in poverty when we retire.

With employers left, right and centre closing their well-funded final salary schemes to new employees - HSBC, BT, BA, Marks & Spencer and Halifax among them - workers are increasingly facing the prospect of joining poor occupational pension schemes or having to fund their own pension arrangements.

And to maker matters worse, the pensions options are confusing to such an extent that many people just don't bother. Yet the value of the basic state pension has been eroded since 1979 when the then Conservative government broke the link between increases in BSP and average earnings. To avoid a retirement blighted by poverty, workers need some sort of personal or occupational pension provision.

So read on for a quickfire guide to workplace pensions, personal pensions and state pensions - and hopefully be confused no more.

Final salary pension schemes
These schemes - also called defined benefit schemes - promise to pay members a pension at retirement based on their earnings at or near retirement. Thus you get a guaranteed level of pension linked to your salary no matter what happened with inflation, prices or earnings throughout your working life.

Credits are accrued for each year you've worked, usually on a one-sixtieth or one-eightieth basis. So, for example, if you've worked 30 years with the company and have a one-sixtieth scheme you'll get 30/60 (or half) of your final salary as an annual pension.

Both sides contribute to the scheme, with the split being roughly 5% from employee and 10-15% from employer. Most of the big public sector pension schemes - such as local government and teaching - are final salary based. However there are concerns - see right hand box - over proposals for pension payouts to be based on average earnings over an employee's lifetime rather than the last few years of service (when earnings are usually at their highest).

Defined contribution schemes
Unfortunately many employers are closing or have closed their final salary schemes. Many rather lame excuses have been given including the government's introduction of the Financial Reporting Standard 17 (FRS17) whereby companies will have to declare their scheme's surplus or deficit each financial year on their balance sheet.

But the reality is it boils down to money - employers want lower pension costs. The employers are moving towards so-called defined contribution schemes - also called money purchase schemes - because:

• there is no guarantee of the level of pension provision - they are subject to the whims of the stock market
• employer contributions are greatly reduced - often to around 5%
• the burden of cost and risk is shifted to the employee.

Only if employers can be committed to providing a decent level of contribution (minimum of 10%) can defined contribution schemes still deliver a decent pension.

Stakeholder pensions
Millions of workers do not have access to an occupational pension scheme. The low paid - and women especially - are much more likely to work in sectors where fewer employers provide occupational pensions. Yet the high upfront costs of personal pensions put many off starting their own savings scheme.

So the government introduced the stakeholder pension, targeted at those who do not have a regular income and those in occupational schemes on less than £30,000 a year who want to make additional contributions.

Unions, banks and insurance companies all provide stakeholder schemes. Employers with more than five employees must also provide access to a stakeholder although they are not obliged to make any contributions themselves.

Stakeholder pensions are flexible - contributions can be as low as £20 a month and can be stopped and started at any time - and cheap, with charges restricted to 1% of the value of the scheme.

State pensions
Government pension provision includes the basic state pension and the State Second Pension (S2P), which replaces the State Earnings-Related Pensions (SERPS) in April of this year. There is also the Minimum Income Guarantee which is basically income support for those pensioners relying solely on state pensions.

To get the maximum Basic Pension (currently £75 a week for individuals, £120 week for couples), you need a full National Insurance contributions record. Meanwhile in a few years the S2P will likely be a flat-rate payment only for the lowest paid.

And to complicate matters further, from October 2003 the new Pensions Credits will come into effect. This means-tested scheme will guarantee single pensioners £100 a week, and couples £154 a week.

Contact the article's author Kieran Wyatt