What is a pension?
Simply put, a pension is a pot of cash that you and your employer can pay into to provide an income you can access any time from the age of 55.
The great thing about paying into a pension is that contributions attract tax relief. This means that investing £100 each month into a pension would only cost you £80 each month as the balance is provided by the government. If you are a higher or additional rate taxpayer then you could claim extra tax relief through your tax return of 20% or 25% of your contributions.
Tax relief is essentially free money and can make a huge difference to your pension savings over a number of years.
With life expectancy on the rise and the requirement to work for longer before you receive the State Pension, it is vital that you consider paying into your own pension as early as possible to provide a liveable income in retirement.
You can start a pension as soon as you start work with small contributions every month that can be increased any time you want. Small contributions built up over decades can result in a sizeable pension pot when you do eventually retire.
Pension types
Workplace pension
Under new rules set out by the government, your employer will have to auto-enrol you in workplace pension if you:
- work in the UK
- are not already in a suitable workplace pension scheme
- are at least 22 years of age but not yet reached State Pension age
- earn more than £10,000 a year for the 2024/25 tax year
If you are under the age of 22 you will not automatically be enrolled in a workplace pension but you can request your employer to enrol you if you are earning at least £6,240 a year for the 2024/25 tax year.
The great thing about a workplace pension is that in addition to you contributing, your employer has to contribute too. The total minimum contribution is currently set at 8%. This is made up of 5% from you and 3% from your employer. The contribution from your employer is what makes the workplace pension an attractive pension option.
If you have more than one job you can be enrolled in a workplace pension for each job provided that you meet the criteria.
To find out more about workplace pension visit - Automatic enrolment – an introduction
Personal pension
If you are not able to join a workplace pension then you will have to arrange your own pension which is simple to do.
There are three types of personal pension and they are:
Ordinary personal pension
- an ordinary personal pension is easy to set up and will allow investment in a limited range of funds offered by the pension provider
- these schemes are typically run by insurance companies
- normally covered by the Financial Services Compensation Scheme (FSCS) up to 100% if the company goes bust
- not covered for any investment losses
Stakeholder pension
- a stakeholder pension is a personal pension with low and flexible contributions, capped charges and a simple default investment strategy
- allows flexible contributions which may be useful for those who are self-employed and have a fluctuating income
- covered for up to £85,000 under FSCS rules if the pension provider goes bust
- not covered for any investment losses
Self Invested Personal Pension (SIPP)
- essentially a pension 'wrapper' that holds a selection of investments until you want to withdraw a retirement income.
- similar to a personal pension but with a much wider range of investments to choose from
- even if you have no investment knowledge you should not be deterred from starting a SIPP as most SIPP platforms have ready-made investment portfolios to make your investment choice easier
- covered for up to £85,000 under FSCS rules if the pension provider goes bust
- not covered for any investment losses
We strongly suggest you read our comprehensive article - The best and cheapest SIPPs to find the best SIPP provider for you. If you are unsure as to whether you would be better off with a SIPP or personal pension, read our article 'Choosing a SIPP vs Personal pension'
Which pension should I choose?
If you are eligible to join a workplace pension then that would be the best option to start with as you will benefit from your employer's contribution. If you are not eligible for a workplace pension or you belong to a workplace pension and want to contribute to your own personal pension as well then a SIPP is a good choice.
A SIPP is an ideal pension vehicle as you can start with a low monthly investment and build up from there. It is also ideal as most SIPP providers have ready-made portfolios that allow you to start investing with little or no knowledge. As you build up your pension pot you may want to make more of your own investment decisions and most SIPP providers have a range of tools to help with your decision making.
A SIPP can either be managed by yourself or a third-party, so you need to decide if you are comfortable making investment decisions yourself. If you prefer to enlist the services of a professional, you might consider using the services of a financial adviser or ‘robo-adviser’ like Nutmeg, Moneyfarm and Wealthify, which will invest your money for you. They are online investment managers which use computer models, known as algorithms, to manage portfolios. Their services are lower cost than traditional wealth managers. Alternatively, if you are looking to cut costs, you may want to consider an investment platform that charges a fixed-fee model such as Interactive Investor.
For a comprehensive pension guide read our article - How to set up a pension - everything you need to know
How much do I need to pay into a pension?
There is no exact answer to this question as it will depend on how long you have before you want to retire and how much income you want in retirement. The earlier you start your pension the bigger your pension pot will be when you want to retire.
To help you find out how much you need to save and how much you need to retire we have created a free pension calculator that will give you an estimate of your potential retirement income from a defined contribution pension scheme, such as a personal pension or SIPP. It will also tell you if your retirement income will be sufficient to achieve the retirement income you want and if it isn't, you can work out how much you need to be putting away to ensure that it is.
How do I manage my pension?
Managing your pension investment is very simple and requires no investment knowledge so don't be deterred from starting a pension through lack of knowledge.
If you are a member of a workplace pension then your pension will be managed by the scheme administrator and they will probably make investment decisions on your behalf.
When you start investing in your own pension you may ask the question 'Where do I invest my pension?', but don't worry, most SIPP providers will direct you towards a ready-made portfolio which is designed to reflect your attitude to investment risk. These ready-made portfolios are a great first step on your pension or investment journey. If your investment knowledge improves and you want to take more control over your pension pot then you can change your pension at a later date and any investment changes can be made very easily online. Most SIPP providers will have a range of investment tools as well as a lot of information regarding the markets and investments which will help your knowledge.
What is the best pension provider?
To help in your search for the best pension provider we have created a SIPP best buy table. This table has been created using our own independent research, expert knowledge, customer reviews and personal experience, read more here - SIPP Best Buy Table
How to start a pension if you are self-employed
If you are self-employed then you are on your own when it comes to building an income for retirement. If you are running your own business or a freelancer there is often a misguided belief that you will not need a pension as you will just carry on working or will sell your business when you want to retire. In reality, these may not be viable options due to ill health or your business is not worth what you think it is, so starting a pension for retirement is the practical option.
For more help with your pension decisions please read - A complete guide to self-employed pensions
Do I need financial advice to set up a pension?
It is not necessary to seek financial advice in order to set up a pension as this can be achieved quickly and easily online. If, however, you have more complex requirements regarding your pension or other financial matters then you may need to seek the advice of a financial adviser.
For some tips on how to find a good financial adviser read our article - 10 tips to find a good financial adviser
Are there any alternatives to starting a pension?
There is more than one way to build up a retirement income and these are some of the most popular options:
ISA
- can accumulate long-term savings with all growth completely tax-free
- can withdraw all savings whenever you want with no age restrictions
- investments do not attract tax relief unlike a pension
- for the 2024/25 tax year, there is an investment limit of £20,000 per year
- can inherit from spouse or civil partner without paying inheritance tax
Lifetime ISA
- can be started by anybody between the ages of 18 & 40
- contributions can be made up to £4,000 per tax year and any contributions made before age 50 will attract a 25% bonus from the government
- can withdraw money at any time but withdrawals before the age of 60 will have a 25% deduction (unless it is used for buying a first home under £450,000 or due to terminal illness)
Property
Main residence
- can downsize on retirement and use capital to fund retirement
- tax-free capital growth can be achieved from the increase in property value
- illiquid investment as the selling of a property may be protracted
Second property
- if purchasing a second property then income can be achieved from renting the property, known as 'buy to let'
- capital growth can be achieved from the increase in property value
- returns are liable to tax as a second property and rental income
- if sold there is tax payable on the growth in value of the property
- acquisition costs such as stamp duty & solicitor cost
- leverage on investment can be achieved by using a mortgage
- illiquid investment as selling of a property may be protracted
- ongoing costs of repairs
- possible rental voids will reduce income
