What is a pension?

What is a pension, and how does it work?

Pensions are a popular, tax efficient way of saving money for retirement and old age. You can choose a private pension yourself or pay into a workplace pension.

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What is a pension?

Pensions are a type of saving product that help you save money during your working life to ensure you have an income when you retire.

There are several types of pension you can pay into, depending on your employment.

What is a pension pot?

A pension pot is the term used to describe the amount of money saved in your pension account.

How do pensions work?

As you pay into a pension, the money is put into long-term investments to grow. When you decide to retire, you can normally take a tax-free cash amount and receive the rest as an income.

There are three different types of schemes, and you pay into them in different ways:

• Workplace – The money is paid in by you and your employer
• Private schemes – The money is paid in by you
• State Pension – Dependent on your National Insurance contributions

Workplace and private schemes get tax relief from the government, boosting your savings whilst you work, and you pay tax on the income in retirement.

Some pension schemes guarantee a fixed income, while for others your income is dependent on investment performance and charges.

The State Pension is a regular payment from the government.

What are the benefits of a pension?

There are plenty of benefits to having a pension, including:

• Receive a regular income when you stop working
• Easy way of saving for retirement
• Help to maintain your standard of living in later life
• Tax-efficient way of saving
• Free money from employers
• Investment growth is likely to better than keeping your savings in cash
• You can usually take up to 25% of your pot as tax-free cash.

Pensions and tax allowance

Pensions provide several tax-saving incentives:

• Income tax relief 
  For every £80 contributed to a pension, the government adds £20 in tax relief, making the total contribution £100. Those paying tax at higher than the basic rate can get additional tax relief by applying to HM Revenue & Customs (HMRC). For info please see Tax on your private pension contributions: Tax relief – GOV.UK.
  
  
• National insurance (NI) savings (salary sacrifice)
  When you join a workplace pension through salary sacrifice, both you and your employer pay less in NI. This is because you’re agreeing with your employer to be paid less if they move that money into your pension, and you’ll be receiving less taxable income.
  
  
• Tax-free investment growth
  Pensions are excluded from capital gains tax, unlike other investments, such as a general investment account, or buying property that will not be your main home.
  
  
• 25% tax-free lump sum
  From age 55 (57 from 2028), you can usually take up to 25% of your pensions as a one-off cash payment. The tax-free part is limited to £268,275, after which you may be liable for tax.
  
  
• Standard annual allowance
  For the 2025/26 tax year, you can save up to £60,000 across all your pensions before paying income tax on your pension pots. You may be able to carry forward unused annual allowances from the three previous tax years. However, if you take a lump sum out of your pension this allowance comes down to £10,000.
  
  
• Inheritance tax
  Pensions are typically paid tax-free to beneficiaries, but this is changing on 6 April 2027. See our dedicated inheritance tax page for more details.

How much do I need for my retirement?

How much you need to save all depends on the lifestyle you want during your retirement. While working, you also need to consider how much you can afford to save, any other savings goals, household needs, health and your overall personal circumstances.

You can use our helpful retirement planner to get a better understanding of how you can achieve the retirement you want.

When can I take my pension money out?

Typical pensions allow you to access your pot when you turn 55 (rising to 57 from April 6, 2028). However, there are exceptions, including early retirement due to serious ill health and your policy having a protected pension age. You can check these details with your provider.

Learn how to withdraw from your People’s Pension.