Wondering how pensions work in the UK? Or perhaps you’re unsure how much you’ll need for retirement. You’ve come to the right place. We asked Clare Seal, financial coach, author and creator of the My Frugal Year Instagram account to take over our blog to talk about all things pensions.

Pensions can be mysterious and confusing in the world of personal finance. Often disregarded as something to ‘worry about later’ until the point at which panic about not having started early enough sets in, they’re a form of saving and investing that can feel invisible and intangible.

There’s an education and mindset shift that needs to happen when it comes to pensions and retirement savings, particularly among younger people. This can be difficult to navigate when incomes are already stretched by high living costs. But being mindful of your pension and taking advantage of the many benefits it can offer with regard to your future financial freedom and security is important at any age or stage of your career. Here are some things you need to consider when it comes to your pension:

How much should I contribute towards my workplace* pension?

The answer to this question is personal to everyone. It depends on many factors from age to affordability. A rule of thumb that you may wish to take into account is that, if you’ve never paid into a pension before, you can take your current age and halve it to give you the percentage of your gross salary that you should contribute to afford a good standard of life in retirement – though don’t worry if this sounds like far too much. It’s just a suggestion and something to base your plans on. This figure also includes any contribution that your employer might make too.

If you’re employed and earn more than £520 per month, your employer must also contribute a minimum of 3% of your salary into a workplace pension for you, with you contributing 5%. Some employers may offer a more generous contribution, and this is something that it’s worth including in your negotiations when moving roles. You can find out more about how employee and employer contributions work here.

How much will I need to save for retirement?

Again, this is personal and will depend on your lifestyle, aspirations for retirement, housing situation and any other investments you might have. However, there are things that you can do to help you to calculate a figure to aim for. Many pension providers have online calculators that you can use to calculate how much you’ll need – and often they’ll give you a suggestion about what to contribute each month. But do take these suggestions with a pinch of salt, as many will assume that you need to keep the same level of income in retirement as you currently have, which is not the case for everyone. For example, if you currently have a mortgage which will be paid off by the time you retire, children to care for or other expenses associated with your life stage to cover, your income requirements may be greatly different when you do eventually stop working.

One way to calculate your retirement pot is to speak to a pension advisor or financial planner. You may also be able to get a good idea of your annual income requirements by thinking about your plans and lifestyle aspirations for retirement and putting together an example of a monthly budget. Also, factor in things like travel plans, and whether you are hoping to downsize in order to release some cash from your home.

Should I consolidate my pensions into one pot?

With so many of us changing jobs every few years, one of the most confusing decisions to make about your pension pots can be whether to keep them all separate or consolidate them into one account. Usually, when you move jobs, your new employer will set you up with a new pension account from scratch. Even if it’s with the same provider, you can end up with lots of little pots in different places throughout the course of your career. This can feel overwhelming and prevent you from being able to see the bigger picture.

Keep hold of your pension details when you change jobs. It could be helpful to take some time every few years to review your pension pots, assess fees and returns, and make a call on whether to consolidate them into one account. You do this by setting up a new private pension or adding them to your current workplace pension scheme. Different pension accounts have different rules about transferring in and out, and some may apply fees for transferring, so make sure that you research thoroughly before making any moves. Consolidating your pensions into one account can really help with planning and give you greater control and visibility over your financial future. It’s important to weigh up the pros and cons based on your own circumstances.

What are the tax benefits of saving into a pension?

You may wonder why we’re encouraged to pay into a workplace or personal pension to save for retirement, rather than other types of investment. The answer to this lies largely in the tax relief that you can benefit from (in addition to that employer contribution). Your pension contributions are tax-free up to either 100% of your annual earnings or £60,000, whichever is higher. You’ll then pay tax when you withdraw money from your pension, after you retire.**

Another benefit is that your workplace pension contributions may be paid as a salary sacrifice, meaning that your payments are deducted from your pre-tax salary. This can lead to a reduction in the tax and National Insurance that you pay on your salary overall, as it reduces your gross pay. If you’re self-employed, paying some of your profits into a pension, rather than taking them as income, can help to reduce your annual self-assessment tax bill. This is something to discuss with your accountant and a specialist pension or tax advisor. There is more information on pensions and tax here.

What if I’m self-employed?

If you’re self-employed, it’s important to make sure that you’re paying into a pension - there’s no auto-enrolment, and self-employed people in the UK are chronically underpensioned. Perhaps this is because there’s so much else to think about when running your own business, pensions get pushed to the bottom of the list. If you operate as a sole trader, setting up a SIPP (Self-Invested Personal Pension) with a provider of your choice, and paying in either a lump sum or monthly amount, is a great place to start. If you operate as a limited company, you may be able to set up a workplace pension through your company – speak to your accountant and/or a tax advisor about the best way to go about this.

When can I withdraw my pension?

The age at which you can start to withdraw funds from your pension, either as your full income or to top up your income if you choose to reduce your hours and semi-retire, is currently 55, rising to 57 in 2028. It may rise further in future, so this is something to check periodically. It’s worth bearing in mind that the earlier you start withdrawing from your pension, the longer the money you’ve saved potentially has to last. So do think carefully about when you’d like to retire. You may be able to withdraw from your pension early due to exceptional circumstances, such as ill health or a disability, but this is at the discretion of individual providers.

You can start claiming your State Pension*, which is set at a statutory amount, from your State Pension age. You can calculate this here, based on your date of birth.

Pensions can feel complex, but they don’t have to be. It might take a little time to sit down and research your options, gather information about existing pots and create a plan for your retirement savings, but every bit of effort and investment you put in now will pay off in the long run.

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* A State Pension and your workplace pension are two different pension schemes. The State Pension is provided by the Government and a workplace pension is provided by your employer. You receive a State Pension income based on your National Insurance contributions. You can receive both the State Pension and a workplace pension once you hit retirement age.

** This information is correct at the time of publishing (June 2023).