What is a pension?

A pension is essentially a retirement fund that gives you an income to live off when you have retired and no longer work. When you are of working age and earn your salary, a small chunk is taken out of your pay cheque every month and added to your pension pot for later life. Your employer also matches your contribution, too, and you receive a 20% tax break from the government. In later life, when you retire, you can then begin to draw your pension and use the funds you have saved (while you were working). There are many choices you have in terms of how you use your pension, these include:

• Drawing money from your pension fund (in one lump sum)
• Arranging a drawdown (in which you receive the income in instalments)
• Purchasing an annuity (exchanging the fund with an insurance company)

If you are working and an employee of an organisation, your employer by law has to enrol in a pension scheme. If this hasn’t happened, speak to your employer immediately. Employers must enrol all employees over the age of 22 earning at least £10,000 per year into a pension scheme by law. The minimum amount an employer can contribute to a pension scheme is 3%.

If you are self-employed, it is a good idea to set up your own private pension scheme with a pension provider. The sooner you set up a pension, the sooner you will be saving income for your future. With a personal pension, you have more control over how your money is invested, and you can also take payment holidays if you wish. A negative of a personal pension if you are self-employed is that you don’t get additional contributions from an employer.

Do you require financial advice on how to make the most of your pension pot? Financial Advisor UK offers a national network of fully FCA-registered and approved pension advice professionals. We can match you in less than a minute to a professional and highly qualified advisor, ensuring that you receive the right guidance and best deals available on the market.

What types of pension are there?

There are three types of pension – a State pension, a defined benefit (DB) pension and a defined contribution (DC) pension.

State pension

Most UK citizens receive a State pension from the government. The amount you can receive is set by the government, and rises with inflation. The National Insurance contributions you make during employment help to pay for your State pension, and you must have at least 35 years of records of paying National Insurance to be eligible. The State pension is £168.60 per week.

Defined benefit (DB) pension

If you work for a large well-known company or organisation, it is likely that you will be enrolled into your employer’s pension scheme as receiving a defined benefit (DB) pension. Your pension and the type of plan you receive will depend on the number of years of service you have contributed towards your employer. In some cases, you may be on a ‘final salary’ pension with lots of benefits, which is a pension based on your final salary with that company before you retire.

Defined contribution (DC) pension

A defined contribution pension is a pension pot/cash sum that you can drawdown from once you have retired or scaled back your working hours. You must be 55 or over to receive a DC pension. You can withdraw (in one go) 25% of your pension pot, without paying any tax. If you withdraw more than this in one go, you’ll have to pay tax on it. The amount in your pension pot will depend on how much you and your employer have both contributed, and how your pension is invested/the scheme you are enrolled in.

For more details on types of pensions, how much you can invest, pension tax and other pension pros and cons, read our more detailed guide to pension need-to-knows here.