What is a pension? 

At its simplest, a pension is a long-term savings plan with special tax rules. Unlike a regular bank account, the government adds money to your pension in the form of tax relief, and your employer will often contribute too.

The money you save is invested, meaning it buys shares, bonds, and other assets to help it grow over time. The goal is to build up a large enough pot of money to provide you with an income when you retire.

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How do pensions work? 

Pension pots are built up through ‘compound growth’. You contribute a small amount regularly over many years, and that money earns a return. That return is then reinvested to earn its own return.

Money gets into your pension in one of three ways:

1. You pay in: Regular monthly payments or lump sums.
2. Your employer pays in: If you are employed, your company is usually legally required to contribute.
3. The government pays in: This is called tax relief, effectively ‘free money’ from the government to reward you for saving. We’ll come back to this later.

Read our full guide on pension contributions.

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Building your pension pot

‍What are the main types of pension? 

When building your retirement fund, almost every UK pension falls into one of two categories: Defined Contribution or Defined Benefit. 

Defined Contribution pension scheme 

Most modern private and workplace pensions are Defined Contribution schemes.

• You and/or your employer pay into a pot. That pot is invested.
• The final value of your pension depends on how much you paid in and how well your investments performed. This amount is not guaranteed.
• Examples: SIPPs, Nest, most workplace schemes.

Defined Benefit pension scheme

These are often called ‘final salary’ or ‘career average’ schemes. They are now rare in the private sector but common in the public sector (e.g., NHS, Teachers, Civil Service).

• Your employer promises to pay you a guaranteed income for life when you retire.
• The amount is based on your salary and years of service, not on investment performance. Your employer takes the risk, not you.

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Sources of pension income

‍What is the State Pension? 

The State Pension is a regular payment from the government, based on your National Insurance record, not your personal savings.

• Current amount (2025/26): The full New State Pension is £230.25 per week (approx. £11,973 a year).
• You usually need at least 10 ‘qualifying years’ on your National Insurance record to get anything, and 35 years to get the full amount.
• You can claim it when you reach State Pension age, which is currently 66. 

Read our full guide on the State Pension.

What is a workplace pension?  

A workplace pension is arranged by your employer. Thanks to Automatic Enrolment laws, employers must set up a pension for eligible staff and contribute towards it.

• Minimum contributions: Currently, the minimum total contribution is 8% of your qualifying earnings. 3% must come from your employer. 5% comes from you (including tax relief).
• If you opt out, you are essentially turning down a pay rise in the form of employer contributions.

Read our full guide on workplace pensions.

What is a private pension?  

A private pension (also known as a Personal Pension) is one you set up yourself. This is essential if you are self-employed or want to save extra money on top of your workplace scheme.

• SIPPs: A Self-Invested Personal Pension (SIPP) is a popular type of private pension that gives you full control over where your money is invested.
• Flexibility: You can usually stop, start, or change your contributions whenever you like.

Read our full guide on private pensions.

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An intro to pension tax rules

‍What is pension tax relief? 

Tax relief is how the government encourages you to save. It effectively refunds the Income Tax you paid on the money you put into your pension.

• Basic rate taxpayers (20%): To save £100, you only pay £80. The government adds the other £20.
• Higher and additional rate taxpayers (40-45%): You can claim back an additional 20-25%, meaning a £100 contribution effectively costs you only £55-60. The first 20% is typically paid out automatically into the pension and the additional 20-25% will need to be claimed through a Self Assessment tax return. 

What is the pension annual allowance? 

The amount you can save into a pension each year while still benefiting from tax relief is limited.

• The limit (2025/26 tax year): For most people, the Annual Allowance is £60,000 per tax year (or 100% of your earnings, whichever is lower).
• High earners: If you earn over £200,000, your allowance may be reduced (tapered).
• If you don't use your full allowance, you can often carry forward unused allowance from the previous three years.
• Once taxable income has been taken by an individual through flexible drawdown or the tax-free lump sum, tax relieved contributions to defined contribution pensions are limited to £10,000 per tax-year. This is the Money Purchase Annual Allowance (MPAA).

Read our full guide on pensions tax, relief and allowances.

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Understanding SIPPs

While workplace pensions are a great foundation, they often lack flexibility and investment choice.

A Self-Invested Personal Pension (SIPP) allows you to choose exactly where your pension is invested. Read our next guide to discover how SIPPs work and if one is right for you.

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