Pension types

Choosing the wrong pension type — or not understanding how yours works — can mean missing out on thousands of pounds in tax relief and employer contributions over a working lifetime. With four distinct pension types available in the UK, each with its own rules on contributions, growth and access, knowing which applies to you is the first step to building a retirement pot that actually works in your favour.

Before you begin to plan for retirement, it is important to know the different pension types. The UK has four main pension types. These are state, occupational, personal and civil service. 

State pension

The UK government provides state pensions to eligible citizens once they reach a certain age. To be eligible, you need to build up qualifying years. Usually by making National Insurance contributions. The state pension pays for the rest of your life. 

Occupation pension schemes & group personal pension schemes

Under the Pensions Act 2008, employers must enrol their employees in a pension scheme. You and your employer contribute. The government boosts your contributions through tax relief. 

Occupational pension schemes come in two distinct types:

1. Defined benefits are also called final salary pension schemes
   
2. Defined contribution 
   
   

Defined benefit pension schemes are still widely used in the civil service. They work in very different ways.

Defined benefit schemes work differently. Your employer’s pensions scheme agrees to pay you a fixed income from retirement for as long as you live. The size of the income depends on several factors:

• Your salary when you leave your job (or your average salary over employment)
• How long have you worked there as a member of the pension scheme?
• The pension scheme accrual rate
  
  

The defined contribution scheme is the most common pension these days.

Defined contribution schemes allow you to build up your pension pot. Through payments from your income. It is then invested in various funds to deliver long-term growth. Both occupational schemes and group personal pension schemes can operate as defined contribution schemes.

Your pension pot size at retirement will vary depending on performance. At retirement, you can use the money to acquire a pension product e.g., annuity or drawdown scheme. Most workplace and all personal pension schemes work this way. 

Personal pension schemes 

You can also take out a personal pension yourself. Several pension types of personal pensions exist, but they are all defined contributions. You also receive tax relief on a personal pension. The main differences between a workplace pension and a personal pension are:

• You don’t receive employer contributions
• You can take contribution holidays where you don’t pay into your pension 
  
  

What is pension tax relief? 

Tax relief is the most significant advantage that pensions have over other investments. The government gives you back the tax you paid. This amounts to a boost of at least 20 per cent on every pension contribution. So every £1 you pay becomes £1.20 instantly. You can even claim even more tax relief through your self-assessment if you are a higher-rate taxpayer.

How to set up a pension? 

If you’re an employee, your employer must enrol you automatically. If you are self-employed, you can set up your pensions. The sooner you set up your retirement, the more you can save. 

Hopefully, this explains the different pension types in the UK. It is always best to seek advice from a financial advisor about the pension types. We have lots of qualified advisors to choose from at Regulated Advice.