An introduction to pensions

Pensions are long-term saving plans that you contribute to throughout your life. Once you retire, you can access the money in your pension pot as lump sums or smaller, regular payments.

Your pension can be a personal pension, workplace pension or both. You may also receive a State Pension from the Government, which is paid once you reach state retirement age. To receive a basic State Pension in full, you must have 30 qualifying years of National Insurance contributions or credits.

When you can claim your state pension varies depending on your age. You can find out more on the official Gov.uk website.

You can organise your own personal pension where you’ll make regular contributions to build up a pension pot that you can then access usually once you turn 55, this will be increasing to 57 in 2028. This is a popular option for anyone who is self-employed and may not have access to a workplace pension.

Workplace pensions vary, but typically an employee and employer will pay a set percentage of the employee’s monthly income into their pension. By law, employers are required to offer you a workplace pension.

The two main workplace pension choices are:

Defined benefit

A defined benefit plan is a pension scheme where your employer agrees to pay you a set amount of money when you retire. The amount will be based on your length of time with the company, your salary history and your age. These schemes are largely historic now, only offered by a handful of employers (usually public sector).

Defined contribution

Employees are automatically enrolled in the scheme, providing their employment status meets the qualifying criteria. You will make regular, automatic contributions to your pension that will typically come out of your wage. Your employer will then match your contribution, or a percentage of it.

When you change jobs, the pension you’ve accumulated becomes ‘frozen’ but will still be available to you when you retire – however you may not qualify for all of the benefits if you have switched pension providers. Pensions can also be consolidated with one another if you change jobs, but you should consider speaking to a Financial Adviser first as it can be a complex process.

For more information, our guide on different types of pensions goes into more detail about your pension choices.

You can start saving towards a pension at any point in your life – a parent can even set up a pension for a child from birth.  Most people begin saving with their first workplace pension.

Starting your pension as early as possible gives you more time to save for retirement. That said, it’s never too late to start contributing to your pension.

If you are unable to start a workplace pension, for example if you are self-employed or unemployed, you may prefer to start saving into a personal pension.

For workplace pensions, you can work out your pension contribution by calculating how much money you and your employer contribute monthly. The total will be your monthly pension contribution.

To do so, you will have to check your pension contribution agreement with your employer. You will also need to check if your employer’s pension contribution is based on your basic or total salary. Basic is what you earn before any additional pay. Total salary includes any extra money you earned in bonuses, commissions or otherwise.

The below example illustrates this in more detail:

Steve is 28. His employer matches his monthly pension contribution of 10%, based on total salary, which makes his overall contribution 20%. The contributions are taken before Income Tax and National Insurance.

This month, Steve earned £2,100. To calculate Steve’s monthly pension contribution, he calculated 20% of £2,100, which equals £420. However, only £210 (10% of his total salary) is from Steve’s salary; his employer contributed the remaining £210.

Note that bonuses are often not included in pension calculations, only base salary. Consult your employer to find out how bonuses affect your specific pension contributions.

If you have a workplace pension, you can typically contribute up to 100% of your salary or £60,000 per tax year (inclusive of employer contributions), depending on which is lower. Your employer takes your contribution from your pay before it’s taxed. You only pay tax on what’s left.

The £60,000 limit reduces to £10,000 once you begin to take an income from your pensions – although this does not apply if you only take out the tax-free cash amount of 25% of your pension after the age of 55.

If you earn £260,000+ per tax year, you will be subject to a tapered allowance system. This means for every £2 over the threshold you earn, your pension contribution allowance reduces by £1 up to a maximum reduction of £50,000.

For example, if you earn £300,000 pa before tax, this is £40,000 over the threshold (£260,000). The tapered allowance system means your pension contribution allowance reduces by £20,000 and you can only contribute £40,000 to your pension without paying tax.

You can carry forward any unused allowance from the past 3 years so that you don’t waste your unused allowance. 

If you earn under £3,600 or do not earn a salary, you can still contribute to a personal pension. The maximum amount you can contribute is £2,880, with tax relief this will add £3,600 to your personal pension pot.

The age you can retire will vary depending on your pension scheme and your age, but in general you can claim most personal and workplace pensions once you reach the age of 55 and this is due to increase to 57 from 2028.

There are instances where you may be able to access your pension earlier. These include if you are:

• Retiring early due to poor health (you will need to speak with your pension provider for their definition of ill health)
• If you joined your pension scheme before 6 April 2006 – although this only applies to certain professions it should be confirmed with your pension provider as it will only be possible if you have a protected retirement date in your pension plan which you were granted before 6 April 2006, outlining the date you can begin to access your savings.

Tax on pensions is a complex issue, speak to a financial adviser to find out more.