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How pensions work

By Paul Davies

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How pensions work

Learn the basics about the three types of pension – state pension, workplace pensions and personal pensions – and how they work.

A pension is a way of saving for your retirement. You put money into your pension each month and, in return, you get a regular income once you've retired. You don't have to pay tax on pension contributions, which is one of the reasons saving into a pension can be more effective than saving for your retirement in other ways.

There are three types of pension – state pension, workplace pensions and personal pensions. All three types are available to everyone, as long as you are in employment.

State pension

When people reach their state pension age (currently between 63 for women and 65 for men), they will receive an income from the state, called the state pension. 

To claim the state pension you have to have made National Insurance (NI) contributions throughout your working life – you can read more on this in our guide, your state pension and benefits.

Workplace pensions

The state pension will not be able to provide all your retirement income, so most people take out a pension with their employer to top it up. Workplace pensions take contributions from you, your employer and the government, and use them to provide you with a pension when you retire.

Your contributions will take the form of a percentage taken from your salary each month, and your employer's will also be added as a percentage of your pay. 

The fact that your employer pays into your workplace pension is one good reason for having one – it is like extra pay. These contributions will be invested, with the aim of increasing the amount you have to retire on.

There are two types of workplace pension – defined benefit and defined contribution. Our guide - what is a company pension? -has more information on this type of scheme.

Personal pensions

These work by you paying money into a pension scheme from a provider (selected by you, rather than your employer, unlike a workplace pension) and getting a sum at the end with which to buy an annuity or arrange income drawdown, although people have had more flexibility since April 2015. An annuity is a type of financial product that gives you retirement income for life. You can learn more about your options for cashing in your pensions in our guide. 

Like workplace pensions, personal pensions invest your money with a view to increasing it. Personal pensions are particularly suitable for the self-employed or people who aren't in work, who don't have access to workplace pensions. But anyone can save into a personal pension.

  • Last updated: December 2016
  • Updated by: Paul Davies

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