How do pensions work?

A beginner’s guide to funding your retirement

Sarah Pennells – Virgin Money Living Mentor

by Sarah Pennells | Independent Money Mentor

Founder of SavvyWoman and award-winning journalist


Pension plans are a bit like an episode of Love Island or Game Of Thrones. Okay, so there’s not much in the way of fire-breathing dragons or lilo-based flirtation. But – like the best cult TV – pensions can be very rewarding for those who understand them, and totally baffling for newcomers. Consider this your explainer episode: Everything you wanted to know about pensions but were afraid to ask.

What is a pension?

Rather confusingly, the word ‘pension’ is used to describe both the policy or scheme that you pay money into while you’re working and the payment you get from that scheme when you retire.

A pension isn’t a type of investment, instead it’s a tax-efficient ‘wrapper’ that lets you invest money for your retirement. All pensions have a couple of things in common: they give you a government top-up (called ‘tax relief’) on money you pay in and they lock your money away until you’re 55, so you don't spend it all before you retire.

Workplace pensions

For anyone who’s in employment, workplace pensions appear to be win-win: you pay into the pension and so does your employer. Plus you get the government tax top-up. Despite this, many UK adults are not currently contributing to a pension. To combat this, automatic enrolment has been introduced meaning that as long as you qualify to join, you’ll be automatically enrolled in your company’s pension scheme – although you can opt out if you want to.

Workplace pensions can be defined contribution pensions, where you and your employer save into a pension scheme to provide a pot of money to use at retirement. These pensions are flexible in the options available to you to provide an income from that pension pot at retirement. Alternatively you will have a defined benefit pension scheme, which gives a specified benefits at retirement based on a number of criteria such as earnings and length of time in the scheme.

Personal pensions

If you’re self-employed or not working, you don’t have the option of taking out a workplace pension. Instead you can take out a scheme directly with a pension provider (most let you do this online).

You can pay into your pension regularly every month, make one-off payments whenever you are feeling flush or do a mixture of the two. It might be worth asking a financial adviser to recommend the best personal pension plan for you.

So there you have it: your future sorted, and all in all far less complicated than the politics of Westeros or why Amber chose Jonny over Simon. Pass the remote…

Before making financial decisions always do research, or talk to a financial adviser. Views are those of our mentors and customers and do not constitute financial advice.