Do I have to join a pension scheme?

Updated on 20 April 2017

This short guide aims to give you some basic information on pensions and pension schemes. We cannot advise you as to which type of scheme might be best for you. We cannot advise on whether or not you should pay into a particular pension.

We cannot advise you as to which type of scheme might be best for you. We cannot advise on whether or not you should pay into a particular pension.

What are pensions?

Pensions are a way of helping you to save up to pay for your living costs during retirement.

The UK Government gives tax relief on contributions you pay in to pensions. The idea is to encourage people to provide for their own retirement rather than rely on the state.

Growth on your pension savings is generally free of tax. When pensions are paid out to you they are taxable, but you should be able to take some part of the pension as a tax-free lump sum.

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What is the basic state pension?

The Government pays the basic state pension as a regular payment to eligible people who reached state pension age before 6 April 2016. You can use the calculator on GOV.UK to work out when you will reach state pension age. If you reach state pension age on or after 6 April 2016, you must claim the new state pension.

You must have paid enough National Insurance contributions (NIC) or been credited with them in order to qualify to receive the basic state pension. You will normally pay NIC if you are working. You may be credited with NIC if you are getting certain benefits, for example, certain unemployment, sickness, parental or carer benefits.

The basic state pension is taxable, but it is paid gross, that is, with no tax taken off before you get it. If your income including your basic state pension is less than your tax allowances you will probably not need to pay any tax. If your taxable income, including your basic state pension and any other pensions, is more than your tax allowances you may need to pay some tax.

The maximum basic state pension is £122.30 per week from April 2017. You will need a minimum number of 'qualifying' years of NIC payments or credits to qualify for the full basic state pension. You need a minimum of 30 years. 

If you have paid NIC for fewer than the minimum number of years you need when you reach state pension age, your pension will be less than the maximum basic state pension or you may not get anything at all, depending on how many qualifying years you have.

The amount of basic state pension you receive depends on the number of years you paid National Insurance contributions or were credited with National Insurance credits.

Each qualifying year gives you some state pension – 1/30 of the full basic pension amount. For example, if you have 15 qualifying years, you get 15/30 (50%) of the full amount.

There is more information on the basic state pension, including deferral, in the 'pensioners section' of this website.

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What is the state second pension?

The state second pension only applies to individuals who reached state pension age before 6 April 2016. If you reach state pension age on or after 6 April 2016, see our note below about the new state pension as the new state pension is paid at a flat rate.

Up until 5 April 2016, you were able to build up an extra state pension as well as the basic state pension when you were working.

This extra state pension was previously called the State Earnings Related Pension (SERPs), but is now known as the state second pension or the additional state pension.

The state second pension was based on your NIC record and the level of your earnings.

What is ‘contracting out’?

You could choose to opt out of the state second pension if you joined an employer-operated pension scheme and the scheme itself wass opted out. This was called 'contracting out'. You used to be able to contract out using other private or personal pensions but can no longer do so.

If you were part of an employer contracted-out scheme, you and your employer paid lower NIC to HM Revenue & Customs (HMRC). On retirement, you would then receive a pension from your employer’s pension scheme.

If you contracted out of the state second pension, you will not receive it. If you only contracted out for certain periods, the amount of state second pension you receive will be reduced.

Am I eligible for the state second pension?

The state second pension does not apply to you if you:

  • are self-employed,
  • do not work at all, or
  • are employed but earned less than the lower earnings limit for NIC – £5,824 for 2015/16 (the last tax year of relevance to the state second pension);
  • reach state pension age on or after 6 April 2016

With the move to the new state pension, many people will need to consider the impact on their retirement savings. You should try to understand how much you are likely to get when you retire and what additional savings you might need to make if possible.

You can check how much state pension you are likely to get by going to your ‘personal tax account’ via GOV.UK, or you can request a statement by telephone or post – contact details are also given on GOV.UK

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What is the new state pension?

If you reach state pension age on or after 6 April 2016, you will fall under the flat rate state pension scheme, known as the new state pension. This means that most workers, whether employed or self-employed, will build up entitlement to the same state pension over their working lives.

There is no state second pension for individuals who reach their state pension age after 5 April 2016.

If you reached your state pension age before 6 April 2016, you will keep your entitlement to the basic state pension and state second pension.

If you reach state pension age after 5 April 2016, you will fall under the new state pension scheme. To get the full pension, you will need 35 qualifying years of NIC or NI credits. If you have fewer qualifying years, you will receive a smaller single-tier amount. But you need at least ten qualifying years to get any new state pension at all.

The full new state pension is £159.55 per week for 2017/18.

There is more information on the new state pension in the 'pensioners and tax section' of this website.

You can also find out more about the new state pension on GOV.UK.

How is the state pension age changing?

The state pension age is in the process of increasing to 66 for everyone. You can use the calculator on GOV.UK to find out when you will reach state pension age under the current law.

Note that the state pension age will increase, under the Pensions Act 2014, to 67 between 2026 and 2028, and to 68 between 2044 and 2046 (though the increase to 68 may change).

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What are stakeholder and personal pensions?

A personal pension plan is a way of saving for your retirement. You can set one up yourself and invest in it personally, as opposed to an occupational pension which is generally set up through your workplace. Your employer may offer you access to a group personal pension scheme through your job and may also pay into it. Most employers are now required by law to offer a workplace pension scheme and to automatically enrol eligible employees into it. See 'What is auto-enrolment' below.

A stakeholder pension is a special type of personal pension plan. It is available to both earners and non-earners. The tax rules are no different than those for personal pensions generally, but the scheme has to meet certain other rules, such as low charges.

Even if you do not have any earned income, for example, income from employment or self-employment, you can invest up to £3,600 each tax year in a personal pension. This total includes £720 of tax calculated at 20%, which means you only have to actually pay £2,880. This works out as £3,600 less 20% basic rate tax.

You pay personal pension payments or contributions net of basic rate tax. This means you only pay the net premium of 80%, after 20% basic rate tax, but you are treated as having paid 100%. So if you pay in a contribution of £80, the government pays £20, meaning that £100 goes into your pension pot. More information is given under ‘What tax relief do I get on pension contributions?'

If you are a Scottish taxpayer, see our section on Scottish income tax for information on tax relief on your pension contributions.

You can get a personal pension or stakeholder pension from financial services companies such as insurance companies, bank and building societies. These are known as pension 'providers'.

The pension provider invests the funds in the scheme, to pay your pension when you retire or decide to take money out (though there are restrictions on when you can do so). Depending on the type of investment you may have to pay some charges to the pension provider. The charges will come out of the pension contributions you pay.

When you draw your pension, or take an income, from a personal pension, the provider will pay the income under Pay As You Earn (PAYE), which means they will take tax off any taxable part of the pension. The provider will deduct tax according to your tax code.

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What are retirement annuity schemes?

If you took out a personal pension before 1 July 1988 it would have been called a retirement annuity policy. Quite often these were linked to insurance policies and any payments to the insurance policies were also treated as being pension payments.

Retirement annuity policies are able to pay out larger tax-free lump sums than personal pensions.

Payments to retirement annuity policies are made gross, without any tax taken off. You are still entitled to tax relief, but you need to get the tax relief through your PAYE coding notice or your self assessment tax return.

If you are getting tax relief through your coding notice, the full amount of the payments you are making will be shown in the allowances column of the coding. This means you are setting that amount against your income and only paying tax on the balance.

If you pay your tax through self assessment, for example, because you are self-employed, you must claim the full amount of the payment on the online or paper tax return. You will then get tax relief via your tax calculation for the year in question or you can carry back the payment to be relieved in the previous tax year.

When you draw money out of them, or take an income from them, retirement annuities are paid to you under PAYE, in the same way as wages and personal pensions.

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What are occupational pensions?

An occupational pension, sometimes called a ‘works pension’, is a pension scheme organised by your employer.

Occupational schemes are becoming increasingly rare and many are closed to new joiners. Your employer is more likely nowadays to offer you access to a group personal pension arrangement than to a traditional works pension.

If you are a member of an occupational pension scheme, your employer is likely to contribute. Generally you can make extra payments of your own into the employer’s scheme.

There is more information on occupational pensions in the ‘employed section’ of our website.

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What is a rebate only or appropriate personal pension?

As mentioned in ‘what is the state second pension?’ above, you used to be able to 'contract out' (that is, opt out) of the state second pension, even if you were only paying into a personal pension. If you contracted out using a personal pension scheme, HMRC paid some of your NIC to a personal pension of your choice.

This type of personal pension was called an appropriate personal pension (APP).

The amount of the rebate from HMRC to your APP scheme depended on your age and your earnings.

The HMRC payment was called the minimum contribution and was paid once your earnings were known at the end of the tax year.

If you contracted out of the state second pension and you earned less than a set limit, you also got a top-up to the minimum contribution paid into your APP.

You could also make additional payments of your own to an APP.

Some personal pensions were 'rebate only' which meant that the only money paid into the scheme was the NIC rebate. This type of personal pension was just intended to replace the additional state pension.

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What is auto-enrolment?

Most employers now have to have an 'auto-enrolment' pension scheme. This means that they have to automatically enrol eligible workers into a qualifying pension scheme, if they are not already in one. Workers not automatically enrolled will also be able to opt in to a pension scheme, if they wish.

We have produced an ‘Auto enrolment - worker factsheet’ giving the basics of this type of pension, and more detailed guidance can be found on our page: ‘What is automatic enrolment for employees?

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What are the rules for paying into pensions?

Providing your pension scheme provider agrees, there is no limit on the amount you can put into your pension. The tax relief you can get may be limited, however, and you should remember that once your money has been saved into a pension there are rules on how much you can take out (depending on the type of pension you have) and when you can take it. Heavy penalties can apply if you break these rules, though from 6 April 2015 for personal pensions, these penalties mainly arise only if you try to cash in your pension too early.

You can save in more than one pension scheme at the same time, for example, in both a personal pension and an occupational pension.

What tax relief do I get on pension contributions?

You can get tax relief on contributions of up to 100% of your UK earnings, if you are a UK taxpayer, subject to the 'annual allowance', which is explained below.

If you do not have any earned income or are a non-taxpayer, every £100 of contributions you make will receive a contribution of £25 from HMRC up to a maximum of £3,600 per tax year. This means your maximum net contribution, before the addition of tax relief, is £2,880.

For every £100 you want to put into your pension you only actually need to pay £80 out of your income after tax – the Government pays the remaining £20.

If you pay tax at the 40% higher rate or the 45% additional rate you will also be able to claim an extra 20% or 25% tax relief. You can claim the difference through your self assessment tax return or by making a claim to HMRC by telephone or letter. This is also how you claim relief if you do not get tax relief at source on your pension contributions (for instance, if you pay into a retirement annuity scheme).

If you are a Scottish taxpayer, see our section on Scottish income tax for information on tax relief on your pension contributions.

Example

You are paying £50 per month (£600 each year) to your pension provider. That is treated as being net of basic rate tax. So your pension provider claims back £150 from HMRC, meaning that the total amount going into your pension scheme is £750 per year. (You can check that basic rate tax on £750 is £150 - that is £750 @20%).

Example of relief for higher rate taxpayers

This example shows how relief works for higher rate taxpayers if you pay £50 a month into a personal pension. You will see from the example above that you obtain basic rate tax relief at source, so your gross payment is £750 each year.

In your tax calculation, you then assume that more income is taxed at basic rate – that is, you add the gross pension payment to your basic rate tax band.

If your total income for the year is £50,000, your income tax liability for 2017/18 would be calculated in these two ways, depending on whether or not you had paid £600 net (£750 gross) personal pension contributions (PPC):

  No PPC PPC
Total income £50,000 £50,000
Personal allowance £11,500 £11,500
Taxable income £38,500 £38,500
Tax due    
£33,500 @ 20% £6,700  
£34,250 @ 20%   £6,850
£5,000 @ 40% £2,000  
£4,250 @ 40%   £1,700
Total tax due £8,700 £8,550


You will see that you have obtained a further £150 of tax relief via the second calculation in addition to the £150 tax relief you obtained by paying your contributions net of basic rate tax. So in total you have received tax relief of £300 i.e. 40% tax relief on your pension contribution of £750.

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What are the annual and lifetime allowances?

These allowances should not impact on you if you are on a low income and only have modest pension savings. We mention them here briefly, for completeness.

Annual allowance

There is an annual allowance of up to £40,000 (2017/18 onwards). For those with income exceeding £150,000, the annual allowance is tapered, at a rate of £1 for every £2 of income above £150,000. If the increase in the value of your pension rights or your contributions (including employer contributions) exceeds the annual allowance, there is a tax charge on the excess. But you may have unused allowance from any of the three previous years which can be offset against the excess amount. The tax rate of the annual allowance charge depends on the level of your taxable income.

In order to get full tax relief, the amount you pay in to your pension is restricted to the lower of: 

  • amount of your earnings; or
  • £40,000

But you can always pay the equivalent of £3,600 gross (that is £2,880 net) even if you have no earnings.

If you have taken money out of a pension, the annual allowance drops to £4,000 (from 6 April 2017; prior to that date it was £10,000).

There is more information on the annual allowance on the GOV.UK website.

Lifetime allowance

There is also a lifetime allowance (LTA), which has been set at £1 million for 2017/18. It will be increased in line with inflation from 2018. If your total pension savings exceed this, you may be taxed on any amount over the limit when the pension starts to be paid or in certain other circumstances. This lifetime allowance charge is set at 25% if you take the additional savings as a pension and 55% if you take them as a lump sum.

There is more information on the lifetime allowance on the GOV.UK website.

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When can I take my pension?

When can I get the state pension?

The earliest you can get the basic state pension  or the new state pension is when you reach the state pension age.

You can find out when you will reach the state pension age by using the calculator on the GOV.UK website.

But you can also choose not to claim your state pension immediately and 'defer' it. If you reached state pension age before 6 April 2016, the old state pension rules allowed you to defer then later take either a higher income or a lump sum, depending on how long you left it before claiming. The new state pension rules for those retiring on or after 6 April 2016 only allow you to take a higher income when you stop deferring – you cannot take a lump sum. See our further guidance on state pension deferral.

When can I get my personal pension?

We give detailed information on when and how you can take money out of your personal pension in our ‘pensioner section’. As there is a lot to think about, we suggest you read that guide in full before taking action.  

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Where can I find more information?

Pensions are complicated. If you need detailed advice, the Pensions Advisory Service has an excellent website and a telephone helpline. The Pensions Advisory Service is an independent, non-profit organisation. It provides free information, advice and guidance on company, personal and stakeholder pension schemes.

The government offers a free service, called Pensionwise aimed at peope thinking about taking money out of their pension. This provides basic information on your possible options.

HMRC have a general helpline for individuals, pensioners and employees, which you can phone if your question relates to income tax on your pension.

The calculator on GOV.UK can tell you when you will reach state pension age.

There is more information about the changes to the state pension and the new state pension on GOV.UK .

For information about workplace or occupational pensions and auto-enrolment, read our guide, or go to GOV.UK.

The Pensions Regulator has produced information for individuals on auto enrolment and warnings on pension scams which you may find helpful.

GOV.UK has more information on various types of pensions.

For more information on the annual allowance and lifetime allowance, visit the GOV.UK website.

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