Most people will be eligible for some form of state pension when they retire; however, since in most cases, the amount you will be eligible for could be relatively small, the government encourages people to make alternative arrangements for their pension.
To entice people to either join a company pension scheme or establish a pension scheme of their own, the government provides a tax break for pension contributions. Basically all contributions you will make to a pension fund or pension scheme will come out of your pre-tax earnings. However, as with all good things, there is a limit. The limit is determined by the type of pensions scheme you are contributing to and by an annual cap.
You will first need to find out if your personal pension is tax approved by the Inland Revenue. The manager or financial adviser of your scheme should be able to tell you if it is or not. If your personal pension is tax approved, then you will be able earn a range of tax benefits.
First, you will receive tax relief on the contributions you pay into the scheme. For example, for the average wage earner, if you contribute £78 to your pension scheme the government will give you the £22 in taxes you would normally have to pay on that amount, allowing you to contribute £100 to your pension scheme.
Second, the contributions your employer makes on your behalf into the scheme are also tax-free. So is the income growth your pension fund realises during its lifetime. This means that your pension can grow tax-free until your retirement.
And thirdly, when you reach retirement age, part of your pension benefits may be paid out as a tax-free lump sum. This tax-free lump sum can be up to 25% of the value of your pension. The remainder will be paid out in monthly instalments, which will, unfortunately, be liable for income taxes.