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What is a pension and how does it work?

Whether you're new to pension savings or just looking to refresh your knowledge, we'll tell you all you need to know.

What is a pension?

A pension is a tax-efficient way of saving money for your retirement.

There are different types of pension. One of the most common is a workplace pension, where both you and your employer save (or contribute) into a pension. You may also have a personal or private pension that you've set up for yourself. You can save into several different pensions, as long as you stay within your annual and lifetime limits.

To encourage you to save into your pension, the government also adds money to them through pension tax relief.  

Remember, as with any investment the value of your pension and any income may fall as well as rise and is not guaranteed.

When you reach age 55 (rising to 57 from 2028) you can take the money from your pension as an income, a lump-sum or a combination of both.

How does a pension work?

The basics are fairly consistent across all types of pension:

  • You and / or someone else (for example, your employer if it’s a workplace pension) pay into your pension.
  • You'll receive tax relief on the pension contributions you make.
  • Ideally, your pension pot grows as you pay into it and the value of your investments rises. Of course, the value of your investments can fall too, so in challenging financial times your pot could shrink rather than grow.

From age 55 (rising to 57 from April 2028) you can access your pension. Usually you can take up to 25% as a tax free lump sum. Then you have to decide what you want to do with the rest, whether that's starting to withdraw some or all of the money, or keep paying in. If you continue to pay in you may be subject to the Money Purchase Annual Allowance (MPAA).

Find out more about your pension pot options

Types of pension

Learn more about the different types of pension, and which might be right for your personal circumstances.

What are the benefits of opening a pension?

A pension is a good way of building up a pot of money to live on in retirement, when you may no longer want or be able to work. If you can wait until you’re 55 (rising to 57 from April 2028) to access your savings and you’re comfortable making your own decisions, a personal pension might work for you.

A personal pension is a long-term investment that gives your money time to grow. If you're saving into a Personal Pension, you can continue to contribute until you’re ready to decide how to use your savings. You could also get a 25% top up on what you save and you may be able to claim more from HMRC if you're a higher rate or additional tax payer. Find out more about pension tax benefits.

If you have access to a workplace pension (which your employer will also contribute to), a personal pension won’t replace it. But it’s a useful way of saving if a workplace scheme isn’t an option – if for example, you're self-employed – or you want to add to your workplace pension savings.

A personal pension can give you control of where your money is invested. For example, it could help you invest in ethical or sustainable funds (sometimes referred to as Environmental, Social and Governance - or ESG - funds) if that’s important to you.

The benefits of a pension – personal or otherwise – are long term ones. It's designed to help you save throughout your working life. If you're looking for a shorter-term way to save or invest, or are likely to need the money before you're 55 (rising to 57 from April 2028), other products, such as an ISA, may be a better option.

With all pension schemes, your money is invested. There are risks associated with investing. The value of your investment(s) could fall as well as rise. It’s important to make sure you’re comfortable with that.

How much can I pay in and what are the tax allowances?

The government sets a limit on how much you can pay in to your pensions every year before incurring tax charges. This is called the 'annual allowance'. For the 2023/24 tax year, the standard annual allowance is £60,000. This is a combined total across all of the pensions you're paying into. It could be lower, depending on your individual circumstances.

There's also a lifetime allowance, which is the limit on how much you can build up in pension benefits over your lifetime while still enjoying the full tax benefits. The current lifetime allowance is £1,073,100.

How do I open a pension?

If you'd like to open a personal pension, you'll need to find a provider that meets your needs. Key points to consider include:

  • The investment options they offer
  • The fees they charge for managing your account
  • If they’ll let you transfer and combine existing pensions.

Depending on the provider, you may be able to open your pension online.

Legal & General offers a personal pension which you can open and manage online. Find out if our Personal Pension is right for you.

You don't need to open a workplace pension. Your employer will do this on your behalf.

How large a pension pot do I need?

The amount of money you'll need from your pension depends on various factors, including:

  • When you want to start using your pension
  • Any other sources of income you'll have
  • The lifestyle you'd like and how much you expect to spend.

To work out how much money you'll have when you reach retirement, you should consider:

  • How much you're currently saving
  • How long until you retire
  • How your pension is performing
  • The impact of any pension charges.

In general, the sooner you start saving and the more you pay in, the more savings you could have in retirement.

Use MoneyHelper's pension calculator to get an idea of how much your pension pot will be when you want to retire.

You can also use our retirement income calculator to find out how long your pot might last, depending on how you use your pot.

How do I take my pension?

Once you reach your 55th birthday (rising to 57 in April 2028), you can take your pension at any point, and in several ways:

  • Get a guaranteed income for life by using your pension pot to purchase an annuity.
  • Get an income for a fixed-term by purchasing a product like our Cash-Out or Fixed Term Retirement Plans.
  • Place your pension into Pension Drawdown, and choose when and how much you want to take.
  • Cash in your pension pot and take all of the money as cash.
  • Combine two or more of the options above, either at the same time or one after the other.

Whatever you choose, you'll be able to take up to 25% of your pension pot as a tax-free lump sum.

Your pension provider will send you details of your options when you get closer to retirement. Before deciding what to do with your pension, you should shop around to make sure you're making the right choice. Remember, you don't have to stick with your existing pension provider when buying a retirement income product.

For more information, take a look at our guide to your options for using your pension.

Pension fees and charges explained

When was the last time you checked the fees you were paying on your pension pots? It’s really important to keep track of them, as you could be paying too much – or you could have the balance just right.

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Pension saving made simple

Sorting out your pension with us couldn't be simpler. With a quick and easy sign-up process, you can start putting money away for retirement from as little as £100.

  • A low service charge of 0.25% and a Fund Management Charge of just 0.31%.
  • Choose from five diverse multi-index funds, based on your risk appetite, or from our extended fund range.
  • Open your account, check the value of your pensions, set up regular payments or top-up your savings with our secure online account.

You can withdraw money from your pension when you turn 55 (rising to 57 from 2028 onwards). Please remember the value of your pension pot will go up and down. It isn’t guaranteed, so you may get back less than you put in.

Pensions explained

How much money do I need in my pension?

One of the key things you'll need to think about is how much money you'll need to have the lifestyle you want in retirement. Find out with MoneyHelper's Pension Calculator.

What do I need to know about the State Pension?

The State Pension is your basic income when retired. Discover how it works and how much you could be eligible for.

What happens to your pensions when you die?

After you die, it may be possible for your spouse or civil partner to receive money from your pensions. Find out more here.