Pensions – are you saving enough?

What is a Pension?

A pension is a tax-efficient way of saving money for your retirement.

You might have a workplace pension set up through your employer, but you may also have a personal or private pension that you’ve set up for yourself. It’s possible to save into several different pensions within the same tax year, as long as you stay within your annual limits.

There are broadly two main types of pension schemes:

• Final salary (Defined Benefit Scheme)
  • A final salary pension scheme (or defined benefit schemes) is linked to your salary and based on pay at retirement, as well as the number of years worked. An accrual rate is set by your employer and used to work out the pension amount. For example, an accrual rate of 1/60th means you get 1/60th of your final salary for every year of service. So, if you worked for 45 years, you’d get 45/60ths, or three quarters of your final salary at that company on retirement.

• Money purchase (Defined Contribution Scheme)
  • A money purchase scheme (or defined contribution scheme) is based on the amounts paid into the scheme – by either the employee, or employer, or both – and the way that this money has performed when invested. The income you get from a money purchase scheme depends on when you choose to access your cash, what charges apply and how successfully the money was invested.

Key points to remember:

• To get pension tax relief, your personal pensions contributions can’t be higher than your earnings or £3,600, whichever is greater.
• Your pension contributions are limited by the pension annual allowance (AA) which is £60,000 per annum.

To encourage you to save into your pension, the government also adds money to your pot through pension tax relief.

When you reach the age of 55 (rising to 57 from 2028) you can take the money from your pension as an income, lump-sum, or a combination of both.

What is a State Pension?

The state pension is a regular payment from the government to help with the cost of living in later life. The payments begin when you reach the government’s state pension age (currently 66 years for both men and women, this will gradually increase to 67 from 6 May 2026).

It’s not always easy to know whether your pension(s) will be enough to provide you with the retirement you want. You also need to factor in how much the State Pension will provide you with.

For the 2024-2025 tax year, the full rate State Pension is £221.20 a week (£11,502 per year), but only those who meet two criteria are eligible for the full sum:

1. You must have reached retirement age on or after 6 April 2016.
2. You must have made 35 “qualifying years” of National Insurance contributions.

You accrue one qualifying year for every year you are in work, and you need a minimum of 10 qualifying years to receive the State Pension at all. The proportion of the State Pension you receive is calculated on the number of qualifying years you have between 10 and 35 years.

Do I get tax relief on my pension contributions?

If you’re under 75 you will get tax relief on pension contributions, subject to the limits set out below. Basic rate tax relief of 20% is automatically applied. Higher rate taxpayers can claim a further 20% and additional rate taxpayers a further 25% (remember - this is not automatic and must be claimed).

Example:

A pension contribution of £100 gross will cost a basic rate tax payer £80 net, a higher rate tax payer £60 net and an additional rate tax payer £55 net. This ignores potential relief for national insurance contributions if your employer is using a ‘salary sacrifice’ or ‘salary exchange’ arrangement.

Are pensions taxable?

Typically, up to 25% of the pension can be withdrawn as a tax free lump sum. Anything else drawn from the plan subject to income tax at your marginal rate.

Whilst the pension fund is invested, the funds can enjoy tax free growth.

Are pensions protected?

Many people want to know if their pension would be safe if their employer were to go bust.

This depends on what kind of pension you have, but there are safety nets should the business go into administration - as long as your pension provider is authorised by the Financial Conduct Authority.

Most workplace pensions and self-invested personal pensions (SIPPs) are covered by either the Financial Services Compensation Scheme or the Pension Protection Fund, but there are caps placed on the levels of compensation that are available, so you might not get 100% of your money back.

Is my pension subject to inheritance tax?

Pension pots are not subject to inheritance tax when you die and will be paid out to beneficiaries separate to your estate in the event of your death.

On death before age 75, the pension will be paid to your beneficiaries’ tax free.

After age 75, the beneficiaries can withdraw from the pension subject to income tax at their own marginal rate.

Why are pensions important?

Millions of people aren’t saving nearly enough to give them the standard of living they hope for when they retire. Even if you’re eligible for the full State Pension, this is below what most people say they hope to retire on.

If you fall into this category, you have three choices, you can:

1. Retire later
2. Start saving more
3. Lower your expectations of what you’ll be able to afford in retirement.

Are pensions worth it?

In short – yes!

One of the main benefits, when you pay into a workplace pension or personal pension scheme, you can get money back from the government in the form of tax relief. It’s a way of encouraging you to prepare for your retirement and it effectively amounts to free money, so make the most of it!