What is a pension?

Get to grips with the basics of saving for retirement and how different types of pensions work
Paul Davies

In this article

What is a pension?

A pension is a way of saving for your retirement. 

What sets pensions apart from other savings or investment accounts is that you get tax relief on your contributions. This means that the money you would normally have paid in tax on your earnings goes into your pension, rather than to the government.

In most cases, you can't access the money you've saved in a pension until you turn 55. 

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What is the state pension?

The state pension is a regular income paid by the government to those aged 66 or over.

The amount you'll get, and whether you qualify at all, depends on how many years of National Insurance (NI) contributions you've built up.

The full level of new state pension for 2024-25 is £221.20 per week - just over £11,500 per year. 

What is a workplace pension?

Thanks to the introduction of auto-enrolment in 2012, most workers are automatically signed up to their employer's pension scheme when they start a new job.

You then contribute a percentage of your salary to your pension each month. The minimum total contribution for a workplace scheme is 8%. This is made up of 5% from you (this includes tax relief) and 3% from your employer.  

These contributions are invested, with the aim of growing your pension.

There are two types of workplace pension:

  • Defined contribution pensions - the most common type, where the value of your pot at retirement depends on how much you (and your employer) have contributed, and how well the underlying investments have performed.
  • Defined benefit pensions - these give you a guaranteed income for life after retirement based on your final salary or career-average earnings. 

What is a personal pension?

A personal pension is a type of defined contribution pension that you arrange yourself.

Anyone can save into a personal pension, but they're particularly useful if you're self-employed or not in work, and so don't have access to a workplace pension.

Like workplace pensions, personal pensions invest your money with a view to increasing it.

You usually rely on the scheme provider to decide where your retirement savings should be invested, but a self-invested personal pension (Sipp) is a type of personal pension that gives you more control over your investment decisions. 

How can I access my pension?

You have several options for turning your defined contribution pension savings into an income when you retire. You can stick to one option or mix and match to suit your needs:

  • Buy an annuity: this involves swapping your pension savings for a guaranteed regular income that will last for the rest of your life. 
  • Use pension drawdown: this involves leaving your money invested and making withdrawals as you need to.
  • Take lump sums: each withdrawal will be 25% tax-free.
  • Cash in the whole pot: this makes more sense if the pot is relatively small. The first 25% is tax-free.

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