What is a private pension?

6 min Read Published: 16 Feb 2024

What is a private pension plan?Most of us will want to stop working at some point in our lives. When that day comes and the paychecks stop, you will need a new source of income. A private pension plan is a savings pot that you can build up and grow over your working life to then spend when you retire. It can be started by your employer (a workplace pension) or by an individual (a personal pension). You can use your pension pot to buy a guaranteed income, called an annuity, or steadily withdraw the money as an income, known as pension drawdown. In this article we explain the basics of a private pension and why you might need one. We also include links to some of our deep-dives into other pension topics.

Do I need a private pension?

A private pension is a financial product that requires you to build a pot of savings that will grow and eventually fund your income in retirement. Once you retire and stop working, you will stop earning a regular salary. As most people plan to retire at some stage, it is likely you will need a private pension to replace your salary in order to meet your expenses. Your private pension does not necessarily need to provide you with the same level of income as your salary, as many people find the cost of living decreases as they get older. For example, you may have paid off your mortgage or not need to support your children anymore. However, you will still need enough money to pay for food, bills and to enjoy life while not needing to work anymore.

During your working life you will need to pay into your pension regularly to grow your retirement pot. This can be achieved through contributing a percentage of your salary to your workplace pension, paying into your own personal pension or a combination of both. The advantage of a workplace pension is that your employer will also usually have to make contributions, though you will get more flexibility and control with a personal pension. Read our article 'Can I have a personal pension and a workplace pension?' to learn more.

How a private pension works

The majority of private pensions in the UK are ‘defined contribution’ pensions. This means that the money you get at your retirement age will be based on the value of your retirement pot. Some people may still be able to access a ‘defined benefit pension’, which pays out a figure based on your final salary. As most pensions are defined contribution, there is a lot riding on how your pension plan performs and how much you pay in. If you pay in a large percentage of your salary and the investments perform well, you could be looking at a comfortable retirement, or even be able to stop working earlier than you expected.

If your investments underperform, you may find that you need to work for a bit longer or adjust your living costs. Read our article ‘Best Pension in the UK’ to find out more about choosing the right pension provider.

One scenario in which you might not need a private pension is if you plan to live off State Pension payments. You can read more about the State Pension in our article ‘Will I get a state pension?’.

We go into more detail on how a private pension works in our article 'How do private pensions work?'.

What about the UK State Pension?

The UK State Pension is a government benefit paid to people over a certain age who have completed enough full years of National Insurance Contributions (NICs). The current State Pension age is 66, but it is set to rise to 67 by 2028 and 68 between 2044 and 2046. There is also the possibility that the qualifying age rises again before you are old enough to claim, or the State Pension is diluted even further. As it stands, you can be paid £203.85 per week if you are old enough and have made at least 35 years of NICs.

If you have not paid enough years of NICs for the full amount, or even if you have paid none at all, you can top up your record to boost your State Pension payments. Read our article 'How to fill gaps in your National Insurance record to boost your state pension' for more details.

This means that the State Pension may not be enough for a lot of people to meet their weekly expenses, so you should think about a private pension to meet the shortfall. It may also come too late for your retirement plan, so you will need a private pension to support you for a period of time.

You can find out more about how much you will get from the State Pension in our article ‘How much is the UK State Pension?’.

Different types of UK private pension

UK private pensions can be split into two main categories: personal pensions and workplace pensions. A personal pension is set up by an individual who can choose to pay in a regular amount every month or contribute irregular lump sums when they can afford to. You can choose to invest your pension savings in a variety of different ways that you can control yourself or as part of a ready-made pension scheme. You can read more about ready-made pensions in our article ‘Best ready-made pension’.

Personal pensions also allow you to consolidate old workplace pensions into your new scheme, which can help you keep track of your retirement savings and avoid unexpected fees. The main downside to a personal pension when compared to a workplace or company pension is that you will not receive employer contributions on top.

With a workplace pension you can contribute directly from your salary and benefit from your employer making regular contributions too. You may have less flexibility when compared to a personal pension, but that can mean there is less admin and decision-making for you to do. A workplace pension is organised by an employer for its workers, so you have less of a say in where your money is invested. Some workplace pensions are linked to an employee’s final salary – called defined benefit pensions – though these are growing increasingly rare. With this type of pension your eventual payout would be calculated as a specific fraction of your average or final salary, based on how long you paid into the scheme for.

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

Paying tax on private pension schemes

The money you pay into your pension pot will be tax free unless your annual contributions exceed your annual income or £60,000, whichever is lower. You may also have to pay tax on your pension contributions if you go past the lifetime allowance, which is currently set at £1,073,100, however this is due to be abolished from April 2024, so it is best to seek advice if this is likely to apply to you.

All of your pension contributions will be topped up by a 25% tax relief bonus, which your provider will claim automatically from the government. You can get more tax relief through completing a self-assessment tax return if you are a higher or additional rate taxpayer.

You may need to pay tax when you eventually spend your pension savings in retirement.

Spending your private pension

Once you reach retirement age – currently 55, though rising to 57 in 2028 – you can withdraw your private pension. You can take out the first 25% tax free, either as a lump sum or in smaller withdrawals. The rest will be considered as income, so will be eligible for income tax. Find out more about withdrawing your pension by reading our article ‘Can I withdraw my pension?’.

You can withdraw your pension funds steadily – known as pension drawdown – or purchase an annuity. An annuity is a financial product that guarantees you an income for a certain period of time or for the rest of your life. You can read more in our article ‘What is an annuity pension?’.

Paying into a private pension plan

It is important to know how much you need to pay into your private pension in order to build an adequate retirement income, while not running out of money at the end of the month.

You can pay in through regular monthly contributions or one-off lump sums. The best option for you will likely depend on how you are paid and how much disposable income you have.

You should also think about how long you have left until you retire. The number of years you will be contributing to a pension will affect how much each contribution needs to be. If you have not paid into a pension for a while and now need to build your pot quickly, your monthly contributions will likely need to be higher.

You can learn more about private pensions by reading our article ‘How do private pensions work?’. Also, to help understand how much you may need when it comes to your retirement, check out our handy pension calculator.