Understanding Pensions in the UK: A Simple Guide from BM&Co Accountants

At BM&Co Accountants, we know that planning for retirement can feel overwhelming. Pensions, however, are one of the most effective tools for building financial security later in life. Whether you’re an employee, self-employed, or a company director, understanding how pensions work can help you make informed financial decisions.

In this guide, we’ll walk you through:

• What a pension is and how it works
• The different types of pensions in the UK
• The pros and cons of investing in a pension
• What happens to your pension when you die
• Common FAQs: access, inheritance, and more

What Is a Pension?

A pension is a tax-efficient savings vehicle designed to provide income in retirement. You (and in some cases, your employer and the government) contribute money during your working life. These funds are invested, and when you reach pension age, you can access the pot as a regular income or a lump sum.

The key benefit of pensions is tax relief: the government adds to your contributions, which helps your money grow more efficiently than in a regular savings account. Basic rate taxpayers receive 20% tax relief automatically. Higher and additional rate taxpayers can claim extra relief through Self Assessment (if their scheme uses relief at source). Workplace pensions using net pay arrangements provide full relief at the time of contribution.

Types of Pensions in the UK

There are several kinds of pensions available to UK residents. At BM&Co, we help clients understand the most common types:

1. State Pension

The State Pension is a government benefit paid to individuals who reach State Pension age. To receive the full new State Pension, you’ll need 35 qualifying years of National Insurance contributions. At least 10 years are required to receive any amount. You can check your record and top up shortfalls through voluntary contributions.

• State Pension age: Currently 66 (rising to 67 by 2028, with further increases possible)
• Full amount (2024/25): £113.75 per week (~£5,921 per year)
• Check your eligibility: Check your State Pension forecast

2. Workplace Pension

Employers must enrol eligible staff into a workplace pension under auto-enrolment rules. Contributions are made by both employee and employer.

Two main types exist:

• Defined Contribution (DC): A personal pot is built through regular contributions and investment growth.
• Defined Benefit (DB): A fixed income is paid in retirement based on your salary and years of service (e.g., 1/60th of your final salary per year).

3. Private (or Personal) Pension

A private pension is set up by an individual—ideal for the self-employed or those supplementing a workplace scheme.

• Stakeholder Pension: Simple and low-cost, with flexible terms.
• Self-Invested Personal Pension (SIPP): Offers wider investment choices (funds, shares, commercial property) for experienced investors or those working with an adviser. SIPPs qualify for the same tax relief as other pensions.

Defined Benefit vs Defined Contribution Pensions

Example:

• Defined Benefit: If you earned £45,000 and worked 30 years in a scheme with 1/60th accrual, you may receive £22,500 annually for life.
• Defined Contribution: A pension pot of £300,000 could offer £75,000 tax-free and flexible income or an annuity from the remainder.

Pros and Cons of Investing in a Pension

Pros:

• Tax Relief: 20% added for basic rate taxpayers; higher earners can claim up to 40% or 45% via Self Assessment.
• Employer Contributions: Often provided in workplace schemes.
• Compound Growth: Over time, investment gains can significantly boost your savings.
• 25% Tax-Free Lump Sum: Available when accessing your pension.
• Inheritance Tax Benefits: Pensions are usually outside your estate.

Cons:

• Access Restrictions: You can’t usually access your pension until age 55 (rising to 57 from 2028).
• Investment Risk: Defined contribution pots can fluctuate in value.
• Complexity: Annual allowances and tax rules may require advice.

What Happens If I Die Before Accessing My Pension?

It’s vital to keep your expression of wish form up to date. This ensures your pension passes to the right person.

• Before age 75: Beneficiaries can usually receive the pension tax-free.
• After age 75: Funds may be taxable at the recipient’s marginal income tax rate.

Defined contribution pensions can be inherited as:

• A lump sum
• Flexible income or draw down

Defined benefit schemes may instead offer a dependent’s pension.

More on inheriting pensions from GOV.UK

FAQs from Our Clients

When can I access my pension? From age 55 (rising to 57 in 2028). The State Pension is accessed at State Pension age.

Can I take it all as cash? Yes—but only 25% is tax-free. The rest is taxed as income.

What happens to unused pension funds if I die? They usually pass to beneficiaries. Tax depends on your age at death.

Can I adjust my contributions? Yes. You can pause, lower or increase your contributions.

What is the Annual Allowance? It’s £60,000 for most people (2024/25). Higher earners may have a lower tapered allowance.

What if I exceed the allowance? You may face a tax charge but can sometimes use carry forward from previous years.

How Do Pensions Work? An Example from BM&Co

1. You contribute monthly or lump sum.
2. Tax relief is added by the government.
3. Your pension provider invests the funds.
4. Over time, your pot grows.
5. At retirement, you take 25% tax-free and access the rest as income or annuity.

Example: Contribute £250/month from age 35 to 65 = £90,000. Assuming 5% growth, your pot could grow to ~£200,000. You could take £50,000 tax-free and draw income from the remainder.

Disclaimer: This is an illustration only. Your results will vary depending on circumstances and investment performance.

Final Thoughts from BM&Co Accountants

Understanding pensions is key to building a confident financial future. Whether you’re just starting out, self-employed, or preparing to retire, the earlier you plan, the more options you’ll have.

Start by checking your State Pension forecast, or learn more about private pensions at MoneyHelper. Considering a SIPP? Read more about SIPPs. Interested in tax relief? Check HMRC’s guidance.

Need tailored support? At BM&Co Accountants, we help individuals, directors and small business owners optimise their pension strategy. Get in touch to discuss how to build your retirement savings efficiently and tax-effectively.