How do private pensions work?

It is important to start thinking about how you are going to fund your retirement while you are still working. The earlier you begin planning, the easier the process of funding your retirement will be. You may have heard of the State Pension, but unfortunately those payments are unlikely to be enough to support you once you stop earning a full salary. Instead, you will probably need a private pension to form your main source of income, with State Pension payments topping up what you receive once you reach the qualifying age. In this article we will help you understand how private pensions work, how to start saving for retirement and where you can find the right private pension provider for you.

What is a personal pension?

A personal pension is a pot of savings set up by an individual to eventually fund their income in retirement. You can pay in a regular amount every month or through irregular lump sums when you can afford it. You get to choose how your pension savings are invested – for example only in ethical funds – in order to grow your pot over your working life.

Unlike with a workplace pension, you will need to select the provider yourself and set up the payments directly. You will not get the employer contribution benefit of a workplace pension, but you can still get tax relief from the government to top up your payments.

Most personal pensions are more flexible than workplace pensions, though you can transfer old workplace pensions into your own personal pension. Like workplace pensions, most personal pensions are ‘defined contribution’, which means how much you get in retirement depends on the value of your pot when you stop working.

You can find out whether you might need both by reading our article ‘Can I have a personal pension and a workplace pension?’.

What is a workplace pension?

A workplace pension is set up by employers for workers to regularly pay into through pension contributions taken out of their pay packets. The employer must also contribute every month, which means you are effectively being paid extra. The minimum the company you work for needs to pay in is usually 3% of your salary over £6,240, up to a limit of £50,270 (for the 2024/25 tax year). However, many employers base what they pay on a percentage of your entire salary and may also increase their contributions if you pay in more too.

The money paid into the pension pot is invested in a range of funds to help it grow over time. Through you paying in, your employer making contributions and growth through investments, your pension should develop into a pot of money you can rely on when you retire.

Most workplace pensions are ‘defined contribution’ schemes, which means that the money you get in retirement is based on the value of your pot, not how much you were earning or how long you worked for a certain company. Some pensions are linked to your final salary – known as ‘defined benefit’ pensions – though these are more rare now. In that case your payout would be a certain fraction of your average or final salary, depending on how long you paid into the scheme.

What are the pros and cons of private pensions?

Advantages of a private pension

• A pension helps focus a share of your savings on your retirement. You can only withdraw pension funds once you hit a certain age, usually 55. This is a restriction, but it can be advantageous as it stops you spending your retirement pot on something else. If you save for retirement through other investments, you could be tempted to cash out for a big purchase, creating a shortfall when you quit work. With a private pension you can put away a little bit of money every month and leave it to compound and grow.
• There are tax benefits to saving money into a pension. You can withdraw 25% of your pot tax free once you reach retirement age, which you could use to pay off your mortgage or fund any other significant spend. What you pay in will also be topped up by the government. For example, in England, basic rate taxpayers and non-taxpayers who pay £80 a month into their pension will see it topped up to £100 through tax relief. Higher-rate taxpayers get even more.
• Private pensions are flexible, so you can choose which provider you want to save with and where you want to invest. You can move a workplace pension to a personal pension pot when you change jobs, or leave the money in its original scheme. You can choose to invest your pension pot in only ethical funds, choose riskier investments or blend a variety of different options.

Disadvantages of a private pension

• You cannot access your pension until you reach retirement age. This is the one major disadvantage to saving money into a pension scheme. If you have some sort of unexpected expense or a sudden drop in income, you cannot use your pension pot to cover the shortfall unless you are 55 or over. This could be one reason why a worker might choose to save into an ISA for their retirement instead.
• You cannot guarantee returns. Saving money into a pension scheme usually involves investing in funds that could go up or down in value. If you are a long way from retirement, a drop in the value of your pension could balance out over time. A drop may be a bit more worrying if retirement is around the corner. However, most traditional pension plans involve moving money to less risky funds as you get older.

How to set up a private pension

Setting up a workplace pension is your employer’s job – all you need to do is enrol, which is an automatic process for workers who are at least 22 years old, under State Pension age and earning more than £10,000 a year (for the 2024/25 tax year). You can still ask to be enrolled if you earn less.

If you want a personal pension, you will need to open it yourself. Here are the basic steps to take.

1. Choose a provider. There are a whole host of pension providers in the UK offering a variety of different schemes. You can choose one that gives you more flexibility, one that lets you make your own decisions, or one that makes all the choices for you. Think about fees too, as some providers offer better value for money than others.
2. Decide what to do with your existing pensions. You can leave your old workplace or personal pension where they are, or transfer them over when you open your new one.
3. Set up regular payments. The easiest way to fund a personal pension is through regular payments every month. You can set up a direct debit to automate this step, or do it manually every month. You can choose to pay in irregular lump sums instead, but regular monthly payments will likely be easier to budget around.
4. Keep an eye on your money. Most pension providers offer an online dashboard where you can see how your chosen funds or managed pots are performing. If you want to make changes, you can either adjust your risk level or move your money to a different fund, depending on your chosen provider.

Is a private pension right for me?

The New State Pension is unlikely to be a means to support you through retirement. Weekly payments for the 2024/25 tax year are £221.20 per week, which could be enough for some lifestyles, but are more likely to function as a supplement to a private pension. It is important to think about your State Pension age too. If you plan to retire before you are eligible to claim for the State Pension, you will likely need to rely on a private pension until you are old enough.

Read our article ‘How much is the UK State Pension’ to find out more.

Opening a private pension can be a great incentive to save for retirement, as you can get extra money through employer contributions and tax relief. Even if it only motivates you to save the minimum into your workplace pension or a small amount every month in a personal pension, it could make a huge difference to your retirement lifestyle.

Private pension providers

There are a whole host of different pension providers offering a variety of pension schemes for workers to open and we've provided a detailed summary in our article 'Best and cheapest low cost DIY pensions'. The right one for you is likely to depend on what level of control you want over your investments and how many other pensions you already have. Here is a selection of providers that we have independently reviewed.

Interactive Investor

Interactive Investor is one of the UK's largest investment platforms with over 400,000 customers. Its Pension plan can offer a cheaper solution because it charges a fixed monthly fee rather than charging a fee based on the total amount of assets held in the pension pot. Its 'Pension Essentials' plan is priced at just £5.99 per month for those with a pension pot totalling less than £50,000 and those with a larger pot will need to pay £12.99 per month for its 'Pension Builder' plan. Regular monthly investing is free, however, there are additional fees if you wish to trade various funds, stocks and ETFs. You can read more in our independent 'Interactive Investor review'.

PensionBee

PensionBee specialises in helping workers track down old workplace pensions and consolidate their different pots into one personal pension scheme. This can be a great tool for the millions of workers who have had multiple jobs over the years and have therefore contributed to multiple workplace pension schemes. The one drawback could be that if you have paid into a defined benefit scheme in the past, it could be better than the private pension you are looking to consolidate it into. You can find out more about whether PensionBee might work for you by reading our independent ‘PensionBee Review’.

Profile Pensions

Profile Pensions is an advice and consolidation service that can give you a free and impartial whole-of-market pension recommendation. Like PensionBee, it can help you find your old workplace pensions. However, as a pension advisor, it can also recommend where to invest to ensure your money is in the best pension plan for you. Find out more about its services and the costs involved in our independent ‘Profile Pensions review’.

Nutmeg

Nutmeg is an online investment platform that has been around since 2011. Its pension products use a robo-advice system to select your investments based upon your appetite for risk, so it probably wouldn’t suit savers looking for full control over where their money goes. However, not needing to select your own investments could be a big bonus for anyone with low confidence in their investment knowledge, or anyone looking for a value alternative to a financial advisor. You can select from an ethical portfolio or standard options.

You can find out more about the costs and benefits of a Nutmeg pension by reading our independent ‘Nutmeg Pension review’.