Always remember that investments can go down as well as up in value, so you could get back less than you put in. How you are taxed will depend on your circumstances, and pension and tax rules can change.

What Is a Pension?

Updated On: May 2, 2024
Most of the companies featured here are our partners, who pay us to include them in our articles. These payments influence which companies we write about and where and how they appear on a page. However, they do not influence our opinions. Our product reviews remain honest, independent, and unbiased.
Halimah Omogiafo
Author: Halimah Omogiafo
X (Twitter)
What Is a Pension

We all know that pensions are important. No one needs to tell us that someday when we are too old to work, we will need a steady stream of cash to keep us going.

For most Koody readers, retirement might seem ridiculously far away. Still, it’s important to remember that if you want to live comfortably and enjoy life when you are much older, it pays to start planning now.

This post aims to steer you to relevant parts of the website and help you understand on a high level how pensions work here in the UK.

So, without further ado, here’s what we have lined up for you:

What Is a Pension?

A pension is a savings pot you contribute to throughout your working life and spend from when you retire.

The money saved in a pension is usually invested in stocks, shares, funds and bonds by your pension provider, and you normally won’t be able to access this money until you are at least 55 years old (increases to 57 in 2028).

Types of Pensions

There are two types of pensions - defined benefit and defined contribution pensions.

For our generation, the relevant pension type is the defined contribution pension. With a defined contribution pension, the onus is on us to build our own pension pots, which will then serve as an income source in retirement.

Unlike a defined benefit scheme, which promises a specific income at retirement, the amount we might get from a defined contribution pension depends on how much we contribute throughout our lifetime, how our investments perform, and the lifestyle we choose at retirement.

Pension Annual Allowance

You can save as much as you like into your pension each year, but you will be taxed if you:

  1. Contribute more than £60,000 in one year - this is your annual allowance, and you can usually carry forward any unused allowance for up to three years.
  2. Contribute more than 100% of your earnings in one year.

Tax Relief on Pension Contributions

The government will add money to your pension contributions in the form of tax relief (free money).

For every £80 you pay into your pension, the government adds £20 - and you can claim an extra £20 if you are a higher earner.

You can think of tax relief as a refund of the tax you originally paid on your pension contribution at your usual rate of income tax - 20%, 40%, or 45%.

It is your pension provider that claims this tax relief at the basic rate and adds it to your pension. Tax relief for higher-rate taxpayers is slightly different. If you are a higher-rate taxpayer, you will need to claim the additional rebate through your tax return. Alternatively, if you are claiming a large sum, a phone call or letter to HMRC should do the trick.

How to Contribute to Your Pension

  1. Workplace pension and auto-enrolment
  2. Personal pension
  3. State pension
  4. Lifetime ISA
  5. Pension for the self-employed

1. Workplace pension and auto-enrolment

A workplace pension is a way of saving for retirement and is usually arranged by your employer. When you join a new company, your employer must enrol you into their workplace pension scheme if you meet the minimum requirement.

Once enrolled, you and your employer must contribute a percentage of your salary to a workplace pension scheme.

The minimum your employer must contribute to your pension is 3% of your salary. And the minimum total contribution you and your employer must make is 8%.

See: Workplace Pension Scheme - Auto Enrolment

2. Personal pension

Personal pensions are private pensions that you arrange yourself.

If you do not have a workplace pension, a personal pension could be a great way to save for retirement. Even if you have a workplace pension, a personal pension in addition to your workplace pension could be a great way to grow your retirement savings faster.

There are two types of personal pensions - Self-invested Personal Pensions (SIPPs) and Stakeholder Pensions.

See: Best Pension Providers
Also see: Best Stakeholder Pension Providers

3. State pension

In addition to the personal and workplace pensions, you are entitled to the State Pension. This is free money from the government, and the amount you get is based entirely on your National Insurance record.

The earliest you can get the State Pension is when you reach the State Pension age. If you’re currently aged between 20 and 39, your State Pension age will likely be 68. You can double-check that number on GOV.UK.

4. Lifetime ISA

Another way to save for retirement is with a Lifetime ISA. A Lifetime ISA is not a pension but a longer-term tax-free savings or investment account created to help those between the ages of 18 and 39 save for their first home or retirement. Each tax year, you can pay up to £4,000 into a Lifetime ISA. The government will add a 25% bonus to your Lifetime ISA every tax year up to a maximum of £1,000 per year, and you can continue saving or investing into a LISA until you are 50.

5. Pension for the self-employed

If you are self-employed, a solo founder, or the sole director of a company with no other employees, you will not be automatically enrolled into a pension when you start working for yourself.

It is up to you to sort out your pensions. This should not scare you. It is easy to open a pension pot, and saving into one is as simple as transferring money from one account to another.

You might also like 🤓

  1. Best ETFs
  2. Best Index Funds
  3. Best Trading Platforms
  4. Best Investment Platforms
  5. Best Investment Apps
  6. Best Stocks and Shares ISAs
  7. Best Budgeting Apps


  2. MoneyHelper

Koody Man with Laptop

Subscribe to The Plug

Thank you! Your submission has been received!
Error: This email cannot be added because it may already be on our list. Please enter a different email address.

Every month, we’ll send you The Plug - a curation of the best personal finance content in the UK. We share real-life stories, how-to guides, top personal finance news, popular community questions, and tips to help you stay on top of your money.