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 and to 68 in the mid-2030s (assuming Parliament passes the Government's proposals), and further increases are expected after that.
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 (due to rise to 57 in 2028 and to increase in step with state pension age after that). 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). Under current rules, the rest must be used to provide income which is taxable. However, under new rules due from April 2015, many people will be able to take any amounts they like as lump sums – see our article Your retirement options for details. Anything over the tax-free quarter will be taxed as normal income for the year it is withdrawn. Bear in mind that the more of your savings you draw as lump sums, the lower your pension will be.
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, for example, 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 would not be enough to live on. Currently, employees (but not the self-employed), carers and people who are too ill to work may also qualify for some additional pension. The average total state pension is £122.33 a week*.
The Government has said that from 2016 it will introduce a flat-tier state pension (worth £151.57 a week at 2014-15 rates). Our guide to the state pension changes has more details.
Workplace pension schemes
Phased in between 2012 and 2018, all employers are having to automatically enrol most people into a work-based pension scheme and pay into it on your behalf. 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.
You may already be in a workplace scheme. You may be able to join a company pension scheme through work (also often called an occupational pension scheme or superannuation scheme). Your employer must pay contributions to the scheme (and typically you do too), so not joining is like rejecting 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 automatic enrolment does not apply to you yet and 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. Until automatic enrolment applies to you, your employer does not have to pay anything into a stakeholder pension for you, but might do so.
You may instead be enrolled into the new National Employment Savings Trust or a similar multi-employer scheme.
You might want to do this if you have not joined a scheme at work, you want to save extra, there is no workplace scheme you can join, you are self-employed or you're not working.
Self-employed people can choose to join the National Employment Saving Trust (but do not, of course, benefit from any employer contributions). You can find out more on the NEST website.
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 £40,000 (was £50,000 before 6 April 2014).
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 £40,000 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.
Budget 2014 news
Currently, you can carry on paying into pension schemes up to age 75. The Government is consulting on whether to abolish this age limit.
Other guides which might interest you
- How much state pension will you get?
- How to apply for a state pension forecast
- What your budget might look like in retirement
- Your retirement options
* Department for Work and Pensions, Tabulation tool, Data for August 2013 (most recent).