A pension is a tax-efficient way to help you save money for retirement. You save a little of your income regularly while you work, and then use this money later in life when you want to work less or when you retire as an extra income.
If you pay into a workplace pension through your job, then your employer will almost certainly be making contributions towards your pension savings too.
The State Pension is a regular income paid to you by the UK Government once you have reached State Pension age. It makes sure that everyone has a foundation for their retirement income, and is funded through National Insurance contributions, which you and your employer pay throughout your time in work. What you receive depends on your National Insurance record rather than any previous earnings, and the new full State Pension is £159.55 per week. You can check your National Insurance record and when you’re due to get your State Pension online by using the ‘Check your State Pension’ service on GOV.UK.
A workplace or private pension scheme helps you top up that income and access extra money in retirement.
There are various different types of pension schemes. Some are run by employers; others you can set up for yourself. Saving into one scheme doesn’t stop you from saving into another or using other tax-efficient savings plans like ISAs.
If you’ve got a workplace pension, it’s one of these two types:
A defined contribution (DC) pension means that you build up a ‘pot’ of money that your pension provider invests and manages for you. When you reach retirement there’s then a variety of ways you can convert this pension pot into a steady, inflation-linked retirement income, including ways which provide for dependents when you die. The income you might get depends on various factors including the amount you and your employer pay in, the investment performance of the fund, and your retirement choices.
A defined benefit (DB) pension means the amount you’re paid is based on how many years you’ve worked for your employer and the salary you earned. Your employer commits to pay out a secure, specific income for life which is usually linked to inflation so it doesn’t lose value over time. You and your employer both contribute, and your employer will usually continue to pay a proportion of your pension to your spouse, civil partner, or dependants when you die.
Both kinds of pension scheme usually have features which allow you to withdraw a lump sum when you reach retirement age, and both usually allow you to make withdrawals early if you are diagnosed with a terminal illness before reaching retirement age.
With a defined contribution pension, your pension provider will invest and manage your pension pot for you, with the aim of growing it over the years before you retire. Your pension pot will usually be invested in a variety of things including stocks and shares. Many pension providers allow you some choice in how your pension pot is invested, and a key benefit of defined contribution schemes is you can check how much is in your pot at any time.
If you’re a member of a defined benefit pension scheme, you’re not responsible for any investment decisions. Although your employer or their pension provider will invest the money, your final pension is not dependent only on the value of those investments. Your scheme promises you a specific income in retirement, and your employer has to pay out that amount.