If you are in your early twenties and someone mentions pensions, your eyes glaze over. I know. My daughters’ eyes glaze over too. Pensions are something for old people, right? A problem for future you.
Here is the thing about future you: future you is going to be furious with present you if present you ignores this. Because a pension is not a boring savings product for retirement. It is a tax-free investment account where your employer gives you free money, the government tops it up with tax relief, and compound interest does the rest. There is nothing else in personal finance that stacks the deck this heavily in your favour, and ignoring it in your twenties is one of the most expensive mistakes you can make.
What a Pension Actually Is
Strip away the jargon and a pension is just an investment account with special tax treatment. You put money in, it gets invested (usually in a mix of shares and bonds), it grows over time, and you can access it from age 57 (rising to 57 for most people currently in their twenties, from the current minimum of 55).
The “special tax treatment” is the part that matters:
Tax relief on contributions. When you put money into a pension, the government adds back the income tax you paid on that money. If you are a basic-rate taxpayer (20%), every £80 you contribute becomes £100 in your pension. If you are a higher-rate taxpayer (40%), the effective cost of a £100 pension contribution is £60. There is no other savings product that gives you an immediate 25% or 67% bonus just for participating.
Tax-free growth. Everything inside the pension grows without any tax on gains, dividends, or interest. Same as an ISA in this respect.
Tax-free lump sum at retirement. When you eventually access your pension, you can take 25% of the pot as a tax-free lump sum. The remainder is taxed as income when you withdraw it, but by that point you may well be in a lower tax band than during your working years.
Your Workplace Pension
If you are employed, aged 22 or over, and earn at least £10,000 a year, your employer must auto-enrol you into a workplace pension. The minimum contributions are:
You: 5% of qualifying earnings (4% from your pay + 1% tax relief)
Your employer: 3% of qualifying earnings
“Qualifying earnings” means the portion of your salary between £6,240 and £50,270 (2025/26 figures). So on a £30,000 salary, your qualifying earnings are £23,760, and the combined 8% contribution puts £1,901 per year into your pension — of which £713 comes from your employer and £238 comes from tax relief. You only actually pay £950 from your take-home.
Let me repeat that. You pay £950 and £1,901 goes into your pension. That is a 100% return before any investment growth. Where else does that happen?
Why Opting Out Is a Terrible Idea
You can opt out of your workplace pension. Some young people do, usually because the monthly deduction feels painful when money is tight. I understand the impulse, but let me show you what it costs.
Suppose you opt out from age 22 to 28 (six years) because you want the extra cash in your pay packet. On a £28,000 salary, opting out gives you roughly £75 more per month in take-home pay. Over six years, that is about £5,400 in extra spending money.
Now here is what you gave up. Your pension contributions plus your employer’s contributions plus tax relief over those six years would have totalled roughly £11,400 in your pension pot. Invested over the next 37 years until you reach 65, at an average 7% return, that £11,400 grows to approximately £140,000.
You gained £5,400 in spending money over six years. You lost approximately £140,000 in retirement wealth. That is the cost of opting out for six years. Every month you are not enrolled, your employer’s 3% contribution vanishes. It is not saved for you. It is not added to your salary. It simply does not exist. Opting out of your workplace pension is accepting a pay cut.
The Power of Starting Early (Again)
I covered this in the Time — The Money Superpower eBook, but it bears repeating in the pension context specifically, because the numbers are even more dramatic when employer contributions and tax relief are included.
Starting at 22 with the standard 8% combined contribution on a £28,000 salary (growing with inflation): estimated pension pot at 65 of roughly £310,000 to £380,000.
Starting at 32 with the same contribution rate on the same salary: estimated pot at 65 of roughly £150,000 to £190,000.
Same salary. Same percentage. Ten years of delay roughly halves the outcome. The early years of pension contributions are disproportionately valuable because they have the longest to compound.
The Auto-Enrolment Problem
The standard 8% auto-enrolment contribution is better than nothing, but it is widely regarded as insufficient for a comfortable retirement.
The Pensions and Lifetime Savings Association defines three retirement living standards:
Minimum: £14,400 per year after tax (covers basic needs, limited leisure)
Moderate: £31,300 per year after tax (reasonable comfort, annual holiday in Europe, occasional meals out)
Comfortable: £43,100 per year after tax (financial freedom, regular holidays, new car every five years)
The full new state pension is approximately £11,500 per year. So your private pension needs to generate about £27,000 per year (before tax) just to reach the “moderate” standard when added to the state pension.
A £300,000 pot, using the standard 4% drawdown rule, generates about £12,000 per year. Combined with the state pension, that is roughly £23,500 pre-tax— short of “moderate” and a long way from “comfortable.”
If you want a moderate-to-comfortable retirement, the consensus among pension experts is that total contributions (yours plus employer’s) should be closer to 12 to 15% of salary rather than 8%. If your employer offers to match additional contributions, take advantage of it. Even an extra 1 to 2% from you, matched by your employer, shifts the trajectory significantly.
Types of Pension
Defined contribution (DC): This is what most people have. You and your employer put money in, it gets invested, and whatever the pot is worth when you retire is what you have. The investment risk is on you. Most workplace pensions for private sector employees are DC.
Defined benefit (DB): Sometimes called a “final salary” pension. Your employer promises to pay you a specific income in retirement, usually based on your salary and years of service. The investment risk is on the employer. These are now rare in the private sector but still exist in the public sector (NHS, teachers, civil service, police, armed forces). If you have access to a DB pension, it is almost certainly the most valuable benefit you receive. Do not opt out.
Self-Invested Personal Pension (SIPP): A pension you open and manage yourself, with full choice over investments. Useful for self-employed people, freelancers, or anyone who wants more control than a workplace pension offers. You still get tax relief on contributions. Platforms like Vanguard, AJ Bell, and Interactive Investor all offer SIPPs.
Accessing Your Pension
You can currently access your pension from age 55 (rising to 57 by 2028). When you reach that age, you have several options:
Take 25% as a tax-free lump sum and leave the rest invested
Drawdown: withdraw money as you need it, paying income tax on withdrawals
Buy an annuity: convert your pot into a guaranteed income for life
Combination: mix of the above
The rules around pension access are complex and it is one area where professional financial advice (from an FCA-regulated adviser) is genuinely worth paying for when the time comes.
What to Do Now
If you are employed: Check that you are enrolled in your workplace pension. If you opted out, opt back in. Check what your employer contributes and whether they will match additional contributions.
If you are self-employed or freelance: Open a SIPP. You do not get employer contributions, but you still get tax relief. Even small regular contributions, invested over decades, will make a significant difference.
If you have old pensions from previous jobs: Track them down using the government’s Pension Tracing Service (gov.uk/find-pension-contact-details). Consider consolidating them into a single SIPP to reduce fees and make management simpler. Check the fees on the old pensions — some older schemes charge 1 to 2% per year, which is far too high.
Whatever your situation: Do not ignore pensions because retirement feels abstract. The maths does not care whether you find it boring. It works whether you watch it or not, and it works dramatically better the earlier you start.
The Money Sorted book covers pensions in full detail, including the state pension, pension tax relief, and how to build a retirement plan at every life stage.
This article is part of the Money Sorted series on moneysorted.money. For more on pensions, investing, and long-term financial planning, explore the full range of articles, courses, and eBooks.