28 May 2024

What is a private pension?

A private pension is one you own, manage and pay into yourself. Broadly speaking, it’s any pension that’s not the State Pension. In 2022, about seven and a half million UK people were paying into a personal pension and about 20 million people were paying into a workplace pension.

There are two different kinds of private pension:

  • Defined contribution (DC) pensions: You choose how much you pay into them, but their growth and value at retirement depends on how your investments do over the years. They can go down as well as up. You can set one up for yourself or have it set up for you by your employer.
  • Defined benefit (DB) pensions: They pay out a fixed amount when you retire, which depends on your salary and how long you’ve worked for your employer. Only an employer can set one up for you. These days, they’re not very common.

And that’s just the start of our private pensions explained journey. 

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Interested in a personal pension?

Whether you're self-employed and looking to save for retirement, or just looking for a place to bring your pensions together, our Personal Pension could be right for you.

How do private pensions work?

All private pensions help you save for your retirement and top up the State Pension when you get there. When you pay into one, your money goes into a pension pot that will go towards your income in retirement.

How DC pensions work

If you’ve got a DC pension:

  • You’ll pay into it
  • Your employer might top up your payments
  • You’ll get tax relief from the government

When you reach 55 (rising to 57 from April 2028), you’ll be able to access your money. Before that, we recommend planning carefully and getting professional advice to:

  • Make sure you’re saving enough to support your ideal retirement lifestyle
  • Help you choose what do with your pension pot once you can access it.

There are several different kinds of DC pension. To find out more about what they are and how they work, take a look at our DC pensions article.

How DB pensions work

If you’ve got a DB pension, you’ll pay into it while you’re working for the employer who set it up for you. You won’t have any control over how your money’s invested – it’s managed by the pension scheme’s trustees.

When you reach retirement, you’ll start getting guaranteed payments. The actual age when that happens is called normal pension age (NPA) and varies from scheme to scheme. The amount you get will be based on:

  • Your length of service with your employer
  • Your final or average salary while you were with them

The exact details will depend on how your employer’s set the scheme up.

Is it worth having a private pension?

It depends on the kind of retirement lifestyle you’re hoping for. The State Pension is currently £11,502.40 a year, which will only support a very basic lifestyle. If you’re not sure how much later life income you might need, visit the Retirement Living Standards site to find out. As a minimum they recommend an income, after tax has been deducted, of £14,400 in retirement for someone living outside of London.

So the chances are you’ll need more than the State Pension provides. If that’s the case, a private pension is a tax-efficient way of topping it up.

  • If you’re in full-time employment, you’ll probably already have a workplace pension to pay into. As Defined Contribution (DC) pensions are the most common type of private pension, we'll focus on that for the rest of the article. Your employer might match some or all of your payments, and you’ll get tax relief from the government too.
  • If you’re self-employed and want to start saving for later life, you might need to set up a personal pension. You won’t get any employer payments, but you will get a helpful 25% tax relief from the government.

And of course, even though pensions are a great way of saving for the future they’re not your only choice. If you’re not sure what’s best for you, we’d recommend a chat with a financial adviser.

Want to read more about the benefits of saving into a pension?

We cover tax relief, why saving sooner rather than later is so important and share tips on how much to save into your pension.

Is it better to have a pension or savings?

It’s not an either-or choice – ideally, it’s best to have both. You save into your pension to be ready for later life, while putting away money to cover shorter-term costs. They can include anything from big life events like getting married or buying a home to getting through times without work.

And when you’re working out how much to save into your pension and how much to put into other savings vehicles, like an ISA or a Lifetime ISA, don’t forget the benefits that come with pensions.

If you’re paying into a workplace pension, your employer will top up your payments with at least 3% of your salary – and they might match higher payments. 
If you have a workplace or a personal pension, you’ll enjoy up to 25% tax relief from the government on any contributions you make.

For a more in-depth comparison between ISAs and pensions, check out our ISA or pension article.

Private pension tax relief

Private pension tax relief can be a complicated area. We’re going to lay out the basics as simply as we can. So:

  • You can get tax relief on private pension contributions worth up to 100% of your annual earnings
  • You’ll either:
    • Have your pension contribution taken from your net pay, reducing the overall amount of tax you pay on earnings and giving you tax relief straight away
    • Get relief at source, where your provider will claim tax relief at the basic rate and add it to your pension pot.
  • If you’re a higher rate tax payer (above 20%) you may need to claim extra tax relief yourself through a self-assessment tax return
  • You can pay money into your pension until you’re 75 and still get tax relief
    • If you start drawing on your pension, you’ll trigger the money purchase annual allowance (MPAA), which caps the amount you can pay in at £10,000
  • The exact amount of tax relief you can get will depend on your total annual income and your tax rate.

And for a deeper dive we’d recommend:

FAQs

That depends on a variety of factors. The most important ones are how you’ve chosen to invest it and how the markets are doing. As with any investment, it’s hard to predict or control exactly how much your pension might grow.

But you can choose to invest in funds with different levels of risk, which will give you at least some sense of how it might do. And of course however it’s invested, the value of your pension pot can go down as well as up.

No, private pensions don’t increase with inflation. But hopefully over the years your pension investments will grow at a higher rate than inflation so your money gains rather than loses value, but this isn't guaranteed. You can learn more in our Inflation and your pension article.

You can withdraw money from a private pension once you’re 55 or older (rising to 57 from April 2028). You might be able to take money out of it before then if you’re retiring early because of ill health.

You still own your pension pot and are still able to pay into it or, if you’ve reached the age when you can access it, take money out of it. Living abroad might create tax and other practical issues – for example, if you don’t have a UK bank account it might be difficult to receive any money from your pension. There are also limits to how much tax relief you can claim on your contributions when living abroad. 

Take a look at our What happens to my pension if I move abroad article for more info.

Yes, you can – and many people do. But once you start taking money out of your pension the annual amount you can pay into it will go down to £10,000. And of course any money you take out is no longer invested so can no longer grow (though of course its value might also go down).

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