Thanks to auto-enrolment rules, employees will be automatically registered for a pension through their workplace unless they opt out.
Personal pension schemes can also be taken out as a supplementary pension or for those who are not eligible for a workplace pension.
The State Pension is available to everyone who has made at least 10 years of National Insurance contributions by the time they retire.
What pension schemes are available?
There are four main pension schemes to be aware of in the UK:
- Workplace pensions
- Personal pensions
- Armed Forces Pension Scheme
- State Pension
Different rules apply to these schemes and there are variations of workplace pensions and personal pensions that individuals should be aware of.
In addition, the rules around the State Pension vary depending on how many years of national insurance contributions an individual has made at the time of retirement.
We'll look more closely at the different types of pension schemes in this guide.
Workplace pensions involve a percentage of an employee's pay being put directly into a pension scheme automatically each month.
This contribution is often joined by an employer contribution and may be eligible for tax relief from the Government to further increase the pension pot.
Workplace pensions may be known by several other names including:
- Occupational pensions
- Works pensions
- Work-based pensions
- Company pensions
These different names all refer to the same idea: an employee pays money into a pension scheme arranged by their employer.
Auto-enrolment for workplace pensions was brought in from 2012 onwards, meaning workplaces have to offer pensions to employees if they meet certain conditions:
- They work in the UK
- They are not already enrolled in a suitable workplace pension scheme
- They are at least 22 years old (but under State Pension age)
- They earn more than £10,000 per year
For employees earning less than £10,000, auto-enrolment isn't available, but employers must still allow them to join the pension scheme - this is a legal requirement.
Employers cannot encourage or force employees to opt out of workplace pensions. However, employees are not forced to be part of one if they want to opt-out.
There are minimum amounts that must be contributed to a pension scheme once an employee is enrolled:
- 5% from the employee (including tax relief)
- 3% from the employer
For the tax year 2022/23, any earnings between £6,240 and £50,270 are subject to the minimum contribution - these are known as 'qualifying earnings'.
There are two types of workplace pension schemes to be aware of:
- Defined contribution
- Defined benefit
Let's take a quick look at the differences between them.
Defined contribution pensions
A defined contribution pension scheme allows employees to build up a pot of money that is then put into investments by the pension provider.
The total amount of this pot by the time an employee retires will depend on several factors:
- How much has been paid into it by the employee, employer and how much has been added through tax relief
- How long each contribution has been invested
- How much the investment has grown over time
- How much has been deducted in charges
It's possible to withdraw money from a defined contribution pension from the age of 55 onwards (this threshold is rising to 57 from 2028).
Defined contribution pensions are sometimes known as money purchase pensions.
A specific type of defined contribution pension is a group personal pension (GPP). This is a slight variation on the process above and involves a direct agreement between an individual and the pension scheme - although this pension scheme will be chosen by the employer.
Defined benefit pensions
A defined benefit pension is based on how long an employee has been part of an employer's pension scheme and what salary they were earning at the time they left or retired.
This type of pension scheme offers a secure income each year on retirement and this income grows in line with inflation.
Defined benefit pension schemes are far less common than they used to be because the amount paid out is often very generous.
There are two types to be aware of:
- Final salary scheme - this is calculated by looking at the amount of time an employee has been a member of the scheme and their salary at the time of retirement (or when they left)
- Career average scheme - this is calculated by looking at an average of earnings throughout an employee's time enrolled with the scheme (revalued in line with inflation)
Defined benefit pensions can usually be accessed at an employee's State Pension age, although there might be the option to take them earlier.
Personal pensions are a type of defined contribution pension (see above) that is arranged and controlled by an individual rather than an employer.
These can be useful for self-employed workers and those with an irregular income or who may not be in paid employment. They are a useful addition for individuals who don't have any other pension apart from the State Pension.
They can be accessed early from the age of 55 (57 from 2028) or at the time an individual retires.
There are three types of personal pension schemes:
- Self-invested Personal Pensions (SIPPs)
Standard personal pensions are the most common type of personal pension and generally offer a range of investment choices at sign-up.
The other two options are a little more complicated, so let's look at those in more detail.
A stakeholder pension offers flexibility to individuals. It allows them to:
- Make low minimum contributions to their pension
- Start and stop contributions when they need to
- Transfer money out of the pension at no extra cost
One of the attractions of stakeholder pensions compared to other types of personal pension is that customers don't have to make investment decisions on their own behalf - the schemes come with a default investment strategy that makes the pension easier to understand.
Stakeholder pensions have capped charges that must meet standards set by the Government. This can be no more than 1.5% a year of the value of the pot for the first 10 years then no more than 1% per year after that.
Note: an employer can use a stakeholder pension to fulfil their automatic enrolment duties but the charges for those are capped at 0.75%.
Self-invested Personal Pensions (SIPPs)
A self-invested personal pension (SIPP) is similar to a standard personal pension, but it has more flexibility on investments.
Individuals can invest their SIPPs in:
- Company shares
- Collective investments such as open-ended investment companies (OEICs) or unit trusts
- Investment trusts
- Property and land (limitations on residential property)
SIPPs can be managed by an individual themselves or through an authorised financial adviser.
Like other types of personal pension, individuals can decide how much to invest and when. Their contributions are also subject to tax relief.
SIPPs can be subject to a range of fees such as:
- Set-up charges
- Service charges
- Platform charges
- Administration charges
Shopping around for a SIPP that meets an individual's needs is important, plus financial advice should always be taken to manage the investment properly.
Armed Forces pensions
The Armed Forces Pension Scheme is a specific pension designed for regulars and reservists.
There have been several schemes over the years, but some have closed to applicants. All serving members of the Armed Forces from 1 April 2015 are enrolled in the AFPS 15.
The qualifying service period for AFPS 15 is two years and individuals are automatically enrolled. Contributions from the Government are made until a person leaves the Armed Forces and it is calculated under a Career Average Revalued Earnings (CARE) system.
Individuals do not contribute to the Armed Forces Pension Scheme as it is deemed to be a benefit of service.
The new State Pension is the core of most people's retirement income and is available to access when an individual reaches the State Pension age.
To qualify for a State Pension, individuals will need at least 10 qualifying years on their National Insurance record, although a full State Pension is only available to people with 35 years of National Insurance payments.
As of the 2022/23 tax year, the full State Pension level is £185.15 per week, amounting to an annual income of £9,627.80. The State Pension is paid every four weeks and increases each year.
The State Pension is usually taken alongside at least one of the other pension options we've discussed. However, it's worth remembering that pension income is taxed if it's above the income threshold (currently £12,570 per year), so the State Pension won't be taxed but income that takes an individual above the threshold will be.
It's important to note that the State Pension is not paid automatically when a person reaches the State Pension age.
Instead, they will receive a letter inviting them to fill in a claim form. If a person does not receive a letter by the time they reach the State Pension age, they can still make a claim.
Pensions can be complicated and it can be difficult to understand what options there are when looking at pension schemes.
There are a few basic things to note:
- The State Pension is paid to anyone with more than 10 years of National Insurance contributions, although 35 years are required for the full amount.
- All employers are required to auto-enrol employees in a workplace pension unless the employee opts out.
- These workplace pensions are most likely to be defined contribution schemes that build up a pension pot through investments.
- Personal pension schemes can be used to supplement workplace schemes or for the self-employed or those in irregular employment.
- There are different arrangements for serving members of the Armed Forces.
So, most people will be looking at combining a State Pension with a workplace pension or personal pension.
However, when searching for the right personal pension scheme, it's important to understand the fees, charges and risks involved. Speaking to a financial adviser before taking out a SIPP, for example, is crucial.
As with all financial products, be aware of scams and mis-selling. If a scheme seems too good to be true, it probably is.