What is a pension?

A tax-efficient way to put money aside for your retirement

Generally speaking, a pension is a tax-efficient way of saving money now, so you have an income in retirement. There are different types of pension plans available, depending on your circumstances. So here’s a quick overview of your options and how they work.

Remember, the value of your pension can go down as well as up and you may get back less than has been paid in.

Types of pensions

Workplace pension 

This is a pension that’s arranged by your employer. Auto-enrolment to a workplace pension plan was introduced in 2012. This means that 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 pension, although you can opt out.  A percentage of your pay goes into the pension each payday and your employer adds money for you too. The current government guidelines on minimum contributions for a workplace pension are that you would add 5% and your employer 3%, for a total of 8%.

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 pension plan is invested by the pension provider. The amount available to you when you decide to access your pension savings depends on how much has been paid in, the charges taken out, and how well the investments have performed, as you could get back less than has been invested. This is the type of pension most commonly offered under auto-enrolment.
  • 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

There may be more benefit to paying extra into your workplace pension, rather than a personal pension plan. Find out more about the benefits of paying extra into a workplace pension.

Personal pension 

There are many different types of personal pensions, including self-invested personal pensions (SIPPs), stakeholder pensions and individual personal pensions. A personal pension is also considered a defined contribution pension.

How regularly you pay in is usually up to you, although your pension provider may set a minimum amount you have to contribute as a single payment, or regularly. Other people, like your partner or employer, may also be able to contribute to your personal pension. What you get back largely depends on how well your investments perform, what was paid in, and any charges that have been taken out. The value of your pension can go down as well as up, and you may get back less than what has been paid in.

The investments available in a personal pension can vary, depending on the type of pension and the pension provider. For example, self-invested personal pensions usually give people access to a wider range of investments.

State pension 

The State Pension is a regular payment that you have to 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.

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. Find out more about how the State Pension works.

Why pay into a pension

As we mention, a pension is a way of putting away money now, in order to be able to access it when you reach retirement. Your pension plan is one way to prepare and plan for the future, even though it is hard to know how long retirement will be.

While there are many ways to save and invest, below are some of the benefits you only get through 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 be able 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. Read more about tax relief here.
  • 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 much you should pay in will depend on your individual circumstances, and the kind of lifestyle you want in retirement. For more information on how to figure out how much you might need to contribute to a pension, check out our article on how much you should pay in.

It’s never too early or too late to start putting money into a pension

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. See some of the benefits to paying into your pension early in this video

But it is never too late to start putting money into a pension, or finding ways to boost your pension contributions to help prepare you for retirement. Check out our article on 6 simple ways to boost your pension.

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.

You can try our retirement planning tool to see how the amount you pay into your pensions could add up for retirement. Try our My Retirement Planner.

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, which is the current minimum age set by the government, and 65. 

The government also has 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.

  • With a defined contribution pension, you can usually take up to 25% as tax-free cash. There are a number of ways to access the remaining pension benefits, such as: a cash lump sum, a guaranteed income for life (annuity), flexible income (drawdown) or a combination of options. Find out more about the ways to take your pension money.
  • 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.
  • Different ways of taking your money have different levels of risk and security and potentially different tax implications too. As with all retirement decisions, it’s worth getting guidance or advice on what’s best for you.

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

Get to grips with the pension basics

Find out more about the key things you need to know on your retirement journey.

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