The ultimate guide to pensions

A pension is a savings plan whereby you pay in regular amounts during your working years to create a pot of money, which you then use to take an income from in retirement.
You can plan your income for your retirement using savings, investments, personal pension or occupational pension. While savings and investments are of course a viable option, a pension should be the first port of call for the majority. At its heart, a pension is still a savings plan, but it’s specifically designed to provide you with an income to live on when you retire and has numerous tax and contribution benefits.

There are many different types of pension arrangements available, from state pension schemes offering limited financial support in old age, private pension plans giving you the freedom to build a larger fund for your retirement and occupational pensions where your employer also contributes to your pension pot.

Your pension contributions attract tax relief (which means that for every pound you invest in a pension, the Government will pay in a top-up of 20% of the value of the contribution, up to a maximum of the lower of your annual income or £60,000 per year) and can be made in various ways, either regularly or by lump sum, or a combination of both.

Your pension pot is invested in your choice of pension funds, from the selection offered by your chosen pension provider. The idea is that the funds grow over time, maximising the value of the fund so you can get the highest possible income in retirement.

On retirement, up to 25% of your pension fund value can be taken as a tax-free cash lump sum (up to a maximum of £268,275). The remainder of the funds left in your pension pot is used to take an income, either by way of an annuity, or by taking cash directly from your pension fund (drawdown).

Most pension contributions are invested in the financial markets on your behalf by a pension provider in order to get the best return for your future. The income your pension provides you in retirement will vary from provider to provider and will depend on the investment choices you make, the performance of the pension funds, the level of contributions you make and the charges applied by the provider.

Remember: each pension company will vary in both charges and investment performance.

For many, a workplace or occupational pension will be the first option to consider. This is simply a pension plan that's offered through your employer; they’re required to automatically enrol you in a pension scheme if you're not already a member, you earn more than £10,000 per year and are between 22 and state pension age.

There are two types of occupational pension:

This is where you contribute to a pension scheme that will pay you a defined monthly income in retirement, based on how long you've been a member of the scheme and your earnings (not on investment performance). With a final salary scheme, there is no need to purchase an annuity at retirement. These schemes are now more uncommon because of the very high costs to employers of running them.

This is where you contribute to a pension scheme that will pay you an income in retirement, based on the amount you've paid into the scheme and investment performance over the life of the pension. With a money purchase scheme, you can purchase an annuity or drawdown income to convert your pension into retirement income.

In both instances your employer helps by also making contributions to your pension – meaning you can build up a larger pot than if you were contributing alone. So if you don't join the scheme, you are effectively turning away extra money from your employer. However, the downside is that you are restricted to the pension scheme that your employer has chosen, although you may have a choice of funds if you are part of a money purchase scheme. This means you need to ensure you manage it effectively to get the best return on your savings, so make sure to check your particular scheme to see what’s available to you.

Occupational pensions don't have to stop if you leave an employer – you can still contribute to a money purchase scheme after you leave. Although your previous employer's contributions will stop, your pension will continue to grow (depending on investment performance and charges), even if you are no longer contributing. You can transfer your pension too but remember that there may be fees for moving your pot to a new provider.

There's no such thing as a ‘frozen pension’. Even a pension you are no longer contributing to remains invested and is still subject to charges from the fund and pension provider. Find out how to track lost pensions in our guide.

Personal pensions are arranged by yourself, not your employer. Employers are obliged to set up a Workplace Pension Scheme for all eligible employees and are obliged to pay into the pension plan if you join it, which means this should be your first port of call.

However, if you are self-employed or make less than a certain amount, you are not (yet) eligible for automatic enrolment in a workplace pension, which is when a personal pension should be considered. Yet it could also be an option alongside a workplace pension, depending on your circumstances; anyone can have their own personal pension, and even if you are employed, you might like to have a personal pension outside of work (you can have more than one pension provided your overall pension contributions are less than £60,000 per year), so you can decide which company your pension is with and get the most appropriate range of investments for your needs.

When choosing a personal pension, it’s important to shop around for the best deal. But what should you look out for when making a comparison?

The pension that offers the most choice isn't necessarily the best. Look for the pension that will offer the funds that you want to invest in. Most providers now offer ethical funds, so make sure this option is offered if this is where you wish to invest your pension.

Some providers will require you to make a minimum monthly or annual investment to your pension or to each fund within your pension. If you don't meet the pension's minimum contribution requirements, you may be charged a penalty fee.

Many pension plans will charge an annual management fee. If you invest in certain funds, there could be management fees to pay here as well. There may also be a fee if you wish to transfer your pension to another provider. It's worth finding out what these fees are before making an application and comparing them between providers. Pension firms cannot charge more than 1% of the fund value if you transfer out after age 55 where the pension scheme was in place before 31 March 2017. New schemes cannot charge a fee in these circumstances but could do before age 55.

You might find it helpful to use past investment performance to help decide between providers. However, if you're comparing past performance, make sure it's over a longer period (at least five or 10 years) as investments can fluctuate quite a lot in the short term. Always remember that past performance is in no way a guarantee of how successful a firm will be in the future.

If you are in any way unsure which pension or fund to invest in, you should seek independent financial advice to help you manage your pension and make the right investment choices for your personal circumstances.

If you are self-employed, earn less than £10,000 or have extra money that you can put into retirement savings each month, looking into opening your own personal pension can help to increase your retirement funds. You can pay up to a maximum of your annual employment income or £60,000 per year (if less) into your pension and claim income tax relief on this amount, though anything saved above this is taxed. Ideally you should save as much as you can into your retirement savings, but even if you can only save a small amount each month it will provide a boost to your retirement income. For example, even if you can only free up £50 per month, it could add up to an extra £16,800 in your pension over the next 28 years. And that’s before factoring in any investment gains or tax relief you may qualify for over that period.

When considering your retirement strategy, it is best to seek independent financial advice. Professional guidance can really help you make sense of the options available to you and can help put your mind at rest if there's something you don't understand or are worried about.

One of the key benefits of saving into a pension is its tax-efficiency, essentially allowing you to build a larger pension pot without needing to do anything extra.

Here are three ways that pensions are tax-efficient:

1. Personal and stakeholder pensions benefit from Income Tax contributions (up to certain limits). That means every time you contribute to your pension pot, the taxman pays some tax in as well! Here's how it works:

   Basic rate taxpayers

   Your pension provider automatically claims basic rate tax relief from HM Revenue and Customs (HMRC) on every contribution. This means that, for every £100 contribution you make, you’re actually only contributing £80 of your own money; the additional £20 comes from HMRC.

   Higher/Additional rate taxpayers

   However, although your pension provider claims basic rate tax relief from HMRC, the additional 20% or 25% is not claimed back automatically. If you're a higher rate taxpayer you need to contact HMRC to claim the remaining tax relief (which may involve completing a self-assessment tax return). If you're an additional rate taxpayer you will need to declare your pension contributions on your self-assessment tax return and HMRC will reimburse you. There’s another difference to be aware of as well: in both instances this reimbursement comes to you directly, not your pension provider. So, you'd need to either make an additional contribution to your pension as a one-off payment, or if you can afford to, make higher contributions throughout the year up to the £60,000 annual limit.

2. Investment gains made within your pension are also tax efficient because they are exempt from Capital Gains Tax and Income Tax within the pension funds they are invested in.

3. When you come to take your pension, at the age of 55 or later, you have the option to take up to 25% of your pension pot as a tax-free lump sum. This is capped at £268,275. While pension contributions and growth aren't taxed, when you come to take an income from your pension, this will be subject to Income Tax in the same way as earned income.

One of the most important things to remember when saving into a pension is that it’s an investment, albeit a highly tax-efficient one. You invest your money into a pension fund (or funds), be it an active choice or one that you’re defaulted into, and as with any investment, there’s the risk that your fund value could go down as well as up. This is why it’s important to regularly check the performance of your pension pot and to carefully choose where you invest, but the level of risk you want to take with your money will likely come down to several different factors.

The best pensions allow you to hold a range of different investments. You can choose pension funds based on how much risk you want to take with your money, and can hold a number of different funds to spread your risk further across different types of investment and geographical areas.

Risk is an important part of deciding which funds to invest in within your pension. There are two main factors that will affect how much risk you wish to take:

• Your age in relation to when you want to retire
• Your attitude towards riskier investments

Younger pension investors can usually take on more risk as their investments have longer to turn around if a loss is made early on. It's also the case that investments tend to perform better over longer periods of time (though past performance is no guide for the future). You should also consider splitting your contributions among several different funds with varying levels of risk, to minimise the chance of one badly-performing fund wiping a sizeable chunk off your pension.

The closer you are to retirement, the more you'll want to consolidate your pension pot into lower risk investments to protect it from making a loss. Yet as with any investment decision, it's important to take independent financial advice if you are in any way unsure of which pension or fund is best for you.

Unlike with a standard savings account or investment portfolio, your money isn’t accessible until much later, ideally prior to retirement. Under current rules, you can’t access the money held in your pension pot until you reach your 55th birthday, after which you’re free to access it as you see fit. Please be aware, though, that this minimum age will be increasing to 57 by 2028, which may affect your plans.

If you're worried about lack of flexibility in a pension it might be wise to look at keeping a pot of other savings, possibly in a cash ISA or equity ISA, that you can call upon if you need to.

A Lifetime ISA could be an option for those who qualify, too, offering another way to benefit from a top-up from the Government.

A Lifetime ISA is essentially a kind of regular savings account that’s specifically designed for those saving for their first home or retirement. Open to those aged between 18 and 39, it allows savers to stash away up to £4,000 each year, after which they’ll get a 25% top up from the Government – which means they’ll get an extra £1,000 each year, for free, if they save the full amount.

The bonus is paid until the saver turns 50, and under current rules, the money can’t be accessed until they’re 60 (unless it’s to buy a first home, or they’re diagnosed with a terminal illness). This can make them a useful option for saving for retirement, particularly for those who are self-employed and therefore don’t benefit from employer contributions.

The advantage of focusing on saving into a personal or workplace pension is there’s the possibility of retiring before the State Pension age. The age in which you can get the State Pension is increasing; it currently stands at 66, but this is set to rise to 68 by 2046 at the latest, and may even rise beyond that in the future. But you can choose to retire before this by using money saved in your personal or workplace pension (which will usually allow you to access your pot 10 years before your state pension age), or by cashing in your other retirement savings or investments.

Remember, if you are planning to use money from your personal or workplace pension for early retirement you will need to look at your pension scheme rules to see at what age you can start using your pot, and make sure to think carefully about what you want to do with the money.

The full State Pension for 2024/25 is £221.20 per week, but unless you’re retiring imminently, this will change by the time you retire (you can find out more about the State Pension here). Even if the amount increases it is unlikely that it will be enough for you to enjoy a comfortable retirement without supplementing it with an additional retirement income of your own, and it’s important to remember that you’ll need to have 35 years of National Insurance contributions to qualify (and you will need to have made 10 years of qualifying contributions to get any State Pension at all). This is why saving in a personal or workplace pension is so important.