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What is a Pension and why is one important?

Monday 30th Jun, 2025

What is a Pension and why is one important?

The world of pensions may seem complicated, but it’s worth gaining a basic understanding as the decisions you make earlier in your working life will help you plan for a comfortable retirement when that time comes.

What is a Pension?

It’s a long-term plan enabling you to put money aside, with tax relief, while you are working, to use later in life when you are no longer getting your wage or salary. When you retire, most pensions will provide you with a regular income for life and often a tax free lump sum as well. With some pensions, there may be ongoing benefits for your dependents too.

What about the State Pension; won’t that be enough?

The State Pension is paid every 4 weeks once you reach the qualifying age (currently between 66 and 68, depending on when you were born), provided you’ve made at least 10 years National Insurance contributions (NICs). To get the full amount you’ll normally need 35 years of contributions. But you may be able to make voluntary NICs to fill any gaps in your record. You can also boost the amount by delaying taking your State Pension (for example if you are still working).

While the State Pension does increase every April, it’s unlikely to be enough to live on. You can check your State Pension forecast on www.gov.uk.

What other types of pension are there?

Workplace Pension Plans – To help people save up towards their retirement, if you are aged 22+ and earn at least £10k a year from work, your employer must enrol you into a workplace pension plan. This is called auto-enrolment. What’s more, in addition to paying you your wages, they must contribute an amount of at least 3% of your qualifying earnings to your pension plan. Under auto-enrolment, total contributions must be at least 8%, so if your employer pays in 3%, you will need to contribute 5%.

Now, a major benefit of a pension plan, compared to ordinary savings accounts, is that the money you put in qualifies for tax relief. This means that some of your earnings that would have gone to the government in tax goes into your pension instead. Tax relief means for every £80 you pay in, the state pays in an extra £20 (more if you are a higher rate tax payer) to boost your pension pot.

When you consider that your employer and the government both add to your own monthly contributions, and your ‘pot’ grows over time through investment gains, joining a workplace pension plan is an ideal way to save up towards your eventual retirement. You can opt out of auto-enrolment if you want to. But, unless you really can’t afford the contributions or are dealing with problem debt, not joining would be like saying no to the offer of a pay rise!

Being in a workplace pension plan doesn’t tie you up in lots of administration. Your employer automatically deducts your contribution from your pre-tax pay, adds in their own contribution, claims the tax relief and sends it to the pension provider to be invested for you until you retire. And you needn’t worry about your funds being lost if your employer goes bust, as your pension pot is kept at arms-length, either in a trust fund or with a third-party insurance provider.

There are various types of workplace pension plans, including trust-based, group and stakeholder schemes, but all have the same aim – to provide you with a pot of money for retirement. Usually, your employer chooses the provider and the scheme is safely managed on your behalf without you needing to select the investments. But some schemes do allow you some investment choice, if you wish to take that on, and have the confidence and know-how to do so.

Private Pension Plans – If you’re self-employed, you won’t be able to get a workplace pension but it’s just as important to save up for your retirement. You can still benefit from 20% tax relief on your contributions (more if you’re a high earner) but will need to find your own private (‘money purchase’) pension to pay into. Options include Stakeholder Pensions (similar to workplace plans, with low and flexible minimum contributions, capped charges and a default investment choice) and Self-invested Personal Pensions (SIPPs), which are DIY pensions that allow you to select your own investments. If you are unsure which plan to go for, it’s best to seek paid advice from an Independent Financial Adviser, rather than risk losing thousands of pounds over a lifetime making a bad choice.

When should I start a pension plan?

As a rule it’s best to start as early in your working life as possible, and to put in as much as you can. Often young people dismiss this advice, thinking retirement is too far into the future to worry about. It’s scary how quickly those years pass! Missed contributions may never be caught up, and employer contributions and tax relief be lost for ever. One idea is to start with whatever you can afford but increase it whenever you get a pay rise. The MoneyHelper website has a useful pension calculator to help you work out how much you need to retire. There are limits on how much you can pay in to a pension with tax relief but these generally only affect high earners or those aged 55+.

What happens when I retire?

Currently, you are allowed to access your pension plan once you reach age 55. This will increase to 57 from 6 April 2028. You can carry on working until whatever age you like, but when you’ve fixed your retirement date, you’ll need to decide how to take your pension. Your pension provider will provide you with an annual estimate of your ‘pension pot’ (this will depend on how much has been paid in, the investment growth achieved and the value of those investments at the time). Generally, you can (if you so wish) take up to a quarter (25%) of your pension savings as a tax-free lump sum. Anything you take above 25% will be taxed. Alternatively you can leave your pension invested until you need it, you can drawdown a regular income for as long as it lasts (and pass the balance on when you die), or you can use it to buy an annuity with an insurance company, which will give you a guaranteed income every year for the rest of your life.

It’s important to consider these options carefully so that you make a choice that suits you, and don’t pay more tax than you need to. You pension provider must tell you about the Pension Wise service (which offers a free hour-long session to talk through your options) and help you to book an appointment. It’s an impartial service that offers real guidance to make informed decisions.

We hope this article has helped to demystify what may be a complex topic. But if you’d like to find out more, try these links:

Pensions: Everything you need to know for retirement - MSE

Types of private pensions - GOV.UK

What is a pension scheme? | MoneyHelper

Why save into a pension? | MoneyHelper

Workplace pensions - Citizens Advice

How much pension you'll need - Citizens Advice

10 reasons for saving in a pension

Why are pensions important? | UNIQ Family Wealth

Pension Calculator | This is Money

This article is for general information only and does not constitute financial, legal, or any other form of advice.

Written by JES - May 2025.