What is a pension?
A pension is the savings you make to support yourself in later life. You may have received a pension from your employer (or past employers) and you can also set one up yourself to get saving. There are three different types of pension, and you can have more than one kind should you wish to.
Different types of pension
The three different types of pension in the UK are the State Pension, workplace pensions and personal pensions. They vary slightly in what they offer savers, so here’s a brief explanation of each.
What is the State Pension?
The State Pension is essentially a regular payment people can claim when they reach the State Pension age. How much you get depends upon your National Insurance Contributions, with the government determining your pension payments through the credits you’ve accrued throughout your life.
What is a workplace pension?
Exactly as it sounds, a workplace pension is organised through an employer. Thanks to Auto Enrolment legislation it’s now compulsory for employers to set up a pension scheme for eligible staff, either through their own scheme, a specialist pension provider, or through a government-backed scheme. An employer must put in a minimum contribution to a workplace pension, as must an employee. The government also contributes to your pension in the form of tax relief. You choose how much to pay into your pension and your pension provider claims tax relief from the government and adds it to your pot.
What are personal pensions?
A personal pension is a defined contribution pension, which means the amount you receive on retirement depends on how much you’ve paid into the pot and how well your investments have performed. You choose how much to pay into your personal pension and your pension provider claims tax relief and adds it to your pot.
These are the three types of pension you’ll come across as a saver, but it’s worth noting that pensions can also differ in terms of whether they’re defined benefit or defined contribution.
What are defined benefit pensions?
Defined benefit pensions – also known as final salary schemes – promise to pay a retirement income based on a percentage of your salary. What you receive depends on how long you spent working for your employer, and how much you were earning at the time you gave up work. Outside of the public sector, these type of pensions are pretty rare nowadays.
What are defined contribution pensions?
Defined contribution schemes are a type of pension which you (and perhaps an employer) pay contributions into each month. Typically, these contributions are invested into shares or bonds, and the ultimate size of the pension pot depends on how well these perform over time. After the age of 55, you can use a defined contribution pot to buy an annuity, which will then pay you an income for the rest of your life, or you can simply take out your money as you wish (subject to tax).
Updated: 14th June 2020