How UK pensions work

The three sources that build a pension

A workplace or personal pension pot grows from three sources, not just your own money:

• Your contributions — what you pay in from your salary.
• Tax relief — the government adds money back, since pension contributions are made before income tax.
• Employer contributions — if you are in a workplace scheme, your employer pays in too.

On top of these, investment growth compounds over time — which is what makes starting early so powerful.

How tax relief works

Pension tax relief means contributions are topped up at your income tax rate. For a basic-rate taxpayer, every £80 you pay in becomes £100 in the pot — the government adds the £20 you would otherwise have paid in tax. Higher and additional-rate taxpayers can claim further relief.

The annual allowance

For 2026/27 the annual allowance is £60,000 — the maximum you can contribute across all pensions in a tax year while still receiving tax relief. You can also only get relief on contributions up to 100% of your earnings. Most people contribute far less than this limit.

Very high earners face a tapered allowance: it reduces by £1 for every £2 of adjusted income over £260,000, down to a minimum of £10,000. If you have already started drawing from a defined contribution pension, a separate £10,000 limit (the Money Purchase Annual Allowance) applies.

Why starting early matters so much

Compound growth rewards time more than amount. Because returns earn returns, money paid in early has decades to grow, while money paid in late has only a few years. The practical effect is dramatic — someone starting at 22 might need around £250/month for a moderate retirement, while someone starting at 45 could need over £1,100/month for the same outcome.

The tax-free lump sum

When you access your pension (currently from age 55, rising to 57 from 2028), you can usually take 25% of your pot as a tax-free lump sum. This is capped at £268,275 for most people. The rest is taxed as income when you draw it.

The State Pension is separate

Your workplace and personal pensions are on top of the State Pension, which is funded by your National Insurance record. The full new State Pension for 2026/27 is around £12,548 a year, and you need 35 qualifying years of NI contributions to receive the full amount. For most people, the State Pension alone is not enough for a comfortable retirement — which is why workplace pensions matter.

Salary sacrifice and pensions

Contributing via salary sacrifice can be more tax-efficient than a standard contribution, because it reduces both income tax and National Insurance. See our salary sacrifice guide for how this works and worked examples.

Try the calculator

Use our pension calculator to project your retirement pot from your monthly contributions, employer top-up, tax relief and expected growth. Adjust the numbers to see how starting earlier or contributing more changes the outcome.

Where to get advice

This guide explains how pensions work but is not financial advice. Pensions are a long-term commitment and the right strategy depends on your circumstances. For personalised retirement planning, consult an FCA-regulated financial adviser.