A guide to workplace pensions

To receive the full UK state pension, which is currently £11,502 per year based on the 2024/25 tax year, you will need to have paid 35 years of national insurance contributions.

Most of us will need more than that to live on in our retirement, so will be wanting to capitalise on other opportunities to have a more financially comfortable lifestyle.

For PAYE employees, a workplace pension can be an effective way to achieve that.

In this article, our expert team of financial advisers at PIL Southampton explains how workplace pensions work.

What is a workplace pension?

A workplace pension is a pension scheme set up by an employer. Both they and you pay contributions into it, to help you to build your retirement pot. These schemes are also sometimes referred to as work-based, occupational or company pensions.

All employers are legally obliged to offer a workplace pension, known as automatic enrolment, if their employees are at least 22 years of age and younger than State pension age, earn at least £10,000 per annum and are a classified as a worker.

There are two types of workplace pensions – defined benefit pensions and defined contribution pensions. There is also a group of pensions between these two categories, called ‘hybrid’ or ‘cash balance’.

How does a workplace pension work?

Your employer enrols you into their pension scheme if you are eligible. They make contributions to the scheme on your behalf, and so do you. Your employer has a responsibility to give you information about the scheme, including contribution amounts.

You can opt out of (leave) the scheme if you want to, and you will have the opportunity to opt back in at regular intervals if you are still eligible.

Defined contribution pensions

This is the most common type of workplace pension. With a defined contribution pension, a percentage of your pay is automatically paid into your pension scheme every time you get paid.

In this way, you build up a pot of money that you can then draw down as a regular income when you retire.

Usually, your employer will also contribute to your pension scheme each pay day too.

Defined benefit pensions and benefits

This type of workplace pension is generally only available in the public sector, or in older workplace pension schemes. It pays a retirement income that’s based on your salary, and it also takes into account how long you have been a member of the scheme. There is no direct link between your pension benefits, the value of your and your employer’s contributions or any investment gains that may have been made, if applicable.

It will usually be referred to as either a ‘final salary’ or a ‘career average’ scheme. These types of pensions come with guarantees that are not available from most defined contribution plans.

In most cases, you and your employer make contributions to your defined benefit pension scheme each time you get paid. These regular payments ensure that you receive the predicted income when you retire.

Opting out equals missing out

If your employer is providing a pension scheme that it is contributing into for your benefit, choosing to opt out is turning down free money.

It is also worth noting that a £20 contribution is only costing the policy holder £16; the government pays the additional £4. This is tax relief at the basic rate (more on that later).

So, unless you really can’t afford to contribute anything to your pension scheme for any reason, it makes sound financial sense to join.

Pension tax relief

In most circumstances, an employee earning more than the standard personal tax allowance (£12,570 in the 2024/25 tax year) will receive tax relief on their pension contributions. This is the government’s incentive to help you to save for your retirement.

Check with your employer if you need to take any action to claim all the tax relief you’re entitled to.

Regardless of your level of pay, if your workplace pension scheme operates a ‘relief at source’ policy you will receive basic tax relief (20% in the 2024/25 tax year) on your pension contributions.

Higher rate taxpayers can get up to 40% tax relief, so a £10,000 pension contribution could only cost you £6,000. Additional rate taxpayers can get up to 45% tax relief. 

Note: these tax reliefs only apply if you are paying income tax at these higher rates.

Salary sacrifice

A salary sacrifice scheme is where you and your employer agree that you can give up (sacrifice) part of your salary in exchange for non-cash benefits.

Most commonly, this will take the form of additional pension contributions, but it could also be something like a company car or childcare vouchers.

Although, technically, the employer is increasing their contribution into your pension, they are actually your contributions because they’re ‘taken’ from your salary.

The benefit to you of increasing your pension contributions in this way, is that it reduces your gross (pre-tax) salary, which means you’ll pay less income tax and National Insurance. Your employer will also pay less National Insurance.

However, it is important to note that it will also reduce the amount you can borrow if you are looking to buy a property. 

Auto-enrolment

Automatic enrolment is a key duty of an employer. They must make arrangements to enable their eligible employees to become active members of an automatic enrolment pension date.

The employer must automatically enrol every eligible employee from the automatic enrolment date, or the end of the postponement period if the employee has chosen to postpone.

Exceptions to this rule are if the employee 1) is already an active member of a qualifying scheme with that employer or 2) meets any of their exemption conditions.

How do I pay into my pension?

Your contributions will be automatically paid into your pension scheme before you get your take-home pay. If you would like to increase your payments or add one-off payments, you can arrange this with your company’s pension administrator.

How much can I put into my pension plan?

The government sets a legal minimum which, for the 2024/25 tax year, is 8% of your qualifying earnings – currently £6,240-£50,270 for the 2024/25 tax year. 

Your employee contribution is usually 5% of your qualifying earnings, though most people only pay 4% of their take-home pay as they’ll get tax relief from the government on every contribution. The government recommends that the 8% is made up of a 3% employer contribution, a 4% employee contribution and 1% tax relief.

These calculations may vary from scheme to scheme.

Pension contributions are capped. The annual allowance is one such cap, pensionable earnings are another. You may have to pay additional tax if your total pension contribution from all sources exceeds the pension annual allowance. You are also restricted by the level of your pensionable earnings, typically this is your basic pay.

If you start withdrawing taxable income from one of your pension pots, this reduces the annual allowance. If your pension contributions from all sources exceed this lower allowance you may also have to pay additional tax.

Withdrawing pension money

From the age of 55 (this is rising to 57 in 2028) you can choose to take your money in the way that works best for you. Your options are a guaranteed income, a flexible retirement income or a combination of the two.

You can start withdrawing your pension whilst you’re still working, and the first 25% of your pension can be taken tax-free.

How PIL Southampton can help you 

Our experienced team of investment advisers is here to help you to plan for your retirement. We can scrutinise your finances and work with you to establish how much you can afford to contribute to your workplace pension. 

How you can contact PIL Southampton

You can email us, fill out the contact form on our website or call us on 02380 668407. We look forward to hearing from you.