Pension guide: the basics

What is a pension?

There are many ways you can save for retirement, but pension schemes are specially designed for the job.

The state pension provides a fairly low income once you reach state pension age (currently 65 for men and in the process of increasing from 60 to 65 for women). Between December 2018 and October 2020 the state pension age will rise to 66 for men and women. Between April 2026 and April 2028, it is due to rise to 67 (assuming Parliament passes the government's proposals), and further increases are planned.

Private pension plans are schemes you can join through work or arrange for yourself. Private pension plans usually have a 'normal' pension age (commonly 65, at present) although you can start to draw a private pension as early as age 55. However, if you do draw your pension early you are likely to receive a lower income than if you had waited until the scheme's normal age.

Private pension plans have tax incentives to encourage you to save:

• Tax relief on the amount you save.
• Your invested savings build up largely tax free.
• At retirement, you can take a quarter of your savings as a tax-free lump sum (sometimes called a pension commencement lump sum or PCLS). The rest must be used to provide income which is taxable. 

Your state pension

You build up your state pension while you are working and paying National Insurance contributions. You may also build up your state pension while not working such as if you are caring for young children, off work sick, or unemployed and looking for a job.

There are currently two parts to the state pension: basic and additional. For most people, the basic state pension alone (£107.45 a week for a single person in 2012-13) would not be enough to live on. Employees (but not the self-employed), carers and people who are too ill to work may also qualify for some additional pension. The average amount is £26 a week*.

The government has announced that it is going ahead with plans for a single-tier state pension of around £140 a week, with a view to introducing it in the next parliament.

You can find out how much state pension you might get by ordering a state pension forecast from www.direct.gov.uk/pensionforecast or by phoning 0845 3000 168. 

Company and workplace pension schemes

You may be able to join an occupational pension scheme through work (also often called a company pension scheme or superannuation scheme). Your employer must pay contributions to the scheme (and typically you do too), so not joining is like turning down part of your pay.

You may be able to take out another sort of pension through your workplace. This could be a group personal pension (GPP) or a stakeholder pension. If a GPP is the only scheme on offer at work, your employer must make contributions on your behalf equal to at least 3 per cent of your pay. Your employer does not have to pay anything into a stakeholder pension for you, but might do so.

Phased in between 2012 and 2017, all employers will have to automatically enrol you into a work-based pension scheme and pay into it on your behalf. If there is no suitable scheme at work, you will be enrolled into the new National Employment Savings Trust or a similar multi-employer scheme. You will be able to opt out if you want to - though bear in mind that giving up an employer's contribution is like turning down a pay rise. 

Personal pension schemes

You can take out your own personal pension (which could be a stakeholder pension). These are offered by insurance companies and some other providers.

You might want to do this if you have not joined a scheme at work, you want to save extra or there is no workplace scheme you can join such as if you are self-employed or the firm you work for is very small. 

Self-employed people can choose to join the National Employment Saving Trust (but do not, of course, benefit from any employer contributions). You can register your interest at enquiries@nestcorporation.org.uk.

How much can you save?

The pension rules are complicated. But, broadly, the amount you can save each year through private pension plans (whether through work or your own personal pensions) is the greatest of: £3,600 or a sum equal to the whole of your UK earnings. In addition, the amount by which your pension savings increase in a year (for example, through paying in contributions) cannot normally exceed £50,000.

For example: if you earn £3,000 a year, you could save up to £3,600 a year; if you earn £35,000 a year, you could save up to £35,000 in total through pension schemes; or if you earn £70,000, you may be able to save up to £50,000 a year. Anything your employer contributes on your behalf is extra to this.

For help working out the amount of pension your retirement savings might provide or to check how much you might need to save to produce a given amount of pension, use our pension calculator.

* Office for National Statistics,Pension Trends, Chapter 5, October 2011.