What's the deal with Pensions anyway?

Ok, so there’s been a lot of talk about pensions since the budget.
But many people may be thinking "what’s the deal with pensions anyway?" Let me explain:

The government wants you to look after yourself in your retirement.  There's the state pension as a back up, but ultimately they want you to put money aside to fund your retirement.  
The idea is that money put away for your retirement is deferred income.  For this reason the fine fellows at Her Majesty's Revenue and Customs (HMRC) let you off paying tax on the money you save into a pension pot*.  The money invested in your pension pot is then allowed to grow free of taxes** until you get to your chosen retirement date***. Once you decide to receive the money from your pension pot the payments to you are treated as earned income and taxed accordingly****.  

You see simple isn't it!  This is the deal with pensions:

1. Save money into a pension pot and don't pay income tax on the bit you save. 
2. Your pension pot money grows in a tax favoured environment.
3. When you take money out of your pension pot its taxed as income. 

The keen eyed among you may have spotted the small asterix-fest above.  Like all good stories the devil is in the detail (see below).  Some of these rules are due to change over the next year, watch this space!

* Well, they give you tax relief at source up to 20%, which means they add on the tax you've paid to the money going into your pension pot (e.g. £80 contribution becomes £100). If you're a higher or additional rate taxpayer, you have to claim the further 20% or 25% tax relief back via your tax return.  Not all income counts though, it has to be relevant UK income to get tax relief. This typically means income from employment or a trade. You are allowed tax relief on the first £2,880 of contribution even if you don't have relevant UK income (if resident).  There are technically no limits as to how much you can contribute although you can only claim tax relief on 100% of your relevant earnings capped at the annual allowance of £40,000.  Exceeding the annual allowance means you are subject to the annual allowance charge - this effectively means the excess contribution becomes taxable at your highest marginal rate.  Phew!

**You don't pay income tax or capital gains tax on pension pot assets.  Advance corporation tax can no longer be reclaimed thanks to that nice Gordon Brown. You will pay stamp duty when purchasing shares or property and VAT is charged on some fees.  There is a general exemption from inheritance tax on death.  You have pretty good exemption from bankruptcy, you're not safe from divorce though (controversial!?).  

*** Taking your pension pot is called crystallisation.  This happens when you buy an annuity, go into drawdown or take tax-free cash.  There are 11 events in all that crystallise your pension pot and make it potentially liable to tax.  These are called benefit crystallisation events (BCEs to their mates). 

****You can normally have 25% of your pension pot as a tax free lump sum (wahoo!)(occasionally more than 25% if you're lucky - double wahoo!).  The remainder is taxable as earned income.  That is whatever provider pays you the money puts you in the PAYE system (pay as you earn) and pays tax at source based on the tax code they have for you.  You get P60s each year showing how much income tax you've paid.  The government loves rules so much, they made one up called the lifetime allowance.  This means if you have a large amount in your pension (more than £1.25million on 2014/5) then you have to pay extra tax called lifetime allowance charge, this is 25% for income you take and 55% for lump sums. 
Once you've converted (crystallised) your pension pot and gone into drawdown, if you die you have to pay tax at 55% for the lump sum paid to your beneficiaries (other options are available).