You are not alone if you don’t understand your pension and what it will or may provide you with in retirement.
There are two main types of pensions – Defined Benefit (such as final salary or CARE) and Defined Contribution (such as a personal pension, workplace pension, SIPP).
The income you will receive in retirement from Defined Benefit pensions is directly related to your salary when you worked for the employer who provided that pension. You will receive a proportion of your salary for each year you worked there and were a member of the pension scheme. You may also receive a tax-free lump sum on retirement. In some cases, you can also exchange some income for a larger lump sum. The income you receive in retirement is guaranteed for life and will usually increase with inflation, possibly up to a limit.
The retirement income from Defined Contribution pensions is dependent on the value of the pension pot when you wish to take income from it. Contributions are made by either yourself (with tax relief added) or your employer (paid before tax is deducted) and invested. When you are over 55 (currently, although this is set to increase to 57 in 2028), you can begin to take benefits. You can take 25% tax free, either in one lump sum or with every income payment.
Taking benefits from a DC scheme can either be:
- By buying an annuity, which means that you give the pension pot to a provider in exchange for a guaranteed income for life. It is also possible to take an option of income for your spouse after you die.
- By drawing from the pension pot using drawdown. In this case, the pension money will remain invested and your draw income, which can be changed to suit your lifestyle.