How does a pension work?
All types of pension could play a part in your retirement. Whether you're enrolled in a workplace pension or a personal one, we'll help explain what they are and how you might be paying into them.
How does a pension work - video transcript
In a nutshell, a pension is a way of saving money for your retirement. You pay into this while you’re working and how much you get back depends on a variety of factors, including; how much you save, how long you save for, and how your investment performs.
There are three types of pension:
- the state pension;
- workplace pensions, and
- and personal pensions.
These generally fall into two main categories – defined contribution or defined benefit.
A defined contribution pension is like a savings plan which you and your employer pay in to, and on retirement, the amount your pension is worth will depend on how much you have saved and how your investment has performed.
A defined benefit pension (or “final salary” pension) pays you an income in retirement which is based on the salary you earned while you were working, rather than the amount of money you’ve paid in.
If you’re working and are eligible, you’ll have been enrolled into a workplace pension. This is a really easy way to save because your employer sets it all up and the money you put in often comes straight from your salary. If you pay in, your employer will pay in and you’ll also get tax relief on your contributions – so money that you would have paid as tax will go into your pension pot instead.
A personal pension is similar to a workplace pension but is something you would have arranged yourself or with the help of a financial adviser. Your pension provider will add tax relief. A personal pension might be a good option for people that are self-employed or need more flexibility.
Your pension is then invested to potentially help it grow. You can either choose the funds your pension is invested in or your employer will do this for you.
You need to be aware that the value of an investment can fall as well as rise and isn’t guaranteed. The final value of your pension pot when it comes to taking benefits may be less than has been paid in.
You can start taking your money when you’re 55 (age 57 from 2028) and it’s yours to do exactly what you like with, but remember, this pot of money needs to last for the whole of your retirement.
Before taking money from a pension, you should consider getting financial advice and make sure you shop around to find the right solution. Pension Wise provides free and impartial government guidance about your defined contribution pension options.
The state pension is paid to you by the government – as long as you’ve made enough qualifying national insurance contributions. When you get your state pension, and how much you’ll receive, can differ from person to person, so it’s worth checking this out on the government’s website.
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