Personal pensions: we helpfully tackle 7 of your top questions

March 11, 2015

We’ve covered the State Pension and company pensions, so we’re now completing the set by looking at personal pensions. As with most things pensions-related there’s more than one name for these – you might also hear the phrase ‘private pension’.

What is a personal pension?

Simply another way you might choose to save for your retirement that you arrange for yourself. It’s a good idea for you to consider a personal pension if:

  • You’re working but not eligible for your company’s pension scheme (or auto enrolment)
  • You’re self-employed
  • You’re not working
  • You want to save extra on top of your company pension.

As long as you can afford to put money away, you can have a personal pension, even if you’re already paying into a company pension.

Hopefully by now you’re getting the gist of things, but to remind you, the State Pension alone is unlikely to be able to support you comfortably through your retirement so if a company pension isn’t an option for you, you really should look into setting up a personal pension.

How does it work?

You give your money to a pension provider who invests it on your behalf. Over time, your money should increase. Your personal pensions will be a defined contribution (or money purchase) scheme. We covered this in the company pensions article, but to recap:

  • You make regular payments into your pension fund
  • Your fund is invested with the aim of increasing the amount of money in your pot for when you retire
  • You’ll receive an annual statement telling you how much your fund is worth
  • You have access to your pot again when you retire.

How will my money be invested?

When you take out a personal pension, your fund is invested in an attempt to grow it. You’ll need to decide how you want your money to be invested. What you decide is usually dictated by how much you want your fund to increase and how much risk you’re willing to take. You’ll usually be offered a choice of some broad types of investments to choose from including:

  • Cash – your money is saved in the bank or building society – lower risk
  • Bonds – loans to the government or companies which pay interest until the loan is repaid – lower risk
  • Property – your money is invested in land or buildings – higher risk
  • Equities – shares in private companies – higher risk.

Each type of investment comes with its own pros and cons and levels of risk. Over the long term, your money tends to be safer in the lower risk investments, but they also tend to produce a lower return. And there is no guarantee with any of them that your pension will grow (investments can go down as well as up). That’s why it’s a good idea to get some help from an independent financial adviser before you decide how to invest so you’re clear on your options. If you make the wrong choice, you might end up with less in your pension pot than you expected, leaving you short in retirement.

What are the benefits of a personal pension?

The exact benefits will depend on your scheme, but in broad terms, you should benefit from:

  • A pension income during retirement, which can start from age 55 (although legislation around this may be changed so the minimum age for accessing personal pensions will be in line with forthcoming changes to the state pension)
  • A pension payable to a spouse or civil partner if you die
  • Tax relief on your pension.

There’s no limit to how much you can save in your pension schemes. And the good news is that if you’re a UK tax payer aged under 75, you can put up to £40,000 a year in without paying tax on the contributions. Any money that you put in above that figure may be taxed at 40%.

You usually make personal pension contributions after you’ve already paid tax on your earnings, so your pension provider has to claim the tax relief you’re owed back from the government and then pay it into your pension fund. However, your pension provider can only claim tax relief at the 20% rate. If you’re a higher rate tax payer, you’ll have to claim the other 20% back yourself through your tax return or through your local tax office.

If you’re not earning, you can still get tax relief on a limited amount of the contributions you pay in.

How much money will I get when I retire?

It’s very difficult to predict how much pension you’ll get when you retire because it depends on a number of things:

  • How much you pay in
  • How well your investments do (the value of your pot could go down, but in the long run it’ll usually increase)
  • What charges you have to pay
  • How you choose to access your fund when you retire – we’ll cover these options in more detail over the coming weeks; options are set to change from April 2015.

And what’s a stakeholder pension?

A stakeholder pension is similar to a personal pension. They’re largely irrelevant now as there are cheaper options, but they are still used as a benchmark for flexible pension provision. A stakeholder pension has to meet certain conditions set by the government:

  • The pension provider can’t charge more than 1.5% of the value of your fund for the first 10 years and 1% after that
  • Minimum contribution is from £20 per month, or you can pay lump sums any time you want
  • You can choose how often you pay into your fund; you don’t have to commit to regular payments and you won’t be penalised for missing or stopping payments
  • You can switch your fund to another stakeholder scheme or pension any time with no penalty.

I’ve also heard the term SIPP – what’s that?

A self-invested personal pension (SIPP) gives you the freedom to choose and manage your own investments, rather than your investments being managed through the fund you’ve chosen (like for a regular personal pension). Alternatively, you can pay an approved fund manager or stockbroker to make those decisions for you.

SIPPs tend to have higher charges than other personal and stakeholder pensions as they may involve complex investment arrangements or investment in commercial property.

In summary

  • A personal pension is open to everyone
  • SIPPs  are a bit more flexible in terms of investment options
  • From April 2015 you’ll have greater control over what you can do with your pension pot when you retire.

 

This article is for general use only and is not intended to address your particular requirements. It should not be relied upon in its entirety and shall not be deemed to be or constitute advice.

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