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What is a pension and how do I get one?

All you need to know to about the different types of pension, including state pension, personal pension and company pension.


by Michelle McGagh on Feb 01, 2012 at 10:47

What is a pension and how do I get one?

We all know that putting money aside now to pay for your retirement is a smart decision. But what type of pension will work best for you, and how do you go about getting one?

What is a pension?

A pension is a savings plan aimed at building up a pot of money for your retirement. The money is paid in either by you, your employers or a combination of both. Money paid into a pension is topped up by the government as an incentive to encourage you to save.

The money in your pension plan is held by a company, usually an insurance company, which provides you with a range of options over where it is invested (eg, shares, bonds, property or cash).

The aim is for your money to grow as much as possible so that you can buy a pension (or annual income) during your retirement. The earlier you start paying into a pension, the easier it will be to build up a large pot of money and therefore a larger income in retirement. Money can be paid into a pension through a regular amount each month or in one-off lump sums.

Pension types: the state pension

The most well-known pension scheme is that provided by the government: the state pension. However, the cost of providing this benefit is rising as people are living longer in retirement, and the problem is going to get worse. 

A study by charity Age UK predicts that the number of people aged 65 years and older will rise 65% in the next 25 years to over 16.4 million in 2033.

The state pension is provided by the government when you reach the state retirement age. The full state pension is paid to people who meet the National Insurance requirements, and is currently £97.65 per week for a single person and £195.30 per week for married couples.

State pension top-ups

However, people can top up their pensions through government add-ons, such as the state second pension (S2P) and the state earnings-related pension scheme (Serps), which have made the state pension very complex.

urn:INTIMAGE:1261015The government is currently introducing legislation to bring in a £140-per-week flat-rate state pension, sometimes referred to as the universal pension, which is hoped to remove some of the complexity.

Men can take their state pension at age 65, but women have been allowed to take the state pension from 60. However, the government has started a process of equalisation, and from 2018 women will only be able to take the state pension at 65. The state pension age is then set to rise to 66 for both men and women by April 2020.

With the country’s finances stretched to capacity, it's not sensible to rely on the government to fund your retirement. Individuals need to take responsibility for paying for their future. There are two types of private pensions that you can set up by yourself or that your employer may offer:

Defined benefit pension schemes

These pension schemes are run by employers, although they are few and far between nowadays because of the increased cost of running them. This plan pays out a pension which is equal to the number of years worked for a company multiplied by a portion of the employee’s salary at retirement.

Defined benefit schemes are also known as final-salary schemes, as they take into account the employee’s ‘final salary’ before retirement in the calculation of the pension income. These schemes are typically very generous and are distinguished by a set outcome.

Defined contribution pension schemes

This type of pension is the plan most commonly run by employers, many of which have swapped old defined benefit schemes for defined contribution schemes to save money.

Defined contribution pensions, which are also known as money purchase schemes, are paid into by the employer and employee.

Although the amount contributed by the employer, and sometimes the employee, is a set amount of the salary paid, unlike with defined benefit schemes the final income paid in retirement is not guaranteed.

Different types of pension accounts

Personal pension plan (PPP): PPPs are a common type of pension, which are set up by individuals whose employers do not offer a scheme or who want to save more money for retirement outside the workplace scheme.

urn:INTIMAGE:1261016These schemes are run by financial organisations, such as life companies, banks and insurance companies. Money can be invested in regular instalments, for example through a monthly direct debit, or in lump sums.

The company that you give your money to has the task of investing your money based on your risk profile, and will aim to increase your pension pot to give you more income in retirement.

Group personal pension (GPP): A GPP is a collection of personal pension, plans usually set up through an employer. The employer deals with one life company, bank or insurance company to organise the scheme, and each employee is given a personal pension plan within it.

The financial company that sets up the plan will invest the money depending on the specifications of each employee and how much risk they are willing to take. The aim of the investment is to try to increase the pot of money you will have to live on in retirement.

Self-invested personal pension (Sipp): Like personal pension plans, Sipps are set up by individuals but, as the name suggests, the money is invested by the individual instead of the company running the pension. Sipps are for those people confident enough to invest their money in the hope of increasing their pension pot and retirement income.

Read more on our guide to Sipps.

Depending on the provider of the self-invested personal pension, investors can gain access to a much wider range of investments, including access to funds, stocks and shares, investment trusts and commercial property through this DIY pension scheme.

Although savvy investors can increase their pension pot substantially, there is also the risk of losing a lot of money if the investments falter. Some employers offer a group Sipp. These pensions work in the same way as an individual Sipp, with the individual taking responsibility for the investment of their money. The only difference is the employer sets up the scheme and both the employer and employee pays into it, usually a set percentage of salary.

Stakeholder pensions: Stakeholder pensions were introduced as a low-cost alternative to personal pension plans (PPPs) in 1999. These plans work in a similar way to personal pension plans: the individual is responsible for contributing money into the scheme, with a £20 per month minimum, to build up their pension pot and retirement income.

The main difference between stakeholder and personal pension plans is that there is a limit on the annual management charge fund managers can levy – up to 1.5% of the pension fund each year for the first 10 years the product is held and 1% per year after that.

How do I get my money when I retire?

A pension plan will not automatically pay out your money to you annually when you retire; you have to decide how to take the money to best generate an annual income.

urn:INTIMAGE:1261017Annuity: The most common way to take your pension is by buying an annuity. An annuity is essentially an insurance policy, provided by a life company, bank or insurance company. The company pays you a regular income in return for a lump sum (your pension pot).

The life company pays out a level of income based on how long it thinks you will live, taking into account such things as your age, health and even where you live. Annuity rates are linked to gilts and interest rates, both of which have fallen in recent years, meaning you get less income for your money.

Whereas a life insurance pays out if you die too early, an annuity is effectively insurance against living too long, and will pay out until the day you die. Unfortunately, that also means that if you take out an annuity and die a day later the insurer keeps your lump sum.

Income drawdown plans: These plans, also known as unsecured pensions, allow investors much more flexibility and control over how they take their pension. Unlike an annuity that pays out a set income each year, investors are able to reduce and increase the amount they like depending on their circumstances in that year, while leaving the remaining pension pot invested.

Allowing the pension pot to remain invested means investors will benefit from growth in their investments, but also puts their retirement income at risk should the investment go down.

However, those wishing to use income drawdown must have a secure lifetime pension income of at least £20,000 per annum if they wish to take advantage of income drawdown. The secured minimum income can be provided through an annuity, a pension received from a workplace scheme, or money received through the state pension.

What are the tax breaks associated with pensions?

There are two big tax breaks to encourage people to save into a pensions, but ultimately the income your pension providers in retirement will be taxed.

urn:INTIMAGE:1261018Any payments made into a pension attract tax relief, but the type of pension you have affects when you receive the relief. If you pay into an individual pension, the money you put into the pot has already been taxed, so the taxman contributes an amount, depending on what tax bracket you are in, to offset the tax.

For example, a basic-rate taxpayer pays £80 into their pension, the taxman will add a further £20, making the contribution worth £100. Higher-rate taxpayers also automatically receive the 20% tax relief from the taxman, but as they pay 40% income tax are entitled to claim back a further 20%. This extra 20% is not paid back automatically, and must be claimed through a self-assessment form.

If payments are being made into a company pension, the contributions are deducted before tax is taken from your salary, so you automatically receive tax relief at your highest rate of income tax.

There are limits on tax relief for basic- and higher-rate taxpayers. Tax relief is given on the first £50,000 of contributions for the year April 2011-April 2012, the annual allowance, and there is also a lifetime allowance, the amount of tax relief on pension contributions you can claim over your lifetime, of £1.8 million - this will fall to £1.5 million from April 2012.

If you don’t pay any tax on income you are entitled to tax relief on up to £3,600 per year, and no tax relief on contributions after that amount.

Tax-free lump sum

Although you pay no tax when paying into a pension, you will have to pay tax when you take your money out. When you take your benefits at retirement, for example when you buy an annuity, you are entitled to take 25% of your pension pot as a tax-free lump sum.

However, the annual income that you take each year as pension benefit is taxed as income. If you are still working and paying basic rate income tax, you will pay 20% tax on your pension income. Similarly, if you are a higher-rate taxpayer you will pay 40% on you pension income.

Tax breaks for pensioners

Although your pension is taxed, pensioners do benefit from an increased personal allowance, the amount of income that you can take free from tax, at age 65.

Between the ages of 65 and 74 your pension allowance increases. For the tax year 2011/12 it rises from a £7,475 basic allowance to £9.940. For those aged 75 and over the personal allowance increases again to £10,090.

These personal allowance levels are not set in stone, and can be reduced depending on how much income you take in retirement. If you are 65 or over, you can take an income of up to £24,000 before your allowance is reduced.

Over this amount, and up to a limit of £100,000, your personal allowance reduces by £1 for every £2 over the limit you are. For example, if you take an income of £24,500 per year, your personal allowance will be reduced by £250 to £9,690. If you have an income over £100,000 a year your allowance could be reduced to nil irrespective of your age.

How do I set up a pension?

There are two mains way to start saving into a pension: joining a workplace scheme and setting up your own personal pension.

You can set up a personal pension at any time, whether you are employed, self-employed or not working. You can arrange to buy a pension through a life company, insurance company or bank.

A word of warning: if you are going to set up your own pension you should make sure you do not just take the first deal offered by your bank or insurance company. Make sure you shop around to get the best pension product for your needs at the best price.

Use price comparison websites to check the following:

  • What is the return on investment over a set number of years (if the money is ultimately invested by a financial institution rather that the individual)?
  • How many funds and what different types of assets does the pension cover?
  • What is the minimum investment amount?
  • How much does the pension charge in annual fees?

Alternatively, you could use an independent financial adviser (IFA), who can look at the whole of the pensions product market to determine which pension would be the most suitable for you.

Find a qualified IFA in your area with Citywire's Adviser finder tool.


If you are employed but not part of your employer’s pension scheme you will be automatically enrolled (known as auto-enrolment) into the scheme from this year. Each employee who is aged 22 or over but under the state pension age, and earns more than £7,475 per year will be auto-enrolled into their workplace scheme.

The pension you are auto-enrolled into will benefit from contributions made by the employee, the employer and the government. The employee will pay 4% of their gross salary, before tax is paid; the employer will contribute a further 3%; and the government will provide tax relief of 1%.

For example, if you pay £40 into the scheme each month, your employer will contribute £30 and the government will give you tax relief of 1% – equivalent to another £10.

Although everyone will automatically be put into their workplace pension, they can opt out if they choose, although they will have to opt out again every three years. If a company does not have a workplace scheme, employees will be auto-enrolled into the government’s National Employment Savings Trust (Nest).

20 comments so far. Why not have your say?

charles fantham

Feb 06, 2012 at 19:42

what happened to the SSAS - best answer for many many people; need not be intermediated at all

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john dougherty

Feb 16, 2012 at 23:13

why do the ppf not guarentee under 60s pensions a 100%

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Jill Knight

Feb 18, 2012 at 07:50

If you are to receive a married couple's pension do you receive half each into separate accounts or does the male get more? or does it depend on who has paid the most into the scheme? Thanks

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Feb 28, 2012 at 18:12

State Pension for married couples - do both have to be over retirement age to get this?

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Tony Barber

Mar 15, 2012 at 12:34

I believe you both must reach state pension age.

I set up an Aviva PPP (via Cavendish to save on the charges) and a Bestinvest SIPP - should I look to have everything in the same pot or keep the two seperate?

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Kathleen Thomas

Mar 18, 2012 at 17:22

We have currently been offered an enhanced transfer value with Cookson pension scheme. We have been advised to take it and put it into an aviva BlackRock Aquila 50:50 personal pension plan. Can anyone tell me if this suggested pension plan is a good option?

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Apr 02, 2012 at 10:12

"However, those wishing to use income drawdown must have a secure lifetime pension income of at least £20,000 per annum if they wish to take advantage of income drawdown."

Is this correct? My understanding is that anyone with a pension pot greater than £50,000 can go into drawdown but that those who do have a secure income in excess of £20,000 have greater flxibility on what they can draw per annum.

Is the article right or am I, anyone know?

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Apr 02, 2012 at 10:15

"If payments are being made into a company pension, the contributions are deducted before tax is taken from your salary, so you automatically receive tax relief at your highest rate of income tax."

Surely this isn't correct. I'm no longer working but I had to claim my 40% tax relief every year when I was, the tax relief I got through PAYE only amounted to the first 20%.

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Apr 02, 2012 at 10:36

£20,000 is for flexible drawdown only but note you need to have the cover from the point at which you activate the pension. With state pension I will be covered by this but I will not now get that until I'm 66 - so looking at options if I take early retirement, I know there are new plans to allow switching in future but does anyone know the timeframe? My thought would be to start in drawndown and once the state pension kicks in switch to flexible drawdown? HL site has a good calculator for drawdown option

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Apr 02, 2012 at 10:49

The way I read your post is that I am correct. Indeed I'm in a very similar position, I too won't qualify for the flexible drawdown until I start to draw my state pension.

That prompts another issue for me. I qualify for a full state pension having paid stamp for 30 years+ but I also have been contracted in for much of the time and qialify for a second state pension which would boost my state pension to £156. Now the government are saying I'll only get £140 due to the changes they are making.

I think there might be a case in law here. I have based many of my pension decisions on the information the government has supplied me with and now that I am close to retirement they want to move the goalposts, surely that can't be right.

I reckon too that there are many others in the same boat but that they don't know about it because they've never actually asked for a pension statement.

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Apr 02, 2012 at 12:59

Eric I think it is the way things are going to be going from now on - those that saved and prepared are going to pay for others who have not! The mention of £140 flat rate sounds great to everyone on the current pension but for those with extra payments it is going to look very different. I have seen the goalposts moved so many times on the state side I'm doing my own thing - Frustrating I know and no thought given to how much an extra £20 or so a month costs to make up!

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Bill lawson

Jul 06, 2012 at 21:03

I paid good earned income into a government pension scheme for all my working life ,now I am told it was not enough to pay me a decent pension , just what did they do with it apart from making it worth much less. If I had my time over i would not have trusted the goverments to take care of my pension fund they seem uncapable of being fair to the people that worked and paid into the system

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john dougherty

Oct 01, 2012 at 21:41

my nortel pension was cut £40 a month when they went bust .my advise do not take out pension.

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Amarjit Dohil

Nov 22, 2012 at 07:45

Hi, I want to retire when I am 60, I am 48 at the moment and have a private

pension fund invested in a balanced asset portfolio from a selected OBSR rated fund managers. I want to know How should play the next 12 years in terms risk & which type of asset allocation? For example:-

1.From 48 to 53 :- medium high risk.

2. From 53 to 55 :- balanced

3. From 55 to 60:- Income generation


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Spinning Head

Oct 23, 2013 at 16:37

HELP!! 65 years old in 14 months and only just looking at pensions.

Approx 600k in Scottish Widows and my IFA suggests moving it to Standard Life and taking Phased Drawdown which so far appeals to me.

Fisher Investments rep suggests I move to them as SW have under performed over the last 5 and 10 years and I have lost thousands from my portfolio in "hidden charges" He also says that moving to Standard Life (whose "top man" has invested in Fishers and lives in Nottingham??) will be similar to SW.

Also says Hargreaves would be similar. He says FI charges are a lot less than any other company and that nett % increase to my portfolio will be much better with FI. My emotions tell me to stay with my IFA (who I see once in a blue moon and SW are no better ie. they only contact me once a year through a written statement) but the FI rep tells, graphs and talks sense. He has all my info. off SW. Ok it's my decision but am I playing with fire with FI or being soft withSW??

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Always Elysium

May 09, 2014 at 23:25

The wife is denied state pension payout at 60 from 2013 onwards, losing around £40,000 of payout over 6 years.

A mix up has occurred in belief about state pensions. The sole source of payout of state pension is the ring fenced National Insurance Fund that is well in funds, not having needed top up from tax for decades.

As NI is not a tax, government cannot use it for general expenditure.

Women MPs were 'protected from reforms' keeping pension payout at 60 if within 10 years of 60 from 2012. Male MPs kept their pension payout at 65 from 2012.

Much more is lost from the Flat Rate Pension that is not more, but less, and in fact nil state pension for life. Even someone turning 80 after April 2016.

See if your Lady Wife loses most or all of her state pension:

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Feb 13, 2015 at 15:52

Dear All,

is somebody in position to compare HL pensions running costs with other brokers?

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Christopher Duffin

Jan 06, 2017 at 15:09

Your thoughts please.

I am 75 married and retired. Income is just below tax threshold, own flat, and no debts.

Have £70k in growth funds in an ISA.

I am feeling income poor and wonder if I should be moving my investments around from growth to income.

Is it better to stay in growth and spend some of it as I need it, or move away from Growth and into Income stocks and spend the dividends?

If I continue to leave it invested in growth stocks and decide to spend my capital I need to know how long it has got to last.

I googled life expectancy and filled in two actuary forms. The usual, age, height, weight, smoking, drinking, diet, exercise, married/single questions.

You can be sure of one thing never trust an expert.

One said I'd live to be 90 the other said I should have died 5 years ago.

Thank you Chris Duffin

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Jan 06, 2017 at 15:44

Chris, anything you take from your ISA is tax free so you do have a choice, I 'm still a couple of years short of my pension and am starting to move towards income - The difference is with income you know what you're getting and don't have to 'time sales'. With your 70k you should be able to get around 5% without out too much trouble and reasonably security [clearly never guaranteed] and that would give you close to £300 pcm with no tax due and without diluting your capital base

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Alexander Johnston

Oct 08, 2018 at 20:09

A good summary IMO. Only two points I would add. First, try and take out a pension at the earliest possible moment to benefit from compound growth. Note that you can contribute to a Stakeholder for your children and grandchildren from birth to a maximum of 240s pound a month upgraded to 300 a month by the tax uplift.

Second, do not underestimate the State pension. It pays over 8k per year. It is index linked and backed by the Exchequer. In other words it is similar to a gold plated, copper bottomed, platinum topped, jewel encrusted defined benefit scheme.

In recent years even under a Conservative government it is has risen faster than the rate of inflation because of the triple lock. Any Government which tried to abolish it would commit political suicide.

It is not a Ponzi scheme. It's here to stay and backed by the British taxpayer.

It is therefore important that you claim for any missed years which could be added to your pension record in order to obtain the 35 years contribution for the full pension, such as time out to have a baby. You can also pay to obtain added years.

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