Generally speaking, a pension is a tax-efficient way of saving for your retirement. There are different types of pensions available, depending on your circumstances. So here’s a quick overview of your options.
This is a pension scheme that’s arranged by your employer. If you’re between 22 and State Pension age, work in the UK and earn more than £10,000 a year, your employer must enrol you in a scheme. A percentage of your pay goes into the pension scheme each payday and your employer adds money to the scheme for you too.
There are 2 types of workplace pension:
- Defined contribution – a pension that’s based on how much money has been paid into it. The money paid into the scheme is invested by the pension provider. The amount available to you when the policy matures depends on how much has been paid in and how well the investments have performed, as you could get back less than you invested
- Defined benefit – sometimes referred to as final salary pensions. The money you get back doesn’t depend on investments, but is based on your salary and how long you’ve worked for that employer
Personal pensions, stakeholder pensions and self-invested personal pensions (SIPPs) are all types of individual pensions.
How regularly you pay in is usually up to you, and what you get back largely depends on how well your investments perform. The value of your pension can go down as well as up, and you may get back less than what has been paid in.
Other people like your partner or employer may also be able to contribute to your individual pension.
The State Pension is a regular payment 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.
While the State Pension probably won’t be enough to support you on its own, it can be a useful addition to your retirement income.
Why pay into a pension?
- You get tax relief on contributions. The government usually adds money to your pension in the form of tax relief, so if your pension scheme operates the 'relief at source' method of tax relief, the government will add £20 to your pension for every £80 you pay in. If you’re a higher rate taxpayer, you may have to claim any higher rate tax relief you're entitled to through your self-assessment returns. In some workplace pensions, your own contributions are paid by ‘exchanging’ part of your salary for a higher pension contribution than required from your employer. This means you’ll save the tax and National Insurance contributions on this money as it’ll be going into your pension instead.
- Employer contributions. With auto-enrolment fully in place, all employers must contribute to pension schemes on behalf of eligible employees. Check with your employer to see how much they’ll put in. As we mention above, some employers may also allow you to ‘sacrifice’ or ‘exchange’ part of your salary in return for pension contributions. In this way, both you and the employer will save on tax and National Insurance contributions.
How to pay into a pension
- For individual and workplace pensions, you can make regular and one-off payments. This will vary depending on both your provider and the type of pension you have, so check in advance that you can pay in the way you want to.
- You can usually make payments through your employer too. Either contributions will come out of your salary, or your employer will pay into your pension themselves. Speak to your employer to see what they offer
How you can receive money from your pension
Most pensions will set an age from which you can start taking money from your pension. This is usually somewhere between 55 and 65.
They will also have rules for when you can take your pension earlier than normal, for example if you become seriously ill or unable to work.
When the time comes to start taking money from your pension, you’ll need to decide how you want to do this.
- If you’ve got an individual pension or a defined contribution pension, you can take up to 25% of its value as a tax-free lump sum. You’ll usually pay tax on the rest, which you can either take as cash, use it to buy an annuity (a guaranteed income for the rest of your life) or leave invested and make regular or one-off withdrawals over time. Different ways of taking your money have different levels or risk and security and potentially different tax implications too. As with all retirement decisions, it’s worth getting advice on what’s best for you personally
- With a defined benefits pension, you may be able to take some of its value as a tax-free lump sum, but this will depend on the rules of your scheme. The rest of the money will be paid to you as a guaranteed income for the rest of your life
It’s never too early to prepare
The earlier you start thinking about what you’ll need for a comfortable retirement and where your money is going to come from, the more control you can have over that period of your life.