The 3 main types of UK pension, explained
Pension jargon and complex numerical data can make your retirement situation unclear. Return to basics and read this breakdown of 3 main types of UK pension.
At every stage of your adult life, you are likely to have been making some form of pension contribution, hoping that one day you can afford a relaxing retirement.
If this chapter is now approaching, you could be taking your pension contributions and valuations more seriously and actively planning for your retirement. However, once you begin to dig into your pension paperwork, you could feel bowled over by percentages, projections, jargon, and fees.
We’re here to help you break down your situation and gain a clear picture of your retirement options.
Let’s get back to basics – read on to find out the three primary types of UK pension and how they function.
- Defined contribution
Defined contribution (DC) pensions are probably the most common type of private pension in the UK.
If you…
- Have a workplace pension pot that you and your employer pay into each month
- Pay into a self-invested personal pension (SIPP), either if you’re self-employed or have opened a pension in addition to your workplace pot
- Hold several workplace pots from each role you’ve had throughout your life
… These are all likely examples of DC pensions.
How they work
DC pension providers normally invest your money in the stock market on your behalf.
The investments are usually made through pre-set funds and you can often choose your risk level along with selecting the type of fund you want to invest through, such as a sustainable fund. This means that your pension is subject to some risk and the value of your fund can fluctuate right up until you liquidate the assets and take your benefits.
On a more positive note, your pension is invested because this route offers great potential for growth.
When you or a third party pay in, you’ll normally receive 20% tax relief at source – essentially a refund of the Income Tax you paid when earning the money. Plus, if you self-assess, you may be able to claim higher- or additional-rate tax relief, boosting your pot’s value even further.
There is an Annual Allowance that limits how much you can put in each year while still receiving tax relief. For most earners, this stands at £60,000. For very high earners or those already accessing their pensions, the Annual Allowance may be tapered down to a minimum of £10,000.
Ask your financial planner about calculating your personal Annual Allowance if you’re not sure.
Once you retire
You can access your DC pension pot(s) at age 55, rising to 57 in 2028. At this point there are several options, including:
- Purchase an annuity, which “swaps” a portion of your pot for a guaranteed income over a set period
- Draw the entire amount as a lump sum (this is usually inefficient where tax is concerned)
- Enter drawdown and take a flexible income
- Use other sources of income to fund your retirement and keep your pension invested for the next generation.
You can usually withdraw 25% of your pot tax-free, up to £268,275.
As you might know, the remaining 75% is usually subject to Income Tax at your marginal rate if it surpasses the Personal Allowance of £12,570 along with your other income.
For example, imagine that you have already used up your tax-free cash and are drawing from your pension flexibly.
Along with your State Pension payments, in total you’re taking £60,000 a year as retirement income. With your Personal Allowance standing at £12,570, the remaining £47,430 would normally be taxed as income.
After you pass away
Today, your DC pensions don’t count towards your estate for Inheritance Tax (IHT) purposes. So, if you pass away, your beneficiaries could inherit a large pot tax-free.
But as of April 2027, the chancellor has announced that this could change, meaning your pension wealth is likely to be taxed upon your death.
Depending on the age you pass away, your beneficiaries could also pay Income Tax when they draw your unused pension benefits.
Read more: What happens to your pension when you pass away?
- Defined benefit
Highly popular in the 1980s and 90s, defined benefit (DB) pensions are now waning in popularity. In fact, it’s very uncommon for workplaces to offer these schemes today. That said, you could have old DB pensions from previous jobs or still hold one in your current role.
How they work
Often referred to as “final salary pensions” (although DB pensions can also be offered in the form of a “career average” scheme), these pensions give employees a guaranteed income for life. They are usually managed by company trustees.
As with DC pensions, there is a certain level of risk attached to DB pensions. The funds are typically invested in equities, property, and government bonds.
The amount you get is calculated based on how much you earned in the role and how many years you have worked for that employer. This income could form the bedrock of your retirement income, and may be supplemented by DC pots you hold, other savings, and the State Pension.
Once you retire
Normally, the retirement age for DB pensions depends on the scheme, but you can’t usually access it until age 55 or above.
Some schemes give you access to a tax-free lump sum that you could draw upon retirement, using the remaining funds as income. Other schemes don’t offer this – it depends on your company’s policy.
Once you begin to receive your DB pension, you’ll pay Income Tax at your marginal rate, but the payments aren’t subject to National Insurance (NI).
After you pass away
Some schemes stop payments upon a person’s death, while others have provisions in place for immediate family, such as 50% payments made to your spouse.
It’s important to check the exact terms and conditions of your DB pension, as they vary.
- State Pension
The State Pension often forms a substantial part of a person’s retirement income. If you’re eligible and want to claim it, you will receive payments weekly for the rest of your life.
If you are a man born before 6 April 1951, or a woman born before 6 April 1953, you may be able to claim the basic State Pension. If you were born after these dates, yours will be the new State Pension.
The following applies to the new State Pension. If you qualify for the basic State Pension, speak to us about your circumstances.
How it works
When you earn money and make NI contributions (NICs) through HMRC, these payments are entered into your NI record. Each year that you make the minimum number of NICs becomes a “qualifying year”, and once you reach the right age, these are added up to determine how much State Pension you can claim.
The minimum number of qualifying years for the new State Pension is 10, and if you want to claim the full new State Pension, you’ll need to have 35 qualifying years on your NI record. You can learn where you are up to by checking your State Pension forecast online.
The value of the full new State Pension currently rises each year under the government’s triple lock agreement. Each April, it goes up by the higher of:
- Inflation, based on September of the previous year
- 2.5%
- Wage growth.
For example, in 2024/25, the full new State Pension is £221.20 a week.
It’s rising by 4.1% on 6 April 2025, based on the previous year’s wage growth, bringing it to just over £230 a week. If you had fewer than 35 qualifying years on your NI record, your payments would be lower than the full amount.
Unlike DC and DB pensions, the amount you receive doesn’t fluctuate depending on market movements or other factors – it is set by the government.
Once you retire
As of 2024/25, State Pension Age is 66, and it’s likely to continue rising steadily.
If you are ready to start receiving your State Pension once you come of age, you will need to claim it through HMRC – it is not paid automatically.
Alternatively, you can defer your State Pension payments, meaning that once you start receiving the funds your weekly payments will be higher.
Of course, there’s the risk that you will pass away earlier than you’d hoped and won’t have benefited from the State Pension for the maximum amount of time. On the other hand, deferring means you could benefit from more wealth when the time is right for you.
As with other forms of pension income, the State Pension is subject to Income Tax if, in combination with your other income, it breaches the Personal Allowance of £12,570.
After you pass away
State Pension payments normally stop when you pass away. However, in some circumstances, your spouse could inherit some of your State Pension, depending on how many NICs you both made, when you married, and at what age you die.
Work with our team to plan the retirement you deserve
After all your hard work, you deserve a retirement that offers bucket list opportunities, a relaxing lifestyle, and peace of mind for your family.
Our team of experienced financial planners is here to help you manage your pensions and build the big picture of your wealth. Whether you’re decades away from retirement or have already reached this milestone, we can support you.
Email us at hale@kelland.co.uk, or call 0161 929 8838.
Please note
This article is for general information only and does not constitute advice. The information is aimed at retail clients only.
All information is correct at the time of writing and is subject to change in the future.
Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.
A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future performance.
The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates, and tax legislation may change in subsequent Finance Acts.
Workplace pensions are regulated by The Pension Regulator.
Your pension income could also be affected by the interest rates at the time you take your benefits. The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation, and regulation, which are subject to change in the future.