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Types of pensions

What are the different types of pensions?

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Written by  Tim Heming
5 min read
Updated: 19 May 2023

Your pension is your way to save for retirement. Find out about the different types of pensions available in the UK in our guide

What is a pension? 

Pensions are a long-term savings plan. Money is built up which you can draw on in later life – usually after you stop working.  

If you’re an employee working for a business or company, you’ll usually contribute to your pension through a workplace pension scheme.  

If you work for yourself or choose to set up a pension outside of your employee pension, then you could start a private pension instead.

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What are the 3 main types of pension?

There are three main types of pension plans:

Defined contribution pension

How does it work? Defined contribution pensions are built up through the contributions you and employer (if it is a workplace scheme) make over the years, plus tax relief added by the Government to pension savings.

What are the main advantages?

  • Tax relief applied automatically, which means a 25% top-up on contributions for basic rate taxpayers 

  • You’re likely to benefit from contributions from your employer if it’s a workplace pension 

  • You can take a lump sum of up to 25% tax-free when you reach 55 (rising to 57 in 2028) 

  • Your pension pot could benefit from growth while invested

What are the risks?

  • If your investments perform poorly, your pension pot might be worth less than expected 

  • You can usually only access your defined contribution pension when you’re 55 or over. This is expected to rise to 57 in 2028.

Defined benefit pension

How does it work? Sometimes called a final salary pension, a defined benefit pension is almost always a workplace pension. The amount you receive is based on how long you worked for the employer and your level of salary.

What are the main advantages?

  • Typically the gold standard in pensions, you have a guaranteed income for life, which may increase each year with inflation 

  • Often comes with other benefits, such as death-in-service or ill-health payouts

What are the risks?

  • A small risk that your pension scheme may collapse if not adequately funded, although the Pension Protection Fund may cover losses

State pension

How does it work? It’s paid to you by the government once you reach the state pension age and the amount you get will depend on your National Insurance contributions over your lifetime. You can find out your state pension age by using the GOV.UK website.

What are the main advantages?

  • As long as you’ve paid at least 10 years national insurance contributions through your working life, you are entitled to a state pension 

  • The new state pension will increase each year in line with average wage growth or the consumer price index

What are the risks?

  • If you haven’t paid national insurance for 35 years or more you may not get the full state pension 

  • Relying on your state pension alone is unlikely to be enough to fund a comfortable retirement 

  • The pension age is slowly increasing, so you may not be able to retire as early as you’d like with just the state pension as income

What are the other types of pension plans?

Workplace pensions

If you’re over the age of 22, work primarily in the UK and earn more than £10,000 a year, you’ll be auto-enrolled into your company’s workplace pension. Most workplace pensions are defined contribution schemes, and your workplace must provide a 3% minimum contribution. You can then determine how much you contribute and you’ll also receive tax relief on top from the government.  

Defined contribution pensions are generally invested in stocks and shares, and the amount you will get back in retirement will depend on the following factors:

  • How long you have saved for   

  • How much you pay into your pension pot  

  • How much, if anything, your employer pays in  

  • How well your investments have performed  

  • What management charges have been taken out of your pot by your pension provider

Often, you'll be able to choose from a range of funds to invest in with varying degrees of risk, however, you should be aware that the value of investments might go down as well as up.

Personal pensions

Personal pensions, also known as private pensions, are pensions set up privately by you rather than by your employer. They’re also usually defined contribution pensions (see above), with government tax relief on any money you pay in.  

Money you pay into your personal pension is put into funds, such as stocks and shares and equity funds, by the pension provider. You can choose the type of funds you invest in, which you often can’t do with workplace pensions. Unlike the State pension, you can also take a lump sum of up to 25% of the value of your pension pot tax-free when you reach 55 (expected to increase to 57 in 2028).

Self-invested personal pensions (SIPPs)

If you feel confident navigating the stock market, you might want to consider a self-invested personal pension, known as a SIPP. These schemes offer a wider and more detailed range of investment options than standard personal pensions. These might include high-risk investments that you have to choose yourself, without advice. 

Many providers will allow you to invest in ethical investments (ESG funds) so you can be sure that your money is going towards companies that align with your values. However, a SIPP involves more hands-on management so you’ll need to keep track of your funds. A SIPP will also typically have higher charges, which can impact on your overall return.

Which type of pension is right for me?

All pensions offer a chance to save money for when you are no longer working, so for most people some form of pension is essential in retirement. 

The type of pension you get will depend on your personal circumstances. While defined benefit pensions are now very rare, it’s still usually the best option to take advantage of your workplace pension scheme if you’re employed. This is because not only is it tax-efficient, but your employer is likely to be obliged to contribute. 

If you’re self-employed and run your own business, a private pension is likely to be your only option. But this has advantages too. It also has tax benefits and is likely to give you more options on where the funds are invested.

Other useful guides

We have a range of guides to help you navigate your pensions decisions:

Find a private pension with our partner Profile Pensions

Setting up a private pension can be quick and simple online, but it's a good idea to take some time to do your research first. Getting expert and impartial advice is a good idea if you're not a confident or experienced investor, although this will come with an added cost.  

We have teamed up with our chosen partner Profile Pensions to help you choose the right private pension plan. They can help you combine your old pensions into one, easy-to-manage plan and they will choose the best investment plan for you, using funds from the whole of the market.  

You will also get a dedicated Pension Adviser to answer any questions. If you need help tracing a lost pension or want them to check for any penalties or benefits, they can also do that for you, for a one-off fee of 1% of your pension value (taken at transfer from your pension pot).

Capital at risk. Past performance is not a guide to future performance. This website does not constitute personal advice. If you are in doubt as to the suitability of an investment please speak to a financial adviser. Prevailing tax rates and reliefs are dependent on your individual circumstances and are subject to change. Ltd is an Introducer Appointed Representative of Profile Pensions, a trading name of Profile Financial Solutions Limited which is authorised and regulated by the Financial Conduct Authority. FCA number 596398. Registered in England & Wales, Company Number 07731925. Registered office address: Norwest Court, Guildhall Street, Preston, PR1 3NU.

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