Retirement planning

Understanding three of the most common types of UK pensions

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Two people sitting together at a café table with drinks, representing conversations about retirement income and the different types of pensions available in the UK

Why is it important to have the right type of pension?

We all have different circumstances, financial situations, and goals in life. Retirement will look different for every one of us. Pensions aren't one-size-fits-all, and we need to find the types of pensions that will work for us. 

Understanding what type of pension is best for you and starting to plan for retirement early will set you up for success later on. The vast majority of people will need a personal pension (private or workplace) to supplement their state pension in retirement. 

This information is based on our current understanding of HMRC tax rules in the UK. Tax treatment depends on your personal circumstances, which could change.

The earlier you start saving for retirement, the better placed you may be.

While State Pensions provide a set monthly income, contributions to personal pensions enjoy compounding growth over time.  The earlier you start, the longer your money has to grow, and the bigger your pot could be by the time you decide to retire. Starting in your twenties compared to starting in your thirties could result in tens of thousands of pounds more in your pension pot. It’s always important to remember that the value of your investments can go down as well as up, and you could get back less than the amount you invested.

You might have other things you want to prioritise over pension contributions, which you won’t be able to access until you retire (age 55, increasing to 57 from April 2028). But there are huge benefits of contributing to your pension early.

The best pension plan is the one you can stick to. It’s important that it reflects your goals and strikes the balance between enjoying your life now and making sure you can spend your time in retirement as you wish. 

An illustration showing the effect of saving £150 a month invested in global markets

Past performance is not a reliable indicator of future performance. 

The graph above shows how a hypothetical investor aged 25 in 1983 would have grown £150 per month invested into global markets, compared with starting the same monthly amount 10, 20 or 30 years later (ages 35, 45 and 55 respectively). Past performance is not a reliable indicator of future performance. When you invest your capital is a risk. You could lose some or all of your investment.

How does the State Pension work?

The State Pension is paid by the UK government to people who have reached State Pension age (66, rising to 67 by 2028). 

To receive the minimum amount, you’ll need to have at least 10 qualifying years of National Insurance contributions (NICs).  To get the full amount, you’ll need to have 35 qualifying years under your belt. 

A qualifying year is a year in which you’ve either paid National Insurance contributions from your salary or received credits. You can earn credits through self-employment, voluntary contributions, if you’re unemployed, ill, a parent claiming Child Benefit, or a caregiver. 

You won’t automatically receive the State Pension. Before you reach State Pension age, DWP will contact you with details on how to claim it. At present, you can either start taking your pension when you reach State Pension age or choose to defer it. Deferring means you’ll receive a higher income later, as the amount you would have received is increased with interest. For every nine weeks you delay claiming your State Pension, your payments rise by 1%, which adds up to around 5.8% extra over a year.

If you have questions about the State Pension or want to see your forecast, you can contact the Future Pension Centre. 
 

How does a defined benefit pension work?

Defined benefit schemes provide a guaranteed income in retirement, calculated using three key factors:

  1. Your salary at retirement (or an average over your career),
  2. The total years you’ve been a member of the scheme, and
  3. The scheme’s accrual rate, which determines the proportion of final salary earned for each year of service.

Unlike a defined contribution scheme, you don’t build up an investment pot. Instead, you receive a predetermined income. Some schemes allow you to exchange part of your pension for a tax-free lump sum – a process known as ‘commuting’ your pension.

These schemes were once widespread, but most employers now favour defined contribution plans.

You’re most likely to have a defined benefit pension if you work in the NHS, education, the armed forces, civil service, police, or fire service. You might also have one from a previous employer when these schemes were more common. It’s worth checking your pension type, as these benefits will apply when you retire.

In short: a defined benefit pension guarantees a set income based on your salary and length of service. You don’t need to worry about investment performance – the scheme manages that for you.

How does a Defined Contribution pension work?

The most common workplace pension today is the defined contribution scheme. Under this arrangement, both you and your employer pay into your pension pot each month. These contributions are placed in funds, which invest in stocks, bonds and other assets, with the aim of growing the money over time. The amount you have at retirement is determined by how much you’ve contributed and the return you’ve had from those investments over time.

Contributions

  • You pay a percentage of your salary into the scheme.
  • Your employer usually contributes too, often matching your payments up to a set limit.
  • Contributions benefit from tax relief, increasing the amount invested in your pension.
     

Investment

  • Your contributions go into funds that are invested in stocks, bonds and other assets.
  • You can typically choose from a range of funds to suit your risk appetite – whether cautious or adventurous.
  • The value of your pot can rise or fall depending on market performance.
     

At retirement

  • You can take up to 25% of your pot tax-free (in the UK) as a lump sum.
  • The remainder can be used to:
    • Buy an annuity (a guaranteed income for life)
    • Withdraw funds as needed
    • Or take lump sums (subject to tax).
       

In short: you and your employer contribute to a pension pot that is invested to help it grow. The more you pay in – and the better your investments perform – the larger your retirement savings will be.

How can I make the most of my pension?

Think of your monthly pension payments as investments into your future life. It’s worth checking you’re using all the tools and savings accounts available to you to make the most of your pension.

    Find your lost pensions

    Find your lost pensions

    Since 2012, if you work in the UK employers must auto-enrol you into a workplace pension scheme if you’re between the ages of 22 and State Pension age and earn at least £10,000 per year. Most people will have several jobs throughout their life, meaning they could have multiple workplace pensions with different pension providers. 

    In 2024 the Pension Policy Institute found there were an estimated 3.3 million ‘lost’ pension pots, containing £31.1 billion worth of assets. Pensions can be ‘lost’ when you’ve moved house without informing your pension provider, or if you’ve left an old job without updating your pension provider with new contact details. 

    How can I find my old pension?

    How can I find my old pension?

    The first step is to check for any existing pensions you may have. List all the jobs you’ve had and go through old emails to see if you can find information on any pension providers. You may need to reach out to your old employer to find out which pension provider they work with so you can contact them directly. You can also use online tools like the government's Pension Tracing Service. 

    Once you’ve identified the pension provider and have your account details, you’ll need to contact them to gain access to your pension account. This is a great chance to update your details, check how much money you have, and look at how your investments have performed over time. 

    If you have several pension accounts, you might want to consider consolidating them. 

    Should I consolidate my pension?

    Should I consolidate my pension?

    Pension consolidation is a financial term for the act of combining multiple pensions you might have into one pot. 

    Pension consolidation can offer both clarity and convenience, but it’s not without its trade-offs. On the plus side, bringing multiple pensions together can make it easier to manage your retirement savings, reduce paperwork, and potentially lower fees if you move to a more cost-effective provider. It can also give you a clearer picture of your overall retirement position, helping with planning. 

    However, there are important considerations: you might lose valuable benefits or guarantees from older schemes, and there could be exit fees or tax implications. It’s essential to review each pension carefully and, where possible, seek professional advice before making any decisions. A financial planner can guide you through the pros and cons of consolidating your pensions.

    Whether you choose to combine your pension pots or not, make sure to keep your contact information up to date.

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    Pension rules change regularly, and there are lots of things to think about when taking money out of your retirement accounts. Sometimes, once an action is taken – like withdrawing your tax-free lump sum – it can’t be undone. So, it’s a good idea to speak to a professional financial adviser to get pension advice before making any money moves. 

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