A pension is a long-term savings account for your retirement. You pay money into a pension scheme, it’s invested (and, in theory, grows in value), and you reap the rewards when you retire. You can get tax relief on the money you pay into your pension, making it a really tax-efficient way to save.
Once you retire, you can access the money in your pension pot. The age at which you can start receiving payments depends on the type of pension you have, as does how you can access the money.
Pensions have a number of important advantages over other retirement savings options:
There are a few different ways to build up your pension:
We work through these in more detail below.
The state pension is the regular pension income you’ll receive from the UK government when you reach official retirement age. You can find your state pension age on the gov.uk website.
As of the 2021-22 tax year, the maximum amount that retirees can expect to receive under the new state pension is £179.60 a week (the amount that those who retired before April 2016 receive is different). The amount is increased each year by the highest of 1 of 3 measures: inflation (as measured by the Consumer Price Index), average earnings increases or 2%. You can find out how much state pension you can expect to receive by checking on the government website.
To be eligible for the full new state pension, you need to have at least 35 qualifying years on your National Insurance (NI) record. This means that for 35 years (not necessarily in a row) at least one of the following applied to you:
If, by the time you retire, you have less than 10 qualifying years on your NI record, you won’t receive any state pension. Between 10 and 35 qualifying years means you’ll get some state pension, but not the full amount.
Anyone working in the UK who is over 16 and earning more than a certain amount (as explained on the government-backed MoneyHelper website) is required to make National Insurance contributions. If you don’t think that you’ll make enough contributions to qualify for the state pension, you can usually make voluntary “catch-up” payments to get back on track.
Most of us have our first direct encounter with pensions at work, and a company pension scheme can be one of the simplest ways to put money away for retirement. As of April 2017, by law, employers are required to offer company pension schemes that both you and they pay into each month. You’ll be automatically enrolled into a company’s scheme unless you choose to opt out.
The biggest benefit to a workplace pension is that your employer almost always has to pay into it as well (unless you joined the scheme voluntarily, rather than being automatically enrolled, and your monthly income is very low).
Your contributions are taken straight out of your pay before it even hits your bank account, so it’s easy not to miss it, and you don’t pay tax on the money that goes into your pension pot (known as tax relief).
There are 2 different types of workplace pension.
These pay out a fixed, regular income when you retire, based on a percentage of your salary during your time at the company. The percentage is calculated based on the years you’ve worked at a company. Defined benefit schemes are becoming increasingly rare, as the company has full responsibility for ensuring there’s enough money in the pot to pay retired employees’ pension income. This can prove expensive. The most common type of DB pension is final salary, where your income is based on your salary when you left the company. But some organisations also offer career average DB pensions, based on your average salary.
This is now the most common type of pension. Money paid in by you and your employer is invested by the pension provider. The idea is that these investments will grow enough over time to provide a worthwhile return to help fund your retirement. But, as we all know, investment performance is not guaranteed, so the value of your pension pot when you retire isn’t set in stone. When you retire, you can take the cash out (all at once or gradually over time), leave it invested or use it to buy an annuity.
A personal (or private) pension is one that you set up yourself and choose how much to pay into. You can contribute a regular amount or occasional lump sums. If you wish, you can take out a personal pension even if you already have a workplace pension. You can opt to manage it yourself or choose a provider that will manage the pension for you.
As with workplace pensions, you get tax relief on money that you pay in, which boosts the value of your pension pot.
Almost all personal pensions are defined contribution (DC) schemes so, as with workplace DC schemes, there’s no certainty over how much you’ll have in your pot when you retire; it all depends on the performance of your investments.
There are 3 main types of personal pension:
In the same way as with workplace pensions, when you retire, you can take money out of a personal pension scheme, leave it invested and/or buy an annuity.
For some, retirement may seem a long way away. But there’s a good chance that, for many of us, our “golden years” will make up at least a quarter of our lifetimes. And who wants to spend that much time having to scrimp and save?
The sooner you start paying into a pension, the more bang you’ll get for your buck when you retire. With DC pensions, which make up the bulk of schemes now available, starting early gives your pension investments the longest possible time to grow and maximises your chances of a decent retirement income.
If that wasn’t incentive enough, few other savings schemes offer effectively free money to top up your savings. If you pay into a workplace or personal pension, the government rewards you with tax relief (so, basically, you don’t pay any tax on the money you pay into a pension). Plus, if you have a workplace pension, your employer usually has to add to your pension pot on your behalf.
When you put it like that, it seems like a no-brainer. Of course, in reality, it may not be that simple, and if you’re struggling to even pay your household bills, the idea of investing for 30 or 40 years down the line might be well down your priority list. But as soon as you can afford to pay into a pension, do so. It will pay dividends in the long run.
As long as you don’t pay more than a certain amount per year into a pension, the contributions you make usually aren’t taxable. How you benefit from this tax relief can work in 1 of 2 ways:
Regardless of the method, tax relief means that your contribution to your pension pot will be topped up by at least 25%. So if you’re a basic-rate taxpayer and pay £100 into your pension, your pot will go up by £125. That £25 extra equates to 20% of the total amount, the same amount that you paid or would have paid in tax.
It’s worth bearing in mind that you only get tax relief on money you pay into pensions. When you start to receive your pension, you’ll pay the normal rates of tax on any income that exceeds tax-free allowances.
Find out more about tax relief, including limits on how much you can pay into a pension and still benefit, in our full guide to whether pension contributions are taxable.
When you join a new employer, provided you earn more than £10,000 a year and are aged between 22 and state-pension age, you will be auto-enrolled into its workplace pension scheme by default. Not only don’t you have to do anything to open the pension, but you also have to proactively opt out if you don’t want to be part of the scheme. If you opt out and decide you want to join later in your employment, just let your employer know and it can arrange for you to be signed up.
To set up a personal pension, you can either choose a provider and set your pension up yourself (taking into account the things to look for in a personal pension that we’ve outlined further down) or ask a regulated financial adviser to recommend a provider for you.
Yes, and in fact, by the time we retire, most of us will have several (on top of the state pension). That’s most likely to be the case if you’ve switched jobs several times and held a pension with each employer.
You can even be actively paying into more than one pension scheme at a time. For example, you may have 2 or more part-time jobs, each with its own workplace pension scheme. Or, even if you only have a single job, if you don’t feel that its pension scheme is going to give you enough to live comfortably in retirement, you might choose to boost it by also paying into a personal pension.
The money held in pensions is invested – typically in a mixture of funds, stocks, shares and government bonds. Investing your pension pot allows it to grow much more substantially over time than if it was held in cash savings alone. As with all investments, performance can be volatile, and in the short term, the value can go down as well as up. Over the long period, you’re likely to be paying into a pension; however, the periods of growth should outweigh any temporary downturns.
The government has its own pension scheme called the National Employment Savings Trust (NEST), which many employers join. Alternatively, your employer may choose another company to manage your investments. If you have a personal pension, you can choose your own provider. For example, you may specifically opt for a provider that focuses on ethical or sustainable investing.
The types of investment, and the specific investments, will change over time. As you get closer to your retirement, your pension money will increasingly be moved into less risky investments to reduce the risk of those short-term downturns happening just before you need your money.
The investment of your money will usually be managed by the pension scheme provider, though you will have some say over the investment strategy. For example, if you plan to leave your pension invested following retirement, you may prefer to keep your money in higher-risk and (potentially) higher-reward investments, rather than having them moved into lower-risk options. Or, if you have a SIPP, you’ll be able to manage where your money is invested.
Whatever scheme you join, you’ll need to pay fees. The amount and type of charges can vary between pensions. Workplace pensions may have lower charges than personal pensions because your employer may be able to negotiate better terms in exchange for effectively “bulk buying” from the provider.
Common charges include an annual management charge, which covers the cost of running and managing your scheme and making investments, service charges and transaction fees (payable when investments are bought, sold, lent or borrowed). Not all of these will apply to every scheme, but there are several other charges that might. It all depends on the scheme.
Many pension charges are taken directly from your pot. This means that when you look at the performance of your investments, the cost of the fees will already have been taken into account. Not all charges work this way, though, so check the details before you sign up.
The total level of pension charges can vary significantly between providers and can have a big impact on the performance of your pension pot. So be clear up-front about what you’ll be paying and what you get in exchange. Other things to check are whether a scheme charges you if you stop contributions or to transfer your pension away to another provider.
Auto-enrolment is a scheme set up by the government in 2012 that aims to make sure that people contribute to their pensions. The auto-enrolment rules mean employers are legally obliged to offer employees a pension scheme, which they must also pay into. If you take no action to opt out, you’ll be automatically enrolled in an employer’s scheme when you join a new company – hence the name. You can, however, choose to opt out if you wish.
From February 2019, the total minimum contribution into your pension pot if you’ve been auto-enrolled is 8%, of which your employer must pay at least 3%. In this case, you’d need to pay 5%. Some employers might voluntarily pay a higher amount into your pension. If so, you may be able to pay in less as long as the total contribution is 8%.
Your employer must automatically enrol you into its pension scheme if you meet the following criteria:
If you choose to change jobs, then the money paid into your pension by the time you leave (by you and your employer) is still yours. Once you leave, you can leave it where it is, consolidate it with other existing pensions or transfer it to a new provider. If you have a final salary (or defined benefit) scheme, it’s usually best to leave it where it is since to move it, you’d have to convert it into a defined contribution pension. Final salary schemes are often referred to as “gold-plated”, and for most people, are well worth keeping hold of.
Make sure you keep hold of the details to log into your account and keep your details updated. In particular, let the provider know if you move house so that you carry on receiving your annual pension statements. If you have lots of different defined contribution workplace pension pots, it could be worth consolidating them into one pot.
Yes. While self-employed people qualify for the state pension in the same way as anyone else (for example by making National Insurance contributions), you shouldn’t rely on it to give you the standard of living you’ll want in retirement.
Plus, while you won’t benefit from your employer paying into your pension, the tax breaks can still make a pension a much better option than other ways of saving for retirement.
While cash flow can make saving into a pension a bit trickier if you’re self-employed, you don’t necessarily have to commit to a regular monthly payment. Look for a pension scheme that lets you pay in bigger amounts when revenue is flowing in and pause payments when money is tight.
When you’re selecting your own pension scheme, there are a few things you’ll need to consider above and beyond what you’d need to if you were paying into a workplace pension. These include the following:
If you’re not sure where to start, you may want to seek independent financial advice. There will be a charge for this, but it will save you time and effort and help make sure you select the right scheme for your specific circumstances.
There are different rules for the state pension vs personal or workplace pensions.
In most cases, yes; you’ll pay income tax at the same rate as you would on employment income. The tax rate depends on how much income you receive each year. However, there is one notable exception to this rule.
From the age of 55, you are allowed to withdraw 25% of the total of your pension pot (excluding the state pension) as a tax-free lump sum – provided that the total value of your pension doesn’t exceed the maximum lifetime allowance. This applies to both defined contribution and defined benefit pensions. With the latter, the rules of the scheme will determine how much you can withdraw as a tax-free cash lump sum and your subsequent regular income will be reduced accordingly.
As soon as you begin contributing to a personal or workplace pension, it can’t be withdrawn easily. It must stay in the pension pot until the age of 55.
At this age, you can withdraw 25% as a tax-free lump sum. The rest should ideally provide you with enough income for the rest of your life. With defined contribution schemes, you’ll need to decide what you want to do with the money in your pension pot in order to give you that income.
It’s up to you to decide when (from age 55) you want to retire and to begin planning as you approach your retirement age. Some schemes, in particular defined benefit schemes, may have a default age at which they will start paying you an income. If you want to change this, you will need to check the terms of the scheme and let your provider know.
Bear in mind that your official state pension age – the age at which you will start receiving the state pension – may be different to the age at which you consider yourself retired and start drawing the rest of your pension.
Typically, by the age of 55, you’ll be able to withdraw 25% of your pension pot (excluding the state pension) tax-free.
What happens to the rest of your pot depends on the type of pension.
With both the state pension and defined benefit schemes, you’ll receive a regular income once you start receiving them.
With defined contribution schemes, you’ll need to make a decision on what to do with the money in your pot. There are 4 main options. You can do just one of these, or take a mix and match approach.
You can check how much state pension you’re likely to receive by getting a state pension forecast.
For existing pensions, your provider should send you an annual statement giving you an indication of how much you might receive at your selected retirement date based on the scheme’s current value.
If you want to get a sense of how much you might get based on making certain contributions over your lifetime, MoneyHelper – the government-backed money advice website – has a helpful pension calculator.
Yes. If you’ve stopped receiving pension statements for a scheme you’re confident you paid into, perhaps because you’ve moved house and didn’t get round to updating your details, you can get in touch with the provider and ask for details and to start receiving statements at your new address. If you’re not sure how to contact the provider, for workplace schemes try contacting your employer in the first instance. Failing this, the government has a free Pension Tracing Service. Just pop in the provider or your employer’s name, and the search will let you know its contact details.
There are services that can help you search for a regulated financial adviser based on what you’re looking for, including the government’s MoneyHelper website, the Society of Later Life Advisers, The Personal Finance Society and Unbiased. Or for more general information and guidance, you can call a MoneyHelper pensions specialist on 0800 011 3797 or use its webchat.
The type of protection your pension has depends on the type of pension you’ve got:
| Pension type | Type of protection |
|---|---|
| Defined contribution | Your pension is protected by your pension provider. Check if the provider is covered by the Financial Services Compensation Scheme (FSCS). This could mean you’re entitled to up to £85,000 compensation if the provider goes bust. |
| Defined benefit | This pension is protected by your employer, which is responsible for making sure there’s enough money to pay the agreed amount. If the employer goes bust, your pension money is ring-fenced and protected. You’re usually protected by the Pension Protection Fund if your employer is unable to pay your pension. |
For most people, paying into a personal or workplace pension is the best way to save into retirement, thanks to the tax breaks and the possible employer contributions. If money’s tight right now, it may not be your top priority. But if you don’t want money to be even tighter when you retire, it makes sense to join a pension scheme as soon as possible. Doing so could make all the difference between spending your golden years enjoying life and having to count every penny.
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