Pensions have the reputation of being confusing, but they needn’t be. Here we give a brief summary of what a pension is and why it might be a good idea for you.
What is a pension?
A pension is a tax-efficient way to save for your retirement. It aims to provide you with a source of income in later life.
The Government will pay you a secure regular income when you reach the State Pension age. This age is determined by when you were born. The amount you receive will depend on certain factors, including the number of years in which you've made National Insurance contributions and the date you reach the State Pension age.
Your employer may arrange a workplace pension, also known as an occupational or company pension. There are two main types:
- Defined Benefit schemes - these pay you a specific income when you retire. Your income is based on how long you've been part of the scheme and the salary you've earned. Final salary or career average schemes are examples of this. It’s your employer’s responsibility to contribute into the scheme and they may ask you to do so as well.
- Defined Contribution schemes - these allow you to build up a pot of money that you can usually access from age 55. The size of your pension pot will depend on how much you and your employer pay in, how your investments perform and the effect of any charges. You might also hear these called money purchase schemes.
You can also choose to set up a personal pension, which is a type of defined contribution scheme. As you arrange this yourself, you don't need to have an employer, although if you do they can still contribute.
The value of pension investments may fall as well as rise. Any investment you make into a pension plan will be tied up until you take your benefits.
Why do I need a pension?
The earlier you start saving into a pension, the better chance you'll have of achieving the lifestyle you want in later life. By the time you want to take your pension benefits you may want to work less or retire.
What makes saving into a pension so tax-efficient?
To encourage people to save for their retirement, the Government offers the following:
- Tax relief - you'll receive tax relief on your pension contribution at the basic rate, currently 20%. For every £80 you pay, you'll receive £20 of tax relief, so you get a total of £100 paid into your pension plan.
- Tax efficiency – money in your pension pot grows free from UK income tax and capital gains tax.
- Tax-free lump sum – when you choose to take your pension benefits, you are normally entitled to take up to 25% of your pension pot as tax-free cash.
The law and tax rates may change in the future, and the value of tax relief depends on your individual circumstances.
How do I access my money?
If you're aged 55 or over and have a defined contribution pension pot, there are various ways you can access your pension savings.
You can find more information on our Accessing your Pension Pot - what are your options? page.