Essentially, a pension is just a type of savings plan to help you save money for later in life, typically, your retirement. It also has favourable tax treatment compared to other forms of savings.
There are different types of pensions available, depending on your circumstances. So here is an overview of the different options.
Workplace Pension
This is a pension scheme arranged by your employer. Auto-enrolment legislation requires your employer to enrol you in a pension scheme if you are between 22 and State Pension Age, work in the UK and earn more than £10,000 per year. A percentage of your pay goes into your pension scheme every payday and your employer will also pay money into your pension too.
There are two types of workplace pension:
Defined Contribution
Your pension is based on how much money has been paid into the scheme. The contributions made (by both you and your employer) are invested by the pension provider. The amount available when you retire depends on how much has been paid in and how well the investments have performed. You can get back less than you invested.
Defined Benefit
Sometimes referred to as final salary pension schemes. These pension schemes guarantee you will get a specified benefit when you reach the scheme’s retirement age. The benefit is usually based on a formula that reflects your salary and years of service. The money you get back, or your income in retirement, does not depend on how investments have performed.
Individual Pension
You may be familiar with the terms Personal Pension, Stakeholder Pension and Self-Invested Personal Pension (SIPP). These are all types of individual pensions.
The amount you pay in and the frequency of your payments is usually up to you. The amount you get back largely depends on how well your investments perform. The value of your pension can go down as well and up, and you may get back less than what you have paid in.
State Pension
The State Pension is a pension provided by the government when you reach the State Pension Age. To qualify for the State Pension, you must usually have at least 10 qualifying years on your National Insurance record. The exact amount you receive is also based on your National Insurance records and you will normally get the full state pension if you have at least 35 qualifying years of contributions.
You can obtain an up-to-date state pension forecast for your individual circumstances on the government website. If you would like an up-to-date state pension forecast, please click here. Please note, you will need to either register for the Government Gateway or login to the Government Gateway.
How can you take your money from your pension scheme?
Most pensions will set an age from which you can start taking money from your pension. This is typically between 55 and 65.
They will also have rules for when you can take your pension earlier than normal, such as if you become seriously ill.
Different pension schemes have different options when it comes to start taking money from your pension, for example:
With a defined benefit pension, you may be able to take some of the pension as a tax-free lump sum, but this will depend on the rules of the scheme. The rest of your pension will be paid to you as a guaranteed income for the rest of your life.
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 will usually pay tax on the rest and you have several options:
- Take as a cash lump sum, although be aware as this can lead to you paying a significant amount of tax.
- Purchase an annuity (a guaranteed income for the rest of your life).
- Flexi-Access Drawdown – where you leave it invested and take regular or one off withdrawals over time.
Different ways of taking your pension have different levels of risk and security, and potentially different tax implications. For this reason, we suggest you take advice on what option is best for you personally.
Why should you pay into a pension?
You get tax relief on contributions – when you pay into a pension, the government usually adds money into your pension too, in the form of tax relief.
- If your pension scheme operates a ‘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.
- In some workplace pensions, your contributions are paid through ‘salary sacrifice’. This means that you are ‘exchanging’ part of your salary for a higher pension contribution than required from your employer. This means that you will save the tax and National Insurance contributions on this money as it’ll be going into your pension instead.
Employer Contributions – all employers must contribute to pensions schemes on behalf of all eligible employees. You should check with your employer to see how much they will pay in. As mentioned above, some employers allow you to ‘exchange’ part of your salary in return for a higher pension contribution. In this way, both you and the employer will save on tax and National Insurance contributions.
The Financial Conduct Authority do not regulate auto enrolment.
The value of pensions can fall as well as rise. You may get back less than you invested.
Tax treatment varies according to individual circumstance and is subject to change.