If you’ve come to this page at random you may want to start with Easy Pensions.

The Pension Scene

The word ‘pension’ can be used in two ways. Either as a general reference to your income after you retire; or specifically to a ‘pension plan’ – a pension paid from a fund established for that purpose under rules specified by law.

This page is about ‘pension plans’ and SIPPs (Self-Invested Pension Plans). But the single word ‘pension’ may occasionally be used in a general sense.

Pension plans have three important binary characteristics:

•         They are either ‘defined benefit’ or ‘defined contribution’

•         They are either ‘workplace’ or ‘non-workplace’

•         They are either ‘stakeholder’ or ‘non-stakeholder’

‘Defined benefit’ means you contribute to a fund in exchange for a defined outcome (for example ‘two-thirds final salary’ - common in corporate schemes. ‘Defined contribution’ means your benefits depend on the investment performance of that fund. It is also possible to find combinations of the two  - called ‘hybrid’ or ‘cash balance’ schemes.

‘Workplace pension’ means your pension is arranged by your employer (who usually contributes also). Workplace pensions may be one of two types: either a choice of general third-party pension plans to which both you and your employer will contribute; or an ‘occupational pension scheme’, usually with a separate fund, in which only company employees participate.

The rules for ‘occupational pension schemes’ are different from the generality of pension plans. The latter are called ‘personal pensions’. Each occupational pension scheme has its own unique rules. The rest of this page is about personal pensions.

Finally, personal pensions may also be qualified to be called ‘Stakeholder Pensions’. This means they operate subject to a list of minimum standards defined by law and aimed to make them suitable for the generality of members; something like a ‘value mark’. This was a worthy initiative, but now 20 years old. The cap on charges at 1.5% is much too high by today’s standards. ‘Stakeholder pensions’ are usually chosen by employers.

The State Pension

The simplest pension plan is the state pension. Everybody gets a state pension. It means ‘a regular income paid to you by the state after you reach retirement age’.

It is ‘defined benefit’. Note that this does not mean you know exactly what you are going to get when you retire. It means you will get a pension according to promises made by government, not according to the performance of an identified fund.

In fact there is no fund. The pension is paid entirely out of general government funds.

SIPPs

SIPPs are wrappers that allow you to administer your own pension savings but (as always) subject to rules to prevent exploitation. Think of them like ISAs but with different rules.

Tax

Any government is committed to encouraging you to save for retirement. It prevents you becoming a burden on the state and is a source of long-term investment funds. To encourage you, it offers attractive tax reliefs.

The basic framework is relatively simple. But the execution details are complicated.

All methods are subject to limits to prevent large-sum exploitation of the system.

Basic is that if you pay in to your pension plan or SIPP you receive tax relief at your marginal rate and your fund receives your gross amount topped up by 20%. So if your gross contribution is £1,000 and your top rate of tax is 40% the cost to you is £600 (£1000-£400) and your fund receives £1200 (£1000+£200). In effect your contribution is doubled - your £600 goes to £1200. And that £1200 is invested free of tax until you die.

If your marginal tax rate is 20% instead of 40% your cost is £800 (£1000-£200), the fund still receives £1200 and you contribution has been upped by 50%. plus you’ll get extra benefit in later years as you marginal rate moves up to 40%

Workplace Pensions

If you are an employee your employer must offer a workplace pension in the form of a personal pension plan. This may include a contribution from your employer (minimum 3% as at 2024). It may also be delivered by a process called ‘salary sacrifice’ under which your employer reduces your salary by a certain amount, but instead pays it tax free into your fund. This also saves national insurance both for you and your employer.

What you can and cannot do depends on the chosen administrative methods of your employer. The two methods are described as ‘net pay’ and ‘relief at source’. The former can be disadvantageous to low-tax payers.

Make sure you understand the terms of your employer’s plan. Participation will be voluntary, but we suggest that non-participation would only make sense if it would otherwise drive you into debt. There may be consequences for other salary-related benefits (because your salary will be lower).

Lump sums

As you approach retirement you may be allowed to withdraw a proportion of your savings within a pension plan tax free. Currently (2024) this applies from age 55 and the proportion is 25%. This is a major concession, but whether it is right for you is enormously dependent on your personal financial situation, your plans for the future, your life expectation and your attitude to risk. Start prepairing for this decision at age 50.

…..but the rules may change

Pension regulation is a fertile source of government fiddling. You should check on the latest rules at gov.uk.

Sum-up

The objective: to prepare yourself financially for retirement.

The process: the same as for your money management generally: review, discuss, implement, repeat.

The decisions you are making are:

• mostly irreversible - once your money goes into a pension fund you can’t get it out again until you retire, except in special circumstances and under the lump sum concession;

• affecting your whole life - maybe another 60 years;

• dependent on a whole load of future parameters of return and uncertainty;

• with an additional factor not generally present in money management - uncertain life expectancy, of both you and your loved ones.