How Do Pensions Even Work in the UK?

Contributing into a pension is the single best thing you can do to prepare for retirement – but with many ways to save, getting started can feel quite daunting.

Whether you want to know about State Pensions, workplace pensions or personal pensions, we've simplified everything you need to know.

State pension

Let's start with the State Pension, which all of us are entitled to… assuming you've got 35 years of National Insurance contributions under your belt.

These 35 years of contributions can come at any point in your working career and they do not have to be consecutive. You can also get National Insurance credits that count towards your 35 years in situations where you're not working – for example if you're claiming benefits or on maternity leave.

At the time of writing, State Pension comes in at £221.20 a week – or about £11,500 a year – and men and women can begin claiming it on their 66th birthday.

A policy known as the "triple lock" means it is guaranteed to rise every year depending on which of these figures is highest: average earnings, inflation or 2.5%.

But there are a few important caveats we need to make here.

First, if you're currently in your 30s, 40s or even 50s, you should be prepared for the state pension to look very different to what it is now.

The age when Brits are eligible to start claiming is rising to 67 in 2026, and this is bad news for anyone born after 5 April 1960.

A further increase to 68 is expected further down the line, but the exact date is yet to be pencilled in. This is a reflection of the fact that Brits are living longer.

But there's a bigger elephant in the room: whether the triple lock will even exist when the current workforce is gearing up for retirement.

Our population is ageing – and in the years to come, the number of us at state pension age will keep increasing. At the same time, there will be fewer people of working age, meaning taxes may have to go up if current policies are to remain in force.

Even Mel Stride, the Work and Pensions Secretary, has admitted in media interviews that the triple lock is not sustainable "in the very, very long-term".

And even if the state pension did rise with inflation for decades to come, it alone will not be enough to achieve a minimum standard of living – and doesn't even now.

As the Pension and Lifetime Savings Association points out, a basic retirement that only covers essential needs currently costs £14,400 a year – £3,000 more than what pensioners currently get from the government.

This gap is likely to continue growing over time.

Listen, a state pension will be there in some form when you're bowing out of your career. But it's crucial to regard this as the foundation for something bigger – and prepare for the eventuality that it might not even be as generous (relative to the cost of living) as it is now.

With that in mind, let's talk about the other elements of the pension system you need to know about.

Workplace pensions

Back in October 2012, significant changes to the UK's pension policy began to be enforced – meaning employers had to automatically enrol eligible staff into retirement savings plans.

This applied to everyone over 22 who earned more than £10,000 a year, and it was accompanied by a huge advertising blitz.

To cut a long story short, this policy means a minimum of 8% of a worker's annual salary is invested into a pension, with employees making a contribution of 5% that's eligible for tax relief. More on that a little bit later.

Meanwhile, the employer themselves also pays at least 3% – with some companies opting to match contributions to a higher level.

Overall, this led to a huge surge in the number of people who have a workplace pension. According to the Office for National Statistics, just 47% were enrolled in 2012. Fast forward nine years to 2021, and 79% were involved.

There are several types of workplace pension out there.

One that's rarer these days is a 'defined benefit' pension, which means you'll get a regular income when you retire. The value of these is typically very high and this is expensive for employers, meaning they're now less prevalent than they once were.

'Defined contribution' pensions are much more commonplace now – here, the goal is to carefully grow your contributions over time through investments.

Of course, one thing worth bearing in mind is that few of us end up staying with the same employer for the duration of our career.

If you do switch companies, you'll have the option of leaving the pension where it is, or transferring the cash over to your new employer's scheme.

While this can potentially make it easier to manage your savings, and could even help you cut down on the fees paid to pension providers, it's worth making sure you won't be walking away from a generous scheme.

You should have received information about the type of workplace pension you have at the time of enrolment – as well as login details to the provider so you can see how your investments are faring over time. If you don't, make sure you ask your employer for the details.

You can also check out our auto-enrolment pension provider cheat sheet – it's free!

Personal pensions

Combined, state and workplace pensions can offer a decent amount for a good retirement – especially if you enrolled with your employer early, and made contributions beyond the mandatory minimum of 5%.

But there's a third option to consider that can act as a complement to these two pensions, or if you're feeling adventurous, act as a replacement for the workplace pension altogether.

A personal pension can come in handy if you're self-employed, want greater freedom over how your retirement savings are invested, or move jobs frequently and don't want the hassle of auto-enrolling into a new workplace pension every time.

If you want, it's also possible to ask your employer to pay their contribution into your personal pension – instead of the workplace scheme that they have established. Do note that they don't have to agree to this request, though.

The most common kind of personal pension are self-invested personal pensions, otherwise known as SIPPs.

Some of the potential advantages of SIPPs include:

• The ability to pick how your pension is invested – including stocks, shares, trusts, ETFs, bonds, mutual funds and cash
• The same levels of tax relief and tax-free growth as you would receive in a workplace pension
• A direct 20% contribution from the government
• The potential to reduce the amount you're paying on management fees, which can eat into compounding value over time
• Flexibility on when, and how much, you contribute into the pot

It's recommended that you seek professional financial advice when opening a SIPP, as deciding the investments within a pension on your own can be risky.

A number of trading platforms offer ready-made portfolios that are managed on your behalf, with varying levels of risk, which can take some of the stress and hassle out of planning for the future.

Withdrawing your pension

You can start taking money from a private pension when you're 55 – but this is going to rise to 57 from April 2028 onwards, and may increase further in the decades to come.

From the day you become eligible – currently your 55th birthday – up to 25% of your pension pot can be withdrawn as a tax-free lump sum. However, the tax-free pension withdrawal limit is capped at £268,275 over your lifetime, and the rest will be subject to tax.

Before you start spending, make sure you crunch the numbers and check your remaining savings will be enough to see you through retirement.

You could consider using the rest of your pension pot to buy an annuity, which means that you'll receive a yearly income for a set period of time or the rest of your life.

It's also possible to draw a regular income from your pension pot yourself. With this option, the rest will continue to be invested so it'll still have the potential to grow over time.

Top tips 

I've thrown a lot of information at you in this guide. But here are some top tips if you're starting to think seriously about your pension:

• Get contributing now – the earlier the better
• See if your employer will match contributions at higher levels
• Understand the rules on tax relief, and use them to your advantage
• Use the government's pension tracing service to uncover lost pensions from past workplaces
• Decide whether you want your pension to switch to less risky investments as you near retirement

If done right, the drinks will be on you when it's time to start enjoying your golden years.

If done badly – or neglected forever – there's a very good chance you'll never be able to enjoy retirement.

Share this