What is a pension?

Give yourself a break on your retirement savings

When you’re saving for your retirement, every penny counts. After all, keeping up with the things you’ve been used to like holidays and hobbies needs a healthy income when you’re no longer working. One of the best ways to build a decent retirement pot is to make sure you’re taking advantage of tax breaks to accelerate your savings. That’s where a pension comes in.

Tax information is based on our current understanding of tax rules, which may change, and tax treatment will depend on individual circumstances.

How does a pension work?

A pension is a great way to save for your golden years because it’s tax-efficient. To encourage people to save this way, the government may add extra money into your pension when you do – this is called pension tax relief.

If your pension scheme uses the ‘relief at source’ method of tax relief, for every £80 you pay in, the government will add £20. If you’re a higher rate taxpayer, you may be able to claim even more through your self-assessment tax return. 

In some workplace pensions, you agree to give up a chunk of your salary in exchange for your employer making an equivalent contribution to your pension – this is called salary sacrifice. You won't pay any income tax or National Insurance Contributions on the salary you’ve sacrificed and your employer will pay the full amount directly into your pension.

Types of pension

Depending on your circumstances, different types of pension may be available to you.

Workplace pensions

This is a pension that’s arranged by your employer. They come in two types: 

  • Defined contribution (or money purchase pension) – here the money paid into the pension plan is invested by the pension provider. The amount available to you when you decide to take your pension depends on how much has been paid in, the charges taken out, and how well the investments have performed. The value of investments can go down as well as up, so you could get back less than the amount paid in.
  • Defined benefit (or final salary pensions) - with this pension the benefits you receive don't depend on the performance of investments. Instead, they’re based on your salary and how long you were an active member of the scheme. Due to the rising cost, these are much less common in the UK now, particularly for new employees.

Auto-enrolment to a workplace pension plan was introduced in 2012. If you’re between 22 and the State Pension age, work in the UK and make more than £10,000 per year, your employer must set you up with a pension. You can choose to opt out, but here’s why you should think carefully before you do. 

A percentage of your pay will go into the pension each payday, but your employer will add money too. The current government guidelines on minimum contributions for a defined contribution workplace pension are that you would add 5% and your employer 3%, for a total of 8%. That’s just the minimum though, some employers will add even more as it’s an attractive work benefit. 

Along with your tax relief, this employer top-up really boosts your savings. So, it can be much better to pay into a workplace pension than have your own personal pension.

Personal pension

If you’re self-employed or want to save more alongside your workplace pension, you can choose a personal pension. Here’s some more information about pensions for the self-employed.

Personal pensions are defined contribution plans. There are various types with different investment options available and you can choose to pay in lump sums or regular payments. They include:

  • Stakeholder pensions - stakeholder pensions were introduced to ensure that people on a lower income had access to a pension scheme. They have certain minimum standards and capped charges to make them more affordable and accessible. They also offer flexibility in terms of contributions and have limited penalties for stopping or reducing them. 
  • Self-invested personal pensions (SIPP) - a SIPP is a type of personal pension that gives you more control over how you invest your money and where. With a SIPP, you can choose from a range of investments, including stocks and shares, investment funds and even property. At Aviva we offer an award-winning SIPP.

The State Pension 

The State Pension is a regular payment that you claim from the government. To get a State Pension, you must first reach State Pension age, usually with at least 10 qualifying years on your National Insurance record. The amount you receive is also based on your National Insurance record and you’ll normally get the full amount if you have 35 or more qualifying years of contributions.

The State Pension is pretty low and probably won’t be enough to support you on its own, but it can be a useful addition to your retirement income.

How much can I pay into a pension?

The government sets the limit on how much you can pay into all the pensions you own in a single tax year and still benefit from tax relief - this is called your annual allowance. For the tax year 2024/2025, it’s £60,000. If you earn less than £60,000 your allowance is 100% of your earnings. 

With the current annual allowance limit, someone paying income tax at the standard rate of 20% would receive a maximum sum of £12,000 of pension tax relief towards their pot. If you pay tax at the higher rate of 40%, you’d get up to £24,000 of tax relief. 

If you haven’t been paying into your pension, you can also take advantage of the ‘carry forward rule’. This lets you top up your pension contributions with unused allowance from the previous three years. To do this, your earnings must support the contribution. So to put in £240,000 (three years' unused annual allowance plus this year's), you have to be earning £240,000 and you would make a net contribution of £192,000 and tax relief would be added.

The lump sum allowance is how much you can be paid from all your pensions tax-free during your lifetime and in 2024/2025 it’s £268,275. The lump sum and death benefit allowance is the tax-free limit for payments during your lifetime and on death – it’s currently £1,073,100. UK Income Tax is payable on any benefits taken above these limits.

How much do I need in my pension?

The size of pension pot you’ll need really depends on the lifestyle you want when you retire – and how much you’ll need every month to support it. People generally underestimate the size of the pension pot they’ll need, so it’s best to work it out and start hitting your saving goals as soon as possible. 

You can get an idea of how much income your current pensions will provide using our pension calculator

One thing to remember is that the earlier you start paying into your pension, the better. As you get closer to retirement, the amount you’ll need to save every month for the same income increases. But it’s never too late to start putting money aside, as you can benefit from pension tax relief right up to retirement age. Check out our article on 6 simple ways to help boost your pension.

When can you access your pension?

For defined contribution pensions you can start taking money from the age of 55, but this is rising to 57 from 6 April 2028 – unless you have a protected pension age.  

Your pension isn’t necessarily locked away until then though. If you’ve become seriously ill or can’t work through ill health, the government will often let you take your money earlier. 

There are a few ways you can take benefits from a defined contribution pension. You can normally take up to 25% of its value as a tax-free lump sum, with the following options for what’s left:

  • Lump sum – You can take the money from your pension as one or more lump sums.
  • Annuity – You can use money from your pension to buy an annuity, which is an insurance product that gives you a guaranteed income for life. 
  • Income drawdown – You can leave your pension invested and take money from it as and when you like in a more flexible way to suit changes in your life.

You can also use a combination of these. But be careful, different ways to take your pension have different levels of risk and security and can have different tax implications. So it’s worth getting professional financial advice before you make any decisions.

How do I open a pension?

Choosing your pension may seem like a big deal, but you just need to follow a few simple steps to get one that suits your retirement goals. 

Decide on the type of pension that meets your needs. Work out the income you can spare to invest and how much control you’d like over your investments. Also, have a think about whether you’d be better off just paying more into your workplace pension, if that’s an option.

Then it’s time to look at different pension providers. One thing to watch out for are the fees they charge. If fees are too high this will eat into any investment gains and your overall pension fund. Also look at customer reviews for their service and whether they’re regulated by the Financial Conduct Authority (FCA) – this is important as it will provide a level of protection for your pension money.  

You can get a Key Features document for the pension which describes how it works and any limits, costs and risks that are involved. You can also get Key Investor Information documents for any investment options that you're interested in. These will show you how and where money is invested and let you check their past performance, although this isn't a guide to how they will perform in the future.

Once you’ve decided on a provider, you can either apply directly through their website, over the phone or by completing an application form. Some people prefer to use the services of an independent financial adviser to help with choosing and applying for a pension, although there will be a charge for this. With Aviva, it’s simple to apply for our SIPP online

To open a pension, you’ll need some details like your name, address and date of birth plus a few items of ID like your National Insurance Number and bank details. Once you’ve done that it’s just a matter of adding a lump sum or starting your monthly payments and dreaming of your rosier retirement.

Get to grips with the pension basics

More things you’ll need to know on your retirement journey.

Articles on pension basics

On hand to help with your pension – and anything else

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