What is a pension?

Here you’ll find a quick guide to the different types of pension and the benefits of saving for retirement.

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Published  04 April 2023
   5 min read

A pension is a way of saving for your retirement. They’re a tax-efficient way for you to save because unlike some other types of savings plans, they benefit from tax relief.

In general, if you pay 80 pence into your pension the government will top this up to £1. If you pay tax at higher rates, you may be entitled to more tax relief. However, this depends entirely on the type of pension you are saving into, whether and how much you earn and where in the UK you are resident for tax. There is no guarantee the tax rules will remain the same during the period you save towards your pension.

Your savings and investment options

You can pay money regularly into a pension, as well as making single contributions at any time.

The money you pay into your pension is invested. Most pensions offer a lot of different investment options so you can choose one that's right for you and your circumstances. You can also change where your money is invested if your circumstances change.

When choosing where to invest, it's important to consider how much risk you're comfortable taking. Generally higher risk investments can help your money grow more in value than lower risk investments, but there's also a greater chance of losing money. It's important though to understand that the value of all investments, even lower risk ones, can go down as well as up, and you could get back less than you paid into your pension.

To find out more about the investment options available through Royal London pensions, visit our investment options page.

What types of pension are there?

There are three main kinds of pension - personal pensions, workplace pensions,  and the state pension.

 

Personal pensions

A personal pension is one that you set up yourself. The money you pay into it is invested to help it grow in value, although remember that the value of all investments can go down as well as up, and you could get back less than you paid in.

You also benefit from tax relief on the money in your pension. Of course, tax relief on your pension contributions depends on your individual circumstances and may change.

Your employer won’t usually pay into a personal pension, although they can if they want to.

How much pension income you receive will depend on how much you pay in, how long your money is invested for, how your investments perform and any charges taken from your plan.

Take your pension savings in a way that suits you

You can normally start taking your pension savings any time after age 55 – even if you’re still working. This will increase to age 57 from 6 April 2028. You can choose to -

  1. Take it as cash – with each retirement option, you can normally take up to 25% of your pension savings tax free. The other 75% is taxable. You can take some or all of your plan as a cash lump sum.
  2. Enjoy flexible access to your pension savings – take the income you need, when you need it. This is also called 'income drawdown' and Royal London also calls it 'Income Release'.
  3. Buy a secure income – enjoy a guaranteed regular income for the rest of your life. This is also called an annuity.

Your pension savings will remain invested until you decide to access them. You can start taking your pension savings from age 55. This will increase to age 57 from 6 April 2028.

 

Workplace pension

A workplace pension is set up by your employer. Depending on your age and salary, you’ll be enrolled into your employer’s workplace pension automatically. You don’t need to do anything. What’s more, if you choose to pay into your pension, your employer will too.

Types of workplace pension

Workplace pensions fall under two categories – defined contribution and defined benefit. 

  • A defined contribution pension plan is a type of pension where you and your employer save for your future. The money you put into a defined contribution pension is invested to help it grow. Of course, this isn’t guaranteed, so if your investments perform poorly, you could get back less than what you started with.
  • A defined benefit scheme is a type of pension where your employer promises to pay you a set amount of income when you retire. There are two forms; final salary and career average. a final salary scheme provides an income when you retire based on how long you've been a member of the scheme and how much you're earning when you stop working. A career average scheme bases the promised income on how long you've been a member and the average of salary earned over your period of membership.

 

State pension

The state pension is provided by the government. Currently, you’ll receive a state pension when you reach state pension age.

How much state pension you get depends on how much National Insurance contributions you’ve paid while you’ve been working.

State retirement income comes in two main forms:

  • The State pension
    This provides a flat rate payment to people who have met the minimum National Insurance Contribution requirements. In the current tax year (2023/24), the new State pension is £203.85 a week for a single person. This applies to a man born after 6 April 1951 or a woman born after 6 April 1953.
  • State Second Pension
    If you were employed and in your employer’s workplace pension scheme before April 2016, you may have been contracted out of the State Second Pension and/or the State Earnings Related Pension Scheme. This means that you may be entitled to additional state pension from that employer’s scheme. It has not been possible to contract out since April 2016. 

You can check your state pension, find out your state pension age and loads more on the GOV.UK website.

Deciding how much to save

You can choose to save as much as you can afford. If you want to, you could save up to 100% of your relevant UK earnings into your pension each tax year.

There's an upper limit on the amount that you can save into pensions without paying a tax charge. This is known as the annual allowance

Secret Life of Pensions

What does your pension get up to after it leaves your pay packet?

It doesn’t just sit in an account somewhere until you retire. It's busy working hard in the real world so that when you’re older, hopefully you won’t have to.

Find tailored advice that's right for you

We recommend talking about the different types of pension available with a professional financial adviser. They can give you personalised advice and recommendations to match your individual needs and circumstances.

If you don't already have an adviser, there are a number of directories that you can use to search for one in your area and according to their specialisms.