How do pensions work in the UK?

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Everyone should be aware of pensions. 

It is very important that you arrange to have one as early as possible for when you decide to retire. It can help to secure your future financially and you may not have to worry about money when the time comes (if you have enough stashed away).

Read on to learn more on what pensions are and how they work, in a bit more detail.

How do I get a pension?

To start untangling this complicated web of pensions, there are three types:

  • State Pension
  • workplace pension
  • and a personal pension.

Depending on the type of pension and how you contribute to it, you get one of these or all, as explained further down. In some cases, you have to arrange it yourself, the Government does or your employer.

It is your responsibility to ensure that you have a pension and a financial income when you retire.

 

What is the State Pension?

Nearly everyone who works in the UK saves for a State Pension. 

You contribute to it with your National Insurance contributions and credits every time you get paid. You need at least 10 qualifying years in your NI record to receive State Pension and 35 years to receive the full amount. Full State Pension income, as of 2021-22, is £179.60 per week which is not enough for most UK citizens to rely upon.

However, if you don't make NI contributions, since you're earning a low income and you qualify for the personal allowance tax income, you will not receive your full State Pension, or any if you've never made any contributions to the Government.

State Pension age is usually eligible to be paid after 67.

Although the State Pension doesn’t ensure a good standard of living once you decide to retire, it is a basic income that you could rely on for the most important necessities. 

 

What is a workplace pension?

This type of pension most employees have a pot for, in which they save with a small percentage from their salary. 

A workplace pension - or occupational pension in some instances - is a pension arranged by your employer for you, and contributions are made both by you and your employer. In the case of a group personal pension, it is a workplace personal pension arranged by your employer but the contract is individual and personal.

There are two ways you can contribute into your workplace pension, based on:

  • the defined benefit scheme, where you receive your pension based on your final salary with that employer or the years you've worked for that company
  • the defined contribution scheme, where your pension is based on the contributions you’ve made and on how well these contributions are invested and growing.

These days, it is the law for all employees to be auto-enrolled to their workplace's pension scheme, if they qualify for it. This ensures that UK citizens have ensured an adequate income for their retirement and don't rely on State Pension, which is insufficient.

The minimum age you can start receiving your workplace pension is 55. Because life expectancy is increasing, the pensionable age will change to 57 in 2028.

 

What is a personal pension?

This type of pension, everyone should have. And if they don’t have a workplace pension, then this is a must!

A personal pension is a type of pension that is individual to the person. It is usually arranged by you and payments are usually made by you. However, as mentioned before, a personal pension pot can be arranged with your employer's pension provider. It is also possible for your family or spouse to contribute into these pension funds.

There are four types of pensions that can be classified as personal:

  • A personal pension pot which you arranged for yourself
  • stakeholder pension
  • group personal pension
  • Self invested personal pension (SIPP)

It is very common for self-employed workers to choose this sort of pension for themselves since they're not employed by a company and thus not in a workplace pension scheme. A personal pension allows them to secure a retirement income for themselves, just as employed people have a secured income for the future.

Just as with a workplace pension, minimum age you can receive your personal pension is 55, changing to 57 in 2028.

Pensions are necessary in order to have a stable income during your retirement years and peace of mind. 

Pension contributions and limits

State Pension

NI contributions count towards your State Pension, and to receive any at all you need a minimum of ten qualifying years in your NI record and thirty five years to receive the full State Pension.

You might receive a higher full State Pension if:

  • you have Additional State Pension which you were saving before the 6th of April 2016
  • you have deferred your State Pension, which allows you to receive 1% increase in payments every 5 weeks you defer
  • you have filled in all the gaps in your NI record, either through NI credits or voluntary NI contributions.

It is worth mentioning that if you reached State Pension age on or after 6 April 2016, you can no longer save for an Additional State Pension. Unfortunately, you can't pay more into your State Pension to increase the amount.

Workplace and personal pensions

These types of pensions work differently to a State Pension.

Contributions into these pots can be made either by your employer, you or your family, depending on your pension plan. In a workplace pension scheme the minimum amount of total contributions is 8%, meaning that the employer usually pays the minimum 3% and you the remaining 8%. You can make arrangements to pay more into your pension.

In a personal pension scheme, there is no limit on contributions, meaning that you are able to make as many payments and as frequently as you'd like, depending on the arrangements with your pension provider and your employer. However there is a tax limit, meaning that there is a maximum tax-free allowance on contributions.

You pay tax if your money in your pension goes above:

  • 100% of your earnings in a year - for example, if you're earning 20K and you manage to save 20K in your pot, you'll pay tax on the rest of your contributions.
  • £40,000 a year which is called annual allowance
  • £1,073,100 in your lifetime.

Essentially, there is a limit if you mind paying tax according to the above guidelines.

You need to check with your pension provider and employer to find out your limitations and arrangements regarding your pension contributions.

 

How can I withdraw my pension?

Once you're of retirement age and want to start receiving your pension, there are several ways you can receive your retirement income.

  • You are able to withdraw 25% of your pension as a lump sum and tax-free. You can receive the remaining 75% after six months, but you will have to pay tax on it.
  • Another option is to withdraw the 25% tax-free and with the remaining pension, purchase an annuity. An annuity is a financial product that you buy, which secures a stable income for you for a fixed number of years or until death.
  • There's also the option of income drawdown. Any money you don't withdraw stays in your pot and continues to be invested. It allows your pension funds to potentially grow depending on whether the investments are doing well.

 

What if I lose track of my pensions?

It is very normal and very reasonable to lose track of your pensions. This is because most people don't know that when you change employers or change your address, you lose contact with your pension provider. Your pension pot is not transferred from job to job, but you have a new one with each employer.

Raindrop is here to make finding and tracking your pensions easy and stress-free. Our technology can find your pension pots and even consolidate them into one simple online plan.

This gives our customers peace of mind, knowing where their life savings are, and gives them more control over their finances.

Please note that if you choose to consolidate your pensions into a Raindrop account, your capital is at risk and the value of your pension can go up as well as down.

 

Plan your retirement living today

It is extremely important that you have a plan B in regards to your retirement living, and a pension does that for you. 

Usually people think that savings is enough for a secured financial future, and forget that there's so much more to it. For instance, we’re not as disciplined when it comes to our savings and it is very easy to use money from that pot, reducing its value and consequently having less savings for our retirement. But with a pension, you don’t have such accessibility to these savings. 

Generally, pensions are a sure way of securing a stable income during old age and an essential tool for financial stability. Set up yours today too.

 

It is worth noting, investments carry risk to your capital and the value of your pension can go up as well as down. Tax treatment depends on your individual circumstances and may be subject to change in the future. 

Get Started

If you are considering finding and combining your pensions into one place then Raindrop could be a good solution for you. If you choose to combine your pensions with Raindrop, as with all investments your capital is at risk. The value of your pension can go up as well as down.

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