How pensions work

How personal pensions work

  • You save money for your retirement by giving it to a Pension Provider who invests it. This investing should increase its value significantly over time.
  • To encourage you to save, the Inland Revenue adds further money on to your payments / contributions. This is effectively the amount you’ve already paid in tax on the money you’re saving. (There is a maximum limit to this e.g. you can only save 17.5% of your salary before the age of 35 and so on. See Contribution limits for personal pensions).
  • When you retire you use your Pension Fund to buy a guaranteed income – usually for life. (Normal people would call this their “pension” but it’s actually an annuity). You can take out 25% of your pension fund, there and then, as a tax free lump sum.

Pension Basics Contents

How does a company / occupational pension scheme work

Much the same as personal pensions except they’re organised by the pension saver’s employer. (So they’re not available to the self employed or those whose employers don’t provide one).

There are different contribution limits to personal pensions.

Pension Basics Contents

How does a Stakeholder pension work?

These are the new type of pensions introduced in 2001 by the Labour government.

They work in much the same way as a personal pension except there aren’t any initial up front charges – which were the cause of some much controvesy, when people realised that, say, the first 2 years of their contributions had gone to pay “front-end loaded” charges.

Stakeholders were supposed to be aimed at those on “moderate earnings” i.e. between £9,500 and £21,600 pa. However the take up by this category has been very low and they are seen as a failure in this regard. However they still represent a much better deal than the old style personal pensions.

Ironically they seem to be very popular among the rich, who are using them to save for their children and even elderly parents.

The maximum you can put into a Stakeholder is £3,600 of your gross earnings a year.

Pension Basics Contents

How does the State Pension work?

The State pension is the most complex in Europe and the lowest paying.

There’s much more detail in the section on The State Pension

Pension Basics Contents