Pensions Explained

Q: How to opt-out of a pension scheme?

If you&#x2019;ve been automatically enrolled into a workplace pension, you can opt-out whenever you want. Your employer will have provided you with the details of the pension scheme, which makes it easier for you to leave if you wish. If you opt-out within a month of your employer adding you to the scheme, you&#x2019;ll get back any money you contributed. If you opt-out of the pension scheme later down the line, your money will stay within the scheme until you access it once you&#x2019;ve retired.

Q: Can I take 25% of my pension tax-free every year?

You can withdraw 25% of your pension as a lump sum and it&#x2019;ll be tax-free. However, the rest of your pension will be charged income tax as it&#x2019;s treated like income coming into your account each month. You can only enjoy the 25% tax-free amount once.

Q: Can I take my pension at 55 and still work?

There is no longer a set retirement age and most private pensions allow you to access them from 55 onwards. You don&#x2019;t have to retire once you start accessing your pension, so you can continue to work at the same time. The same applies to State Pensions, you can withdraw this whilst still working.

Q: What happens to my pension when I die?

If you haven&#x2019;t retired and you pass away before claiming your pension then most pension schemes will pay out a lump sum that&#x2019;s usually two or three times your salary. If you passed away before 75 then this lump sum will be tax-free. The lump sum will go to your spouse, civil partner or children.

Q: How long will £500k last me in retirement?

As we mentioned earlier, the average retired household spends around &#xA3;25,000 a year. This means that &#xA3;500,000 would last you around 20 years.

Q: What's auto-enrolment?

Auto-enrolment is common with workplace pensions. By law, all employers must now offer workplace pensions and contribute towards the pension. You will be automatically enrolled on the workplace pension but you will be able to opt-out if you wish to. The minimum employer contribution level to workplace pensions is 3%. With auto-enrolment, total contributions must be at least 8%. So, you might have to contribute up to 5% if your employer adds 3%.

Q: Should I take my employer's pension?

If you&#x2019;re employed, are over 22 years old and are earning more than &#xA3;10,000 a year then you&#x2019;ll be auto-enrolled into your employer&#x2019;s workplace pension. As your employer must contribute 3% of your monthly salary into your pension each month, it technically works as a pay rise. So, this isn&#x2019;t something you want to opt-out of!&#xA0; It&#x2019;s also a good idea to save towards your future to ensure a comfortable retirement.&#xA0; However, if you can&#x2019;t afford to sacrifice a portion of your salary each month to go towards your pension, then it might not be worth going into debt.

Q: How is a pension invested?

A pension is invested into pension funds which can you choose if you take out a personal pension. Workplace pensions are chosen by your employer and are also usually invested. The idea is that the investments do well and your pension grows over time. This maximises the value of your contributions. Pensions never make risky investments so the risk of losing money is extremely low.

Q: Who's holding my pension money?

With workplace pensions, your employer will choose a third party pension provider but you can still decide whether to change the investments etc. If you start a personal pension, then you get to choose the manager. With SIPPs, it&#x2019;ll be managed by a firm but you&#x2019;ll make the investment decisions.

Fiona Leake

| Edited by Tom Church

Updated 28th April 2021

What’s the best pension scheme for you? What are pension schemes? In our pensions explained guide, we explain all the basics of pensions and whether they are worth it.

What is a pension?

A pension is a way of saving money for your retirement. You put money into your pension each month and this transforms into a regular income for when you retire.

Pension contributions are tax-free which makes it a great way to save for retirement.

The idea of a pension is that you give up some of your disposable income now to save for the future and potentially be able to retire early. A pension is essentially a savings plan that’s designed to provide regular income when you retire.

There are three main types of pension - State, Workplace and Personal Pensions. We will discuss all the different types of pensions within this guide.

How much money do I need to retire?

On average, retired households spend around £2,100 a month or roughly £25,000 a year. However, if you want a more luxurious retirement, you’ll likely be spending even more.

Generally, you’ll need between half and two-thirds of the final salary you had when you were working a year. People spend less during retirement as there are no commuting costs and people have usually paid off their mortgage. However, this doesn’t apply to everyone and the pension size you need will depend on your lifestyle.

The different types of pension

There are three main different types of pension:

State Pension
Workplace pension
Personal pension

However, many different types fall within these three categories.

State Pensions explained

The State Pension is what UK citizens receive every four weeks from the government once they reach the State Pension age (which is currently 66). To qualify for the state pension, you’ll need to have National Insurance (NI) contributions throughout your working life.

The State Pension isn’t always enough for people to live on. Thankfully, you can also claim any workplace and personal pensions you may have at the same time. So, you might have multiple sources of income from multiple pension schemes each month.

Find out more about the state pension by reading our comprehensive guide.

Workplace pensions explained

It’s a good idea to save into a pension with your employer as State Pensions aren’t enough for a comfortable retirement.

Workplace pensions take a contribution from your monthly salary along with a percentage from your employer and the government. This provides money you can access when you retire.

For example, you might contribute 5% of your salary each month and your employer might also add 3% of your salary on top of this monthly.

The fact that your employer pays into your workplace pension makes it like you earn extra pay each month so it’s worth doing to help with your retirement.

Workplace pensions are invested with the aim of your contributions increasing with value over time.

Find out more about workplace pensions by reading our comprehensive guide.

Personal pensions explained

Personal pensions are a type of pension that you can choose to open yourself and contribute to. You can have a personal pension on top of a State and workplace pension.

Personal pensions invest your money with the aim to make more money than you put in.

Personal pensions are great for those who are self-employed and won’t be saving through a workplace pension. They are also great for those who want a comfortable retirement with income coming from three different pensions.

One of the most popular personal pensions is a SIPP (Self Invested Personal Pension). For more on SIPPs, read our detailed guide.

How pension contribution works

You don’t have to make any contributions into a State Pension, you’re given this if you’ve paid National Insurance in your working life.

However, you do have to contribute to a workplace and personal pension. Let’s run through how pension contributions work:

How much should I put in a pension?

With workplace pensions, you’re often auto-enrolled and there’s a minimum contribution level which is usually a small percentage of your salary. However, if you can afford to, it’s a good idea to save a higher percentage of your salary into your pension.

If you’re thinking about opening a personal pension as well, we would recommend paying off any high-interest debt you might have first, such as loans or credit cards. Once debts are paid off, you can put any spare money into a personal pension.

We would recommend putting 15% of your annual salary into a pension for the rest of your working life. This might sound like a lot but remember, with workplace pensions, your employer contributes a percentage too, so you won’t have to fund the entire 15%.

It’s best to start saving for your retirement as early as possible and to put as much into your pension as you comfortably can afford.

How much can I put in a pension?

There isn’t a limit to how much you can save into a pension. However, there is a limit on the tax relief you’ll receive. There are three different tax limits you should keep in mind:

Earnings limit

You only get tax relief on pension contributions up to your annual earnings. So, for example, if you earn £25,000 a year but you have £30,000 in savings and decide to put all of your savings into your pension, you’ll only earn tax relief on the first £25,000 of your pension contributions.

Annual limit

Pensions contributions have an annual allowance of £40,000. So, if you contribute more than £40,000 to your pension in a year, then you’ll have to pay tax on the excess.

Lifetime limit

The lifetime pension allowance has increased to £1,078,900 for 2021/22. So, if your total pension savings, including any interest, go over this amount, you’ll have to pay tax on the excess.

Remember, pension contributions from your employer are counted in these allowances too.

How do I make pension contributions?

If you’re contributing to a workplace pension, your employer will deduct a percentage from your salary before it reaches your bank account. You can opt to increase the percentage if you want to by telling your employer.

If you’re paying into a personal pension scheme, you can set up a monthly Direct Debit if you make regular contributions or one-off payments if you prefer.

How to check your pension contributions

Whether you have a personal pension or workplace pension, you should be able to check your pension contributions and total value by reading your pension statement. You should receive a pension statement from your pension provider once a year.

A pension statement shows a complete breakdown of your pension, including all the contributions and the total amount.

How are pensions tax efficient?

The great thing about pensions is that you don’t have to pay tax, as long as you stick within the limits mentioned above. Also, the taxman pays tax into your pension too! Here’s how it works:

Personal pensions benefit from Income Tax contributions which mean every time you pay money into your pension, the taxman contributes too.

Tax bracket	You pay	HMRC pays	Total payment into pension	Further tax relief	Cost to you
Basic	£80	£20	£100	£0	£80
Higher	£80	£20	£100	£20	£60
Additional	£80	£20	£100	£25	£55

When you come to use your pension, you have the option to withdraw up to 25% of your pension pot as a tax-free lump sum. However, the rest of your pension will be taxed at the Income Tax rate as you take it out.

What’s the minimum age I can retire?

The earliest age you can retire is usually around 55. It depends on the rules of your pension and you’ll have to check this with your provider. The earlier you take out your pension, the less money you’ll have saved so don’t rush to make a decision.

The State Pension age is usually higher and is the age when you’ll start receiving your State Pension. You can find out your State Pension age on the government website.

What happens to my pension when I retire?

You can’t draw money from your pension whenever you want, you have to wait until you reach retirement age. This can be around 55, depending on your pension.

Once you retire, we recommend you take advantage of the tax-free amount and withdraw 25% of your pension in one lump sum. You won’t be charged tax on this amount so it’s best to withdraw it in one go. The remainder of your pension should provide you with regular income for the rest of your life but you will be charged income tax on it.

If you’re approached by a company telling you to withdraw your pension before you’re 55, it’s a scam and you should ignore it.

How safe is my pension?

With savings, investments and pensions accounts, up to £85,000 per person per institution is fully protected should the bank/company your pension is with goes bust.

However, the Financial Services Compensation Scheme (FSCS) doesn’t protect your pension against performance losses. So, if your pension is invested and the shares go bust, your money won’t be protected in the same way.

Having said this, you will be protected if the pension or investment firm goes bust.

The FSCS protection is complicated. So, make sure you always check with your pension provider how protected your pension is.

How to choose a pension

You won’t be able to choose your workplace pension as your employer will have picked one to offer employees. However, if you’re looking for a personal pension, the choice is yours!

With so many pension providers out there, it can be overwhelming trying to find the best deal. Here are some important things to compare:

1. Pension fund choice

The most choice isn’t necessarily the best choice. Instead, look for a pension scheme that offers funds you want to invest in.

2. Minimum monthly contribution

Some pension providers will require you to make a minimum monthly contribution or an annual investment. Make sure you can afford these monthly contributions or you might be charged a penalty fee.

3. Fees and charges

Most pension plans charge an annual management fee. There might also be fees if you wish to transfer your funds to a different provider. Make sure that you’re aware of all of the fees involved before picking a pension provider.

4. Past pension performance

It’s worth comparing the past performance of investments with different pension providers before picking your personal pension. See how investments performed over the last ten years or so.

You want to make sure that the pension is making money and not losing money!

How do I get a pension?

You’ll usually be automatically enrolled into your workplace pension and so you don’t need to worry about signing up as your employer will arrange it for you.

However, if you’re looking to get a personal pension, you’ll have to find the best pension for you by comparing the things we mention above. You can then approach your chosen pension provider to sign up. You can usually easily do this online.

Is saving into a pension worth it?

It’s always worth saving for your future retirement to make sure that you can comfortably enjoy your work-free years and do the things you enjoy. The State Pension isn’t enough for most people to live on, so you need a workplace pension or personal pension too - or even both!

Another key advantage of pensions is tax relief. Not only do you get tax money back on your pension but also any gains made from pension investments are tax-free.

The sooner you start saving for retirement, the better.

Is it worth getting a personal pension when self-employed?

If you’re self-employed, you won’t be part of a workplace pension scheme and you’ll only be eligible for State Pension. This is why it’s really important to save into a personal pension when self-employed. You’ll be saving towards your future and making your income go further.