Pension information: guide to the basic facts
You may have one or more different types of pension. Understanding which you have is important because it affects the decisions you need to make as you approach retirement.
- What type of pension do I have?
- Your State Pension choices
- Your pension choices if you have a defined benefit pension
- Your pension choices if you have a defined contribution pension
What type of pension do I have?
What is a pension pot?
‘Pension pot’ refers to a type of pension you build up with pension contributions you and/or your employer make. You’ll have one if you have a ‘defined contribution’ pension which includes workplace, personal and stakeholder pension schemes.
There are three main types of pension:
- The State Pension
- Defined benefit pensions
- Defined contribution pensions
Most people get some State Pension. It’s paid by the government and is a secure income for life which increases by at least the rate of inflation each year.
You build up your entitlement to the basic State Pension by making National Insurance contributions during your working life.
In some cases you can do this even when you’re not working, such as when you’re bringing up children or claiming certain benefits.
If you’re an employee who reached their State Pension date before 6 April 2016, you might also qualify for Additional State Pension.
The amount you get is based on your earnings as well as the National Insurance contributions you’ve made or been credited with. The Additional State Pension is paid with your basic State Pension.
If you’ll reach State Pension age on or after 6 April 2016 you’ll get the new State Pension.
The current rate for the full new State Pension is £155.65 per week. The amount you get depends on your National Insurance record.
You’ll usually need at least 10 qualifying years on your national insurance record to qualify.
If you’ve already built up State Pension under the previous system this will be translated into an amount that goes towards your new State Pension.
Defined benefit pension
You’re most likely to have a defined benefit (DB) pension if you work in the public sector or for a large company.
This is a salary-related pension which pays out a secure income for life and increases each year.
The pension you get is based on how long you’ve been a part of the scheme and how much you earn.
You might have a final salary type scheme where your pension is based on your pay when you retire or leave the scheme.
Alternatively you might have a career-average pension where your pension is based on the average of your pay while you were a member of the scheme.
Defined contribution pension
With this type of scheme you build up a pot to pay you a retirement income based on contributions from you and/or your employer and investment returns. Defined contribution (DC) pensions include workplace, personal and stakeholder pension schemes.
DC schemes might be run through an insurance company or master trust provider, or through a bespoke scheme set up by your employer.
The size of your pot depends on how much you and your employer contribute, the charges and how well your investments perform.
Your State Pension choices
You can claim your State Pension once you reach state pension age.
You can also choose to defer it and get more. If you reached State Pension age before 6 April 2016, for every year you defer, your pension is increased by 10.4%.
Alternatively, if you defer for at least a year, you can take the deferred amount as a lump sum.
If you reach State Pension age on or after 6 April 2016, the increase is around 5.8% for every year and can only be taken as income.
Your pension choices if you have a defined benefit pension
Most defined benefit pension schemes have a normal retirement age of 65.
If your scheme allows, you might be able to take your pension earlier but this will reduce the pension you get quite considerably.
Again depending on your scheme, you might be able to defer taking your pension and this might mean you receive a higher income when you do take it.
When you take your pension you’ll usually have to decide whether to take some of it as tax-free cash.
You can take roughly up to a quarter of the value of your pension benefits like this.
Reducing the amount of tax-free cash you take will increase the amount of income you receive.
It is possible to transfer your defined benefit pension to a defined contribution pension which would then allow you to access your pension more flexibly.
However, this is rarely a good idea and you must take financial advice before doing so.
Your pension choices if you have a defined contribution pension
Once you reach 55 (or younger if you’re in poor health) you have complete freedom over what to do with your pension pot.
However, most people will want to continue building it up for some years after this so they have more money in retirement.
To understand the choices for using your pension pot, use Pension Wise – the free and impartial service backed by government.
However, this guidance won’t tell you the best option for you at retirement, only what the options are.
If you want advice about what you should do, talk to a financial adviser.
You can find FCA registered financial advisers who specialise in retirement planning in our Retirement adviser directory.