In this article
A quick guide to your pension options
There are three main types of pension schemes – state, workplace and personal pensions. We take a look at how they work and what the differences are.
In this article
All pension schemes work in a fundamentally similar way. They’re long-term savings plans that aim to provide you with a suitable source of income when you retire.
But they all have different ways of getting you to your ultimate goal: having enough money to live off when you retire.
The state pension is a regular payment from the government that you receive when you retire. In order to get it, you must meet the following criteria:
You’ve reached state pension age. At the moment, this is 65 years old for men and 63 years and 9 months old for women. However, the government plans to raise the age to 66 by 2020, to 67 by 2028 and to 68 years old by 2039.
You’ve paid National Insurance (NI) contributions for at least 10 years. You’ll also qualify if you weren’t paying NI but you received.
How does it work?
In order to get your state pension, you have to claim it.
You should receive a letter with instructions on how to do this about four months before you reach retirement age. You can also file your claim, or by .
You should receive your first payment within 5 weeks of your birthday. Payments are made into a bank account of your choice every four weeks, for the rest of your life.
What do you get?
The size of your state pension depends on how many NI contributions you’ve made during your working life. You’ll need at least 10 years’ worth of contributions to qualify. However, the more you’ve contributed over the years, the larger your state pension will be. To get the maximum amount, you’ll need 35 years’ worth of contributions.
The maximum amount you can receive is currently £159.55 a week (£8,296.60 a year). For a lot of people, this won’t be enough to continue their current standard of living. That’s why it’s important to save for your retirement in other ways if you can.
A workplace pension scheme is a retirement savings plan arranged by your employer. This is in addition to your state pension.
How do they work?
By law, all employers in the UK have until 2018 to automatically enrol employees into a scheme.
To be eligible for a workplace pension, you must work in the UK, earn more than £10,000 a year and be between 22 and the
Your employer doesn’t have to enrol you if you earn less than £10,000. However, you can ask to be enrolled if you earn at least £5,876.
Workplace pension schemes can take one of two forms:
- Defined benefit schemes
Also known as final salary schemes, these are usually taken care of entirely by your employer. These don't require you to contribute to the scheme. Instead, your employer will pay you a pension when you retire based on your salary and how long you’ve been employed with the company.
These types of schemes are getting more and more expensive for employers so they’re becoming rarer outside of the public sector.
- Defined contribution schemes
These are the most common types of workplace pension plans. Your retirement fund is built up from your own (regular) contributions and contributions from your employer (if you’re an eligible employee). The contributions are then invested, usually in stocks and shares, by people working for the pension scheme company. The aim is to grow your contributions enough to give you a suitable income when you retire.
When do I start receiving my workplace pension?
You can usually start getting your workplace pension at age 55 - ten years earlier than the current state pension age.
Check out ourfor an in-depth look at how they work.
What do I get?
If your workplace pension is a defined benefit scheme, what you’ll get will depend on how long you’ve been in your employer’s service, the size of your salary and the scheme's 'accrual rate' (a percentage of your final salary that's set by the scheme)
If your workplace pension is a defined contribution scheme, what you get will depend on how much you and your employer contributed to the scheme, and how well the scheme’s investments did over time.
A personal pension scheme is a retirement savings plan which you arrange yourself. Anyone can start one, but it’s an especially good idea if you’re self-employed or ineligible for a workplace pension.
How do they work?
Personal pension schemes tend to either be defined contribution schemes or self-invested personal pensions (SIPPs).
When can I start receiving my personal pension?
Just like a workplace pension scheme, you can take out your personal pension from your 55th birthday.
How much will I get?
Your retirement pot will depend on three factors:
- how long you’ve contributed
- how much you’ve contributed
- how well the scheme’s investments have done
Some defined contribution schemes have a minimum amount you must contribute each month. But if you only pay the minimum, you may not save enough to comfortably live off when you retire.
A rough rule of thumb is to save a percentage of your income equal to half your age. So, if you start saving when you're 24 you could put aside 12% of your income each year until you retire. If you start saving when you’re 40, then it would be 20% of your income each year.
Here’s a more in-depth look at.
There are a few different options for accessing the money from your personal or workplace pension once you retire:
1. Use your pension pot to buy an annuity
One option when you want to retire is to buy an ‘annuity’. This is a type of insurance product that lets you convert your pension savings into a regular income for the rest of your life.
If you go for this option, the amount you get will depend on the size of your pension pot and the annuity rate you’re given. For example, if you have £50,000 saved up and get offered a rate of 5%, you'd receive £2,500 a year.
2. Enter income drawdown
With most pension plans, the money you save gets invested in order to help it grow further. With this option, your pension pot continues to get invested, but you can take out - or draw down – an income for your retirement.
This can be a more flexible option because you can decide the income you want each year. Although this obviously depends on how much you’re investing and how well your investments are doing. But, because your funds continue to be invested, it can be riskier and doesn’t offer you a guaranteed income.
You can read more about the different types of income drawdown
3. Take out your pension in lump sums
This option lets you leave your money in your pension fund and take money out as and when you need it. 25% of each withdrawal you make will be tax free, and you’ll be charged tax on the rest.
4. Take out your whole pension in one go
You also have the option to take out your entire pension in one go. You can take out up to 25% of it tax-free. However, you’ll need to pay tax on the rest if you do this.
You can take out your pension using a combination of these different methods. So you could withdraw 25% of your pot tax-free and then purchase an annuity, or enter income drawdown using the rest of your savings.
Saving for your retirement is essential – but how much? To figure out how much you will need to answer two questions:
1. How luxuriously do you want to live in retirement?
One way to roughly determine how much you need to retire comfortably is to use the “70% rule”. This means you will need roughly 70% of your normal working income to maintain the lifestyle you want while in retirement. That means if you are used to living from £40,000 a year, you would need a retirement income of roughly £28,000.
At a minimum, you want your retirement income to cover basic living costs like food, shelter and public transport. The most basic cost of living is about £10,200 per year.
But you also want to add in little luxuries. For a high-end example, according to this retirement savings calculator if you want long annual holidays, regular shopping, to update your car every 5 years, a monthly dinner out and tickets to a show, and to stay on top of home improvement, then you can expect to happily get by with about £37,000 per person per year.
2. When do you want to retire?
The later you retire, generally the better your retirement income. This is because you give your money more time to grow.
You can functionally retire anytime (stop working). If you have a pension, you can access it starting at age 55. That said, the average retirement age in the UK is 65. Knowing what age you want to retire at will help to determine how much pension you'll need.
The earlier you start saving, the better your retirement income, even if it’s just a small amount.
If you already have a pension and make regular pension contributions, a simple pension calculator like this one can help you see any shortfall between the retirement income you want and what you can expect. If you don’t have anything saved yet, this calculator can help you figure out how much you should be contributing each month.
- There are three main types of pension scheme in the UK: the state pension, workplace pensions and personal pensions.
- years’ worth of NI contributions over your working life. However, at £159.
- A workplace pension is a retirement savings plan arranged by your employer. It is in addition to your state pension.
- A personal pension is a retirement scheme you arrange yourself. You can use it to supplement your state and workplace pensions or in place of a workplace pension if you’re self-employed or ineligible.
- Most workplace and personal pension schemes are defined contribution schemes. So the size of your retirement pot will partly depend on how much you save over time.
Hannah is currently studying for a Master's in Comparative Cultural Analysis. She knows all about personal finance, but as a student, she's an expert in money saving tips and tricks.