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  • What is a pension?

    We explain the pension basics and explore how different types of pensions work.

    Last Updated: 27 March 2024

    A pension is a long-term investment plan which you typically build up over your working life. It’s there to help provide you with enough income to live off when you retire or decide to work less. It also offers favourable tax treatment compared to other ways of saving.

    We hope you find this article helpful, but it’s not personal advice. If you’re not sure what’s right for your circumstances, you should seek financial advice.

    How do pensions work?

    Here’s a basic breakdown of how a pension scheme could work for you:

    • You pay money in and get a top up from the government (in the form of tax relief)
    • Money in a pension is usually invested in the stock market
    • Money can grow free of UK income and capital gains tax
    • You have a pot of cash to help provide you with an income to live on when you semi-retire or stop working completely
    • You can normally withdraw up to 25% tax free
    • You can pay into someone else’s pension on their behalf (like a spouse or child)

    You can’t usually take money out of a pension until you’re at least 55 (rising to 57 from 2028). Pension and tax rules can change, and tax relief depends on your circumstances. Investments can go down as well as up in value, so you could get back less than you invest.

    Can I get tax relief on my pension?

    As an extra incentive to invest for retirement, the government tops up your pension. If you’re a UK resident under 75 you’ll automatically get 20% on top as tax relief on whatever you pay in, subject to certain limits. You could claim even more if you pay a higher rate of tax.

    How much can I pay into my pension?

    Each year you can pay in 100% of your UK taxable earnings or £3,600 gross (whichever is higher), up to the total annual allowance of £60,000. You may find your allowance is less than this depending on how much you earn and if you’ve already taken money from your pension.

    More on paying into a pension

    The three main types of pension plan

    Defined benefit schemes (e.g. final salary and career average schemes)

    • Largely funded by employers, you get a guaranteed income in retirement and often the option of a tax-free lump sum.
    • The amount you’ll receive in retirement is broadly based on how long you worked for the employer, your salary whilst working and the scheme’s accrual rate.
    • You can normally start taking benefits from the scheme’s normal retirement age, often 60 or 65. You may be able to take benefits earlier, but are likely to receive a reduced level of pension.

    Defined contribution schemes (or money purchase schemes)

    • You can open these yourself, or your employer might set one up for you.
    • Normally funded through you, and your employer if applicable, making contributions.
    • The amount of income received on retirement will depend on, amongst other things, how much you’ve paid in, the performance of any investments and the retirement option(s) you choose.

    The State Pension

    • If you’re eligible, you can claim your State Pension once you reach State Pension age (currently 66, rising to 68 by 2046).
    • The State Pension is usually paid every 4 weeks in arrears.
    • Any personal and workplace pensions can supplement this income.

    Different pension types explained

    How to withdraw money from your pension

    The earliest age you can normally take money from a pension is 55 (rising to 57 from 2028), although this could be different depending on your scheme’s rules. Unless you meet specific conditions, withdrawals made before you’re 55 will be subject to tax charges of up to 70%.

    Here are the main ways to take money from your pension:

    If you have a defined benefit pension

    You will normally receive a scheme pension which pays a guaranteed income for life. Some schemes will also provide a tax-free cash lump sum in addition to any scheme pension. Others may offer the option of receiving a tax-free cash lump sum in exchange for a reduced scheme pension.

    If you have a defined contribution pension

    You can usually take up to 25% of your pension as a tax-free lump sum with the remaining funds taxed as income. Options available include annuities, scheme pensions, drawdown and lump sums (UFPLS). You can normally choose one or more of these options in retirement.

    Compare your pension withdrawal options - watch our videos and read our side-by-side comparison table on the risks and benefits of each option.

    Calculate your potential pension income

    Guidance, help and advice

    • Guidance from Pension Wise - Pension Wise is a free, impartial government service for anyone aged 50 or over, with a UK based personal or workplace pension. It can help you understand what type of pension you have, how you can access your savings and the potential tax implications of each option. But it isn’t financial advice. More about Pension Wise.
    • Support from HL's UK-based helpdesk - Our UK-based helpdesk are here for you six days a week. Our friendly and knowledgeable team are ready to answer your questions no matter how big or small. Call us on 0117 980 9926. Opening hours Monday - Friday: 8am - 5pm, Saturday: 9.30am - 12.30pm.
    • Retirement Advice from HL - Our financial advisers can work with you to: plan your personal budget and retirement income strategy, make sure your investments match your goals and give pension advice, including when and how to take them. Discover retirement advice.

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