Pensions, how do they work?

Pensions, How Do They Work?

Your pension scheme is one of the most important investments of your life. A pension is quite probably the most valuable investment you have after your home; so you really can’t afford to leave too much to chance when your future income and lifestyle is at stake.

Learn the basics about the three types of pension – state pension, workplace pensions and personal pensions – and how they work.

What is a pension? 

A pension is a way of saving for when you reach retirement age. The UK pension age is gradually increasing and will reach 67 by 2028.

You put money into your pension each month and, in return, you get a regular income once you’ve retired. You don’t have to pay tax on pension contributions, which is one of the reasons saving into a pension can be more effective than saving in other ways. 

There are three types of pension – state pension, workplace pensions and personal pensions. All three types are available to everyone, as long as you are in employment.

What is the state pension? 

When people reach their state pension age they will receive an income from the state, called the state pension.  To claim the state pension you have to have made National Insurance (NI) contributions throughout your working life.

What is a workplace pension? 

The state pension will not be able to provide enough income for your retirement, so most people take out a pension with their employer to top it up. Workplace pensions take contributions from you, your employer and the government, and use them to provide you with a pension when you retire. You will pay a percentage from your salary each month, and your employer’s contribution will also be a percentage of your pay.  

The fact that your employer pays into your workplace pension is one good reason for having one – it is like extra pay. There are two types of workplace pension – defined benefit and defined contribution.

Defined contribution workplace pension schemes 

Also known as money purchase or DC schemes, defined contribution schemes work by your employer selecting a pension provider who will invest the money you pay in. Many schemes operate what is known as a glidepath, moving your money into lower-risk investments as you near retirement so that you can maximise your income. The amount you get at retirement will depend on: the administration fees charged by the provider how much has been paid in how long you’ve been paying in for how well the investment has performed.

Defined benefit workplace pension schemes 

Also known as final salary schemes, defined benefit pension schemes are being phased out in favour of defined contribution pensions. This is because they cost more to administer. They work by promising to pay out a certain amount when you retire, based on your salary – unlike DC schemes, which are based on your contributions. How the investments perform won’t affect what you get. People who work in the public sector – such as for the NHS, armed forces or police – tend to be enrolled in final salary schemes. 

What if I haven’t been offered automatic enrolment?

Even if you’re the only employee of a company – other than one you operate alone – and are between the age of 22 and the current state pension age, and you earn over £10,000 a year, your employer is legally bound to offer you automatic enrolment into a contributory pension scheme. Your employer could be breaking pension laws if they haven’t:

  • Offered you a workplace pension if you’re eligible
  • Paid an agreed amount into that scheme
  • Taken pension payouts from staff wages
  • Given you the chance to opt-out of the scheme
  • Ensured that payments start when you reach retirement
  • Honoured due payments to family or dependents of a deceased scheme member

What is a personal pension? 

These work by you paying money into a pension scheme from a provider (selected by you, rather than your employer, unlike a workplace pension) and generally getting a sum at the end with which to buy an annuity or arrange income drawdown, there are some other options available.

An annuity is a type of financial product that gives you retirement income for life. You can learn more about your options for cashing in your pensions in our guide.  Like workplace pensions, personal pensions invest your money with a view to increasing it. Personal pensions are particularly suitable for the self-employed or people who aren’t in work, who don’t have access to workplace pensions. But anyone can save into a personal pension.

Our employment law specialists can help you if you are unsure of your employee rights, we can also provide you with specific advice on pensions.  Whether you are an employer or an employee we can offer expert guidance on this and many other employment law issues. Simply ring our offices in Lisburn or Lurgan and talk to one of our team.