Let's start at the beginning...with a definition
Pension plan, pension pot, pension scheme. The list of alter egos goes on.
The good news is, what you really need to know about pensions is actually quite simple.
A pension is an investment account designed to help you save and invest for retirement.
Before diving in it’s important to know that pension and tax rules can change and depend on your personal circumstances. So before making any decisions, check how anything mentioned below will apply to you. Before you invest you also need to be comfortable that the value of your portfolio can go down as well as up and you may get back less than you invest.
Pension basics
‘Pension meaning’ is one of the most Googled questions out there.
So we’ll start there.
Here are a few simple things to help break down the pension basics:
- The aim is to build a pot of retirement savings you can live off later on in life
- The government tops up your contributions through tax relief
- The earlier you start investing even small sums regularly the longer your investments will have to grow
- In a pension your investments grow free from UK tax
How do pensions work?
There are a few types of pension in the UK: workplace pensions, personal pensions and the State Pension. You’ll likely have all of them over your life but how they work, what you get and when you get it, differs slightly.
Types of pension
Here’s a brief summary of the main types of pensions. For each type we break it down to how it works, what you get and when you get it.
Workplace pension
Workplace pensions are set up by your employer.
And while a workplace pension was once seen as work perk, since 2012 UK employers have legally been required to enrol you into a workplace pension scheme. And that’s the rule whether you work full or part-time.
This means that each new job likely brings with it a new pension. So it’s more than likely you’ve already got a few pensions knocking around.
Check our top tips on finding old pensions.
Personal pension
A personal pension is a pension that you set up and contribute to yourself.
The big thing to know about a personal pension is that you can have one in addition to a workplace and your state pension.
Why have a personal pension?
- To save more and supplement a workplace or state pension
- To save for retirement if you are self-employed
There are a few types of personal pension and one of the options is a self-invested personal pension or SIPP.
Why have a SIPP?
- To make your own investment decisions
- To combine old pensions and keep pensions under one roof
- To see exactly how your pension pot is performing
Find out what are the best pensions for self-employed.
State Pension
The State Pension is provided by the UK government and kicks in later in life.
How much you get and when you are allowed to get it (i.e. State Pension Age), is defined by the government.
What age do you get the State Pension in the UK?
This is an expensive game for the government, so the state pension age has been creeping later and later. It’s currently 66 but that’s set to rise to 67 by 2028 and to 68 by 2039).
How much is the new State Pension?
The amount of state pension you get depends on a few things like personal income and circumstance but one of the main determinants is your history of paying national insurance.
To be entitled to the new state pension you’ll need at least 10 qualifying years on your National Insurance record. This means 10 years in which one or more of the following applies:
- You were working and paid National Insurance contributions
- You were getting National Insurance credits if you were unemployed, ill or a parent or carer
- You were paying voluntary National Insurance contributions
💡 We broken down all the types of pension in a detailed guide.
Things to think about
We’re all going to have to fend for ourselves a lot more in retirement and the earlier we prepare for this, the better. Take a look at our guide to investing in your 30s.
Why pay into a pension?
Pensions have a few benefits to boast about:
- Aim for a comfortable retirement
- Tax-efficient investing
Aim for a comfortable retirement
Having enough money in later life is not guaranteed by the state or even a workplace pension. So making sure you are paying enough into a workplace and a personal pension is an important step in saving enough for retirement.
Tax-efficient investing
The main benefits of personal pensions and workplace pensions are the tax benefits.
Firstly, there’s tax relief.
Tax relief is the government’s way of topping up or adding to your pension contribution, to encourage us all to save more into a pension.
There are different limits around this in terms of how much money you can add and how much money the government will add. But for most of us, the government will add at least 20% in tax relief.
For example, if you pay £80 into a pension, the government will add an extra £20 to the pot, making your total pension contribution £100.
💡 Check out our pension tax relief guide to understand how much money you can put into a pension.
Secondly, pensions are a tax wrapper.
This means inside a pension, your investments grow free from UK tax. So that’s dividends free from dividend income tax and investment gains free from capital gains tax.
Find out more about how your investments are taxed.
Take control of your retirement savings with a Freetrade SIPP (self-invested personal pension). Start a SIPP today and contribute regularly or transfer old pensions to one single pot you can grow and manage yourself.
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