What is a Pension?
Pensions are a long-term savings scheme. Just one of the ways that you can save for your future, so that you have enough savings to live off after you have finished working.
Pensions are an important part of planning for retirement, and can be the key to living the life you want once you retire.
Types of Pensions
In the UK there are 3 main types of pensions:
- State Pension: Paid by the government to eligible individuals when they reach the state pension age. The amount you will get is based on your history of National Insurance Contributions.
- Workplace Pension: Provided by an employer. Workplace pensions will usually contain a mix of payments made by both the employee and the employer.
- Personal / Private Pension: You will have set this up independently, it is a separate pension.
Why You Need a Pension
Unless you plan to work for the rest of your life, you will need either a regular form of income, savings, or a pension from which to live off.
Pensions can provide a steady income in retirement. A private pension combined with the state pension can help to avoid financial struggle in your retirement years. Relying solely on the state pension can be challenging, because it does not cover what is considered the minimum standard of living.
The UK government encourages us to save into our pensions by providing us with tax breaks, based on the amount contributed to the pension and your personal tax circumstances.
When you retire you can access a tax-free lump sum from your pension pot. This is when you can withdraw up to a quarter of your pension savings tax-free. For the remainder of your pension, you will be taxed based on your personal allowance during the tax year of withdrawal. So, while you enjoy the tax break when the money goes into your pension, it is potentially taxed when you withdraw from your pension, depending on your level of income for that tax year.
Saving for a pension, provides you with the flexibility to retire before the State Pension age. Right now, most people can start to take money out of their private pension at age 55. This will raise to age 57 from 6 April 2028 and may change again in the future. For those born before 6 April 1971 the rise in age threshold will not affect you.
You can potentially use your private pension to bridge the gap between when you retire and when you start to receive the State Pension, once you reach the State Pension age.
How Much Will I Need in Retirement?
The Pensions and Lifetime Savings Association have calculated the level of expenditure required to meet three different defined standards of living in retirement. Minimum, Moderate and Comfortable.
Here is what a single person will need to live on each year to reach the living standards:
- Minimum £14K
- Moderate £31K
- Comfortable £43K
For couples living together, the annual income will need is calculated as:
- Minimum £22K
- Moderate £43K
- Comfortable £59K
(K = Thousand)
For additional detail on what has been included to calculate the living standards, visit the Retirement Living Standards site.
The reality is that even for a minimum standard of living the state pension is not enough.
State Pension
The State Pension is a regular payment from the government that most people can claim when they reach State Pension Age. It serves as a foundation for retirement income, but the amount you are eligible to receive will vary, and is based on your National Insurance record.
To be eligible for the State Pension you will need to reach State Pension Age.
You also must be either;
- a man born on or after 6 April 1951, or
- a woman born on or after 6 April 1953
Different rules apply if you were born before these dates.
The state pension age differs depending on when you were born.
Check your personal state pension age here using the UK government tool.
The UK State pension age is currently 66 years old, and will rise to 67 in 2028. It will also increase again from 67 to 68 between 2024 and 2046. The government reviews the State Pension Age at least once every five years.
To qualify for a UK State Pension, you need to have enough qualifying years of National Insurance contributions.
Currently the minimum number of years that you must contribute national Insurance contributions for is 10 years.
A qualifying year for National Insurance is a year where you have either;
- worked and made National Insurance Contributions, or
- are receiving National Insurance Credits,
You can receive National Insurance credits for reasons including being unemployed, being ill, being a parent or carer. You can also get National Insurance credits by paying voluntary National Insurance contributions.
For parents, if you are the parent claiming Child Benefit you will automatically receive National Insurance Credits until your youngest child is 12, even if you are not earning any money.
How Much is the UK State Pension?
The full rate of the State Pension is £221.20 a week. That is only £11,502.40 per year for the tax year 2024/25, and this goes up every April.
Amounts received depends on factors including your National Insurance Record, and if you were contracted out of the state pension before 2016.
If your National Insurance record started after April 2016, you will need 35 qualifying years to get the full rate of the UK State Pension. It is possible to get more that £221.20 a week if you paid into an Additional State Pension before 2016. You can check your own personal pension projection directly with HMRC.
HMRC Personal Tax Account
To check your own personal UK state pension projection all you need is a Personal Tax account with HMRC.
To get your own free personal tax account you need to sign up for a government gateway account. This is entirely free and does not cost you anything.
How do I set up a Government Gateway account?
Go to the Gov.uk sign in page
- Select “HMRC account: sign in or set up
- Click “Sign in”
- Click “Create sign in details”
- Enter the email address that you want to use for your account.
- You are then sent an authorisation code to the e-mail address, that you will need to enter in order to verify the email address
- Enter your full name and then follow the prompts to set up a password
- Set up your recovery password in case you are unable to access your account in the future
Workplace Pension
It is the law that all employers must offer a workplace pension scheme. With workplace pensions the employee (you), your employer and the government all pay into the pension.
Within 3 months of starting work your employer must enrol you into the workplace pension scheme. The employer picks the workplace pension scheme.
You have the right to opt out of the workplace pension scheme, this is not recommended as you will not receive the employer contributions without a workplace pension scheme.
If you meet a minimum level of earnings the employer will contribute into the pension scheme. Employers must contribute at least 3% and the employee (you) contributes 5% of earnings into the scheme, for a total contribution of 8%.
The pension contributions will show on your payslip and you will receive access to the scheme itself, usually via an online portal, to view your contributions. You will also receive an annual statement from the pension provider.
Some workplace pension schemes put the contributions into a particular fund and others permit you to choose how you want to invest your pension savings so that they have the potential to grow.
Workplaces can also offer salary sacrifice and other ways of maximising the amount going into your pension and reducing costs such as National Insurance Contributions.
One important note is that while the law is that employers must input at least 3% into your pension, this is not necessarily 3% of gross earnings and will instead often be based on qualifying earnings which is a set threshold reviewed annually by the government.
The important aspect however is that you are entitled to receive pension contributions from your employer, provided you earn above a minimum threshold.
If you are aged 22 and over your employer must enrol you into the scheme within 3 months of starting employment.
If you are aged between 16 and 21, your employer will not automatically enrol you into the scheme, however you have the right to request to join the workplace pension scheme. Then you, and your employer will both contribute, and you will also receive the tax break contribution directly into your pension from the government. Provided you reach the minimum earnings threshold.
When you leave employment with that employer, you can keep your pension within that scheme or you can transfer it into a different pension scheme of your choosing. This could be into a new workplace pension scheme or a separate private pension scheme.
It is very important to keep track of all your different pension schemes.
Moving your contributions to a private pension with a lower fee structure makes economic sense. One where you are able to invest your pension savings precisely how you want to, while paying the minimum possible in fees.
Private Pensions
You can save outside of a workplace pension scheme for your retirement. This is called a private or personal pension.
The choice of how you want to invest your pension pot may guide you to the choice of provider. For example, if you wish to invest in a certain fund you will need to choose a provider that offers that type of fund as an available investment.
They key to choosing a good private pension provider is choosing one that is regulated, and provides a low fee structure. Any fees taken from your pension will impact the amount by which they can grow. The aim of the pension as an investment vehicle is to grow and compound as much as possible from the initial investment to the point of drawdown, where you then withdraw the funds to live on in retirement.
You will receive tax relief from the government for contributions you make into your private pension. Basic rate tax relief will be paid directly into your pension by the government. If you are a higher rate tax payer you will need to claim the higher rate relief element, within your annual self assessment tax return.
You can transfer old workplace pensions into your private pension. This gives you more control over your savings in terms of fees charged and the investments made with your pension funds. It also helps with keeping track of your pensions. Particularly if you have had several workplace pensions over your working life.
All pension providers in the UK are regulated and must follow strict rules.
Make sure that you choose a regulated provider. There are scammers out there trying to obtain access to your pension savings. Do not make it easy for them.
Points to Remember
Be aware of the level of fees you are being charged. Types of fees that may be charged by your provider can include;
- Annual management charge
- Underlying fund fee
- Platform fee
- Service or policy fee
- Inactivity fee
- Pension transfer fee
- Assets under management fee
- Early-exit charge
- Contribution charge
- Fund-switching fee
- Annual allowance charge
- Lifetime allowance charge
- Drawdown pension charges
There are pension providers available with very low fees. They key is to switch from a high fee pension provider to a low fee provider so that your assets have the time and opportunity to grow.
Keeping your pension with a high fee provider can limit its growth substantially and cost you a lot of money over the life of the pension. The charges are typically withdrawn directly from your pension savings and you may not be aware of how high these really are.
Each person has a unique set of circumstances and if you are not comfortable making these financial choices on your own, you can get independent financial advice from a regulated financial advisor.
The Financial Conduct Authority regulates financial advisors in the UK. You can find a regulated financial advisor here.
Plan For Success
The earlier you start saving into a pension, the more options you will have in retirement.
It is never too late to start saving for retirement. Every bit of savings, no matter how small will have an impact on your quality of life in retirement.
The sooner you start to make consistent regular contributions the longer the money will have to compound, grow, and work for you.
Through the power of compounding, you can have a significant pension pot, provided you start early and contribute regularly. A person who contributes a small amount regularly in their early years can potentially have a much bigger pension pot than someone who contributed much greater amounts later in life.
Consider when you want to retire and what lifestyle you want to have in retirement. Then choose the right type of pension for you.
Remember, it’s never too early (or too late) to take positive action for your financial future.