Pensions

Overview 

A pension is basically a fund built up over the course of one's working life so that a person has some money to draw on when they cease working; the discussion below relates to the personal and workplace pensions that people actually have in place on a day-to-day basis, not the large institutional pension funds, those which are managed by trustees and professional managers, and which are covered separately elsewhere on this site. 

Defined benefit vs defined contribution 

There are two kinds of workplace pension and the difference between them is more significant than most people realise. 

In the case of a defined benefit (DB) pension, a specific income is guaranteed; this income is usually determined by the individual's salary and the number of years' service in the scheme. If the investments turn out to be poor, that is the employer's problem, not the member's. 

With a defined contribution (DC) pension, no such guarantee is offered: both the employee and the employer contribute money to a fund, which is then invested, and the amount the fund is worth at retirement is all the member can count on. 

DB schemes were previously the norm but have largely stopped taking in new members since the 1990s and 2000s because the obligation to pay a fixed income for the rest of one's life proved to be much more expensive than employers had anticipated. 

Today, the majority of workers are automatically enrolled in DC schemes, and this is the reason why the investment risk which used to rest with the employers has now been quietly passed on to individual savers.

Types

Auto-enrolment was launched in 2012 and mandates that employers must enter those who are 22 years of age or over and have an annual income exceeding £10,000 into a workplace pension, usually a DC scheme, with the contributions being directed to a default fund unless the individual chooses to make a different arrangement. 

A Self-Invested Personal Pension (SIPP) offers more control because the individual has the option to choose their own investments – this is advantageous for the self-employed or for people who would like to be more involved. 

There is also the State Pension, which is an income provided by the government according to a person's National Insurance record and is not drawn from a pension pot; in 2026/27 it will be £241.30 per week when received in full, will require 35 qualifying years and will be paid from the age of 66, the age at which benefits are received rising to 67 by 2028.

Tax treatment 

It is one of the more advantageous tax arrangements since the relief on contributions is obtained immediately; for someone paying at the basic rate, £80 paid directly from their own pocket is equivalent to £100 being added to their pension, up to an annual allowance of £60,000. 

Any growth within the pension is free from tax and, from the age of 55 (57 from 2028), usually up to a quarter can generally be withdrawn tax-free as well, the total being limited to £268,275 and the rest being taxed as income when withdrawn. 

Annuity vs drawdown 

The only two methods available for actually getting the money are through an annuity or by setting up a drawdown. 

In the case of an annuity, either a portion or the entire amount of the fund is provided in return for a guaranteed income for the rest of one's life, the risks connected with investment and with the length of one's life being passed on to the insurance company in exchange for certainty. 

Whereas with a drawdown the fund stays invested and money can be withdrawn as one wishes, so that all the various options are kept but at the same time the saver is left exposed if the markets fall or if the withdrawals become too high. 

Many retirees make use of both methods. 

Regulation 

The FCA looks after providers and advisers, whereas The Pensions Regulator handles workplace schemes and is in charge of ensuring compliance with auto-enrolment, which currently requires that at least 8% of qualifying earnings, taken jointly from both the employer and the employee, be paid into the scheme. It should be noted that nothing stated here is final since the abolition of the Lifetime Allowance in 2024 is an example of this, and therefore the following should be regarded merely as an initial reference and not as financial advice.