It is never too early to start thinking about your pension. It may seem like something not worth the worry until you are at least into your 50s but that would be a big mistake.

First of all, the earlier you start to build up your pension fund the better your income should be in retirement. It makes sense. The more you have put into your fund the more you can expect to get out of it in the future.

Next, there are significant tax advantages if you make contributions to an approved pension fund. This means that the real cost of the contribution will be less than the amount you put in, making it a tax-effective way to save.

Finally, it is important to make some provision for your retirement if you want to avoid a dramatic drop in your standard of living.

What you should do about providing yourself with a pension depends largely on your work status. The main categories for pension purposes are: self-employed, employees, and directors of a company owing 5 per cent of the shares or more (called a proprietary director). Changes expected in the imminent Pensions Bill should simplify the pensions area and introduce more flexible and accessible personal retirement savings accounts.

Self Employed: A self-employed person, who does not run their business through a company and is taxed under the self-assessment system, can set up a personal pension plan. Under this plan, they can make contributions and get tax relief on these contributions within defined limits. When they retire, they should have a fund in place that will provide them with an income.

Personal pension plans are offered by or through a range of companies, such as life assurers, bank assurers, brokers, tied agents and financial consultants. The prospective pension customer could approach a number of these sources and check out what they are offering. It is important to try to get impartial advice because the maturity values, or what is available for the fund-holder after years of saving, can vary dramatically between funds. The pension customer could try to seek out an independent broker or consultant - a broker that has agencies with all of the insurers and not just with two or three. They should ask the broker or consultant to act for them on a fee basis. The income for brokers and agents comes from commission paid by the assurers whose products they sell and/or from fees paid by customers. Different products can pay different commission. Where a customer asks the broker/agent to act on a fee basis, it removes the issue of commission from the equation and should ensure that the product recommended is the one best suited to the customer's circumstances.

With the fund set up the customer has to decide how much they want or can afford to put in. The amount put in and the performance of the fund - broadly investment returns less charges - will dictate the benefit available at retirement. But there are limits on the amount of contributions that qualify for tax relief (see table) and there is an earnings cap of £200,000 (€253,947) on the amount of salary that can be used to calculate payments into a fund in any one year.

The tax relief available is at the taxpayer's marginal rate. It means that, if you earn £40,000 and put £5,000 into your fund you will pay tax on £35,000, compared with tax on £40,000 if you hadn't made any contribution. It means the real cost of a £5,000 contribution after income tax would be £2,800 after tax relief at the top 44 per cent rate, an effective saving of £2,200.

On retirement the pension fund will have a certain value and the retiree will have to make some choices. They can take a tax-free lump sum of up to 25 per cent of the value of the fund. With the balance, they can either buy a pension - an annuity that will provide a set income for life - or invest their pension assets in an Approved Retirement Fund (ARF). ARFs are new. They are aimed at giving people more control over the retirement funds they have built up. From the age of 60, self-employed people can start to transfer assets into ARFs, which must be managed by a qualifying fund manager. Retirees can continue to invest in personal pension plans up to the age of 75 years. They can transfer pension assets between different fund managers and life companies.

Any money drawn out of their ARF will be subject to income tax at the investor's marginal rate, but there are no real restrictions on how the funds are invested and the investors choose the level of income and risk.

ARFs allow retirees to hold on to their pension assets for life and to pass on whatever remains to their children. Before ARFs, three-quarters of personal pension capital had to be used to buy an annuity to provide an income for the retiree. That annuity generally died with the person. There are restrictions on ARFs to protect investors. As long as the pensioner has £10,000 in specified annual income (for example, another pension), he can put his entire pension assets into an ARF. But if his annual income is less than £10,000 he must use £50,000 of his pension assets to set up an Approved Minimum Retirement Fund (AMRF). This is basically the same as an ARF except that £50,000 must be kept in the fund until the retiree is 75 years.

Employees: They fall into two categories depending on whether or not their employer operates a pension scheme.

Employees with a Workplace Pension Scheme: Where employees have an occupational scheme, the idea is that the employee/employer contributions will build into a fund over your work life so that when you retire there will be sufficient funds to buy an annuity to provide an income in retirement.

The schemes may be "defined contribution" or a "defined benefit" and may be contributory or non-contributory.

In a defined contribution scheme, the employee makes an agreed level of contribution and the pension provided will depend on the performance of the fund. With defined benefit schemes, the employee is guaranteed a certain pension on retirement based on years of service. The best schemes offer two-thirds of final salary after 40 years of service. On retirement, employees can draw down a specified amount of cash tax-free from the fund - often 1.5 times their final salary. They are effectively exchanging part of their pension for cash. The balance of the fund is used to buy an annuity, which is an investment policy producing an annual income for the rest of your life. Prices vary and the income provided depends on the annuity rates available at the time the annuity is purchased.

Employees in defined benefit schemes will get the pension income their scheme guarantees. For employees in defined contribution schemes no specific income level in retirement is guaranteed, so they can do well or badly depending on investment performance and annuity rates when the annuity is bought.

Additional Voluntary Contributions: Depending on the amount, if any, they contribute to their scheme, employees can make additional voluntary contributions (AVCs) to improve their eventual pension position. The annual tax-efficient contribution an employee can make is limited to 15 per cent of remuneration. Remuneration consists of all taxable income including benefits-in-kind, bonuses and commissions. If the employee is already contributing 5 per cent to the company scheme, they could contribute up to a further 10 per cent to an AVC fund.

Employees can now transfer their AVC fund into an ARF on retirement, giving them similar benefits to self-employed people on this portion of their retirement funds.

Employees with no Workplace Scheme: They can set up personal pension plans in the same way as self-employed people. The tax efficient annual contributions they can make are higher than for employees in an occupational fund above a certain age - see table. On retirement they have the same choices as self-employed people and can invest in ARFs.

Proprietary directors: They can be members of an occupational scheme or take out a personal pension plan. In practice, they are more likely to opt for the occupational pension route funded by the company because of the flexibility offered in funding their pensions. Companies can buy past service benefits for directors and are not limited in the amount they put in. The limit is on the size of the pension that can be provided for the director. A maximum of two-thirds of final salary, indexed, and with widow's pension can be provided (depending on service). In general final salary is defined as the average of the three years' salary before retirement. In a personal pension plan a director's tax-efficient contributions are restricted according to age and the earnings cap in the same way as for the self-employed.

While the pensions area is complicated, it pays to make an early start in providing for your retirement.