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What is a pension – and why should you care?

A pension is essentially a long-term savings scheme. It’s a way to invest for your future and help you build your savings for life after work.

Let’s face it, ‘pension’ is not the kind of word to get you on your feet dancing. It’s not quite up there with ‘winning the lottery’ for excitement levels.

The fact is, though, a pension could be the key to you living the life you want – whether it’s one of basic comfort or all-out adventure.

The sooner you start saving into one, the more options you’re likely to have in years to come. And it’s never too early – or too late – to start.

Why do you need a pension?

If you can, it’s generally a good idea to pay into a pension. Once you stop working or reduce your working hours, you’ll still need an income to live on. The sooner you start thinking about where that income is going to come from, the more likely you’ll have the lifestyle you’d like in retirement.

There are other ways you can save or invest for your future. Yet for most people, pensions are the best option because of:

Tax relief from the government

Tax relief is when some of your money that would have been paid as tax goes into your pension instead. It basically means the government adds 25% to any contributions you make to your pension pot up to a certain limit. And if you’re a higher rate taxpayer, you can claim even more via your tax return.

Contributions from your employer

If you have a workplace pension, your employer is obliged to contribute to your pension on your behalf, unless you earn less that £6,240 a year. This is on top of the government tax relief.

A tax-free lump sum

Up to a quarter of your pension pot can be paid tax-free when you access it. You’ll then pay tax on the income you receive from your pension.

What happens to my pension when I die?

You can choose who will receive your pension pot when you die. Normally your pension is excluded from your estate and is not liable to inheritance tax. Depending on the age at which you die, however, the recipients of your pension may pay income tax on it.

What is the State Pension?

The State Pension is an amount of money paid by the government to people who qualify when they reach State Pension age.

You build up your entitlement to the State Pension by making National Insurance contributions during your working life. You can also do this when you’re bringing up children or claiming certain benefits.

How much is the State Pension?

The amount you get will depend on the National Insurance contributions you’ve made. The government will then pay you your State Pension – a guaranteed income – for the rest of your life.

It’s important to remember that the State Pension alone is unlikely to be enough for a comfortable retirement. However, it could be a useful addition to your retirement income.

Is a State Pension taxable?

If your total annual income adds up to more than your personal allowance, you’ll pay tax on your pension. The standard personal allowance for the 2024/2025 tax year is £12,570. You’ll pay tax on the amount that exceeds this limit. 

You’ll no longer make National Insurance contributions when you reach State Pension age.

How do you claim your State Pension?

You’ll need to claim your State Pension – this isn’t paid automatically. You should receive a letter up to 2 months before you reach State Pension age with details on how you can claim. If you haven’t received a letter, you should still be able to claim the State Pension, if you’re eligible.

What is a workplace pension?

A workplace pension is a savings scheme you may be enrolled into by your employer.

If you’re a member of a workplace pension scheme, you and your employer will be contributing a proportion of your salary or wages to your pension pot. And the government will also contribute to your pension through tax relief.

Some employers will help you build your retirement savings faster by agreeing to pay more than the minimum into your pension pot, if you agree to increase your contributions too. This is known as ‘contribution matching’.

If you’re lucky enough to be offered matching contributions, it’s well worth trying to pay more into your pension to take advantage of what is effectively ‘free money’.  

There are 2 types of workplace pension schemes: ‘defined contribution’ and ‘defined benefit’, sometimes known as a ‘final salary pension’.

These days, most people are likely to be enrolled into a defined contribution scheme, which means money accumulates depending on how much is paid into it and any investment returns.

Your money will be invested in a fund and managed for you. You’ll have the option to select investment funds and should take into consideration your circumstances, goals and risk appetite. Alternatively, you can opt for the default investment option.

If you’re not automatically enrolled into a workplace scheme, you can ask your employer to join your workplace pension.

What is a private pension?

Personal pensions, stakeholder pensions and self-invested personal pensions (SIPPs) are all types of private – or individual – pensions that you set up with a pension provider yourself.

This could be on top of your workplace pension, or instead of one, if you’re self-employed, for example.

It’s up to you to choose your provider – as well as how often and how much you contribute (within the annual and lifetime limits). As with a workplace pension, the government will contribute to your private pension through tax relief. If you’re not sure which provider or option to choose, you can pay for financial advice.

What you get back will depend on how well your investments perform. As with all investments, the value of your pension can go down as well as up, and you may get back less than you paid in.

All pension providers charge fees for managing a private pension. It's important you’re aware of the costs as they can eat away at your pot.

How do workplace and private pensions work?

Depending on the type of pension you have, it works like this:

  • You pay into it – and if it's a workplace pension, your employer also makes a contribution each time you get paid
  • The government also ‘contributes’ to it in the form of tax relief, reducing the impact on your take-home pay
  • The money is invested, giving it the potential to grow further
  • At a set date, you’ll be able to access the money you’ve accumulated, normally once you stop working and have retired (currently from age 55)

The final point above is where pensions are different to some other types of investment. This is to help avoid the temptation of dipping into it before you need it.

Like all forms of investment, the longer you leave it, the more chance your money has to grow. However, there’s also a small risk you may get back less than you put in.

What sort of pension is right for you?

If you’re employed, it makes sense to take advantage of your employer’s scheme.

If you’re self-employed or you don’t think your employer’s scheme is right for you, you might consider opening a private pension or taking out a long-term investment.

Remember, the State Pension should be considered as a buffer, as it’s unlikely to be enough on its own for a comfortable retirement.

When can you get your pension?

It’s best to hold off from accessing your pension for as long as you can afford to – certainly until you’re no longer working full-time. This gives you as much time as possible to make payments into your pension and allow it to grow.

Most workplace pensions set an age when you can take it.

The earliest age you can take your pension is 55.

From 2028, the earliest age you can take your pension will rise to 57.

They’ll also have rules for when you can take your pension earlier than normal, for example if you become seriously ill and unable to work.

What is Pension Credit?

Pension Credit is a government benefit which brings up the weekly income of a pension to a minimum amount. It’s for people over State Pension age and on a low income who fit the eligibility criteria. 

Find out more about the Pension Credit and what it is.

Don’t forget…

Pensions might be more exciting than they sound – and they can help you have the future you want.

It pays (literally) to make the most of your pension, whichever type you have and it’s never too early – or late – to start.

Find out how to make the most of a workplace pension.