Time to go private?
Personal pensions can either be set up privately by yourself or through your employer.
If it’s through your employer, this is known as a stakeholder or group personal pension
Personal pensions typically give you more control over how you invest the money
Personal pensions are a form of defined contribution schemes, whereby the amount you pay into your pension determines how much you receive when you retire.
You get tax relief on the money you pay into a pension (otherwise known as contributions), up to certain limits
You have an annual allowance, which is currently £40,000, and a lifetime allowance, currently £1.03m. Any contributions above these limits may attract tax.
Personal pensions are similar to a workplace pensions we discussed in the previous article in our pension series. They are available if:
You are working but are not eligible for automatic enrolment into your company’s pension scheme e.g. if you below the age of 22 or not earning at least £10,000 a year*.
You’re self-employed or not working.
You are working and have a workplace pension, which is a good option if you want to save more or start paying into a workplace pension later in working life.
You pay money in regularly (known as contributions), as you would with a workplace pension.
*If you earn less than £10,000, you are not auto-enrolled, but still have the right to opt into your workplace pension, but your employed is not necessarily obligated to contribute to the scheme also.
Personal Pensions: Key Facts
1. You receive tax relief. This is the government’s way of encouraging you to save for your retirement, by telling you that they won’t tax you on the amounts you save up to a certain limit. This depends on the amount you save into your pension, be it from your salary or other sources of income.
2. You receive a tax free allowance every year if you are under the age of 75 and a UK tax payer, an annual allowance of £40,000 (i.e. this is the total allowance you receive, whether you one pension or multiple pensions.). So that means if you save up to this amount, it’s tax-free. Anything above may be taxed at 40% or more.
3. If you’re not earning a salary, but you have some money you’d like to save towards your pension (may be some inheritance money from mum & dad, grandma etc.), then any amount you save up to £3,600 is tax free.
4. If you’re a higher rate tax payer (earning a salary between £34,501 - £150,000), and therefore pay 40% income tax, you can claim the extra 20% tax (40% - 20% of basic rate tax) as relief on your pension contribution.
5. If you’re an additional rate tax payer (earning over £150,000), and therefore pay 25% (45% - 20% of basic rate tax) as relief on your pension contribution. The £40,000 annual allowance is however reduced if you have an income over this level.
The government is essentially trying to ensure sure you’re not taxed too much.
N.B. If you have a workplace pension and a personal pension, remember to add up the amount you’ve saved in each one together to know if you’ve reach the annual allowance of £40,000, as once you reach this figure, you may start getting taxed. You also have to do the same for the lifetime allowance of £1.03m.
If you contribute more than £40,000 a year to your pension pot, you will be taxed at the highest rate of tax.
However, you can can carry forward any unused allowances in the previous 3 years to offset any tax you might incur for contributing more than £40,000, as long as you were a member of a scheme in those years.
You receive an income from this pension when you retire, as you would with a workplace pension. You can start to take this income from the age of 55. You can also decide how you take this income (there are a number of options available, which we will cover later in the series). This income can be paid to someone else instead if you choose, like a spouse/partner or a dependent. They can receive a lump-sum if you die before retirement.
Managing your personal pension
You have absolute control over this pension, and so have to decide which company to invest your pension with; which investments to choose etc.
Your choices will be set out in the company’s pension documents. What you decide will be influenced by your individual circumstances:
how much you have available to invest;
how long you have until you retire;
the number of dependants you have; the list goes on.
You can also set up what is known as a self-invested personal pension (SIPP). It works in similar fashion to personal pensions, but gives you greater flexibility (and sometimes greater variety) over the investments you choose for your pension to be invested in, which can be good, particularly if you’re quite financially knowledgeable and understand investments. Variety may not be so good if it is more risky.
Your investments are managed within the pooled fund you choose.
Group Personal Pension and Stakeholder Pension
There are also two other types of personal pensions: group personal pensions and stakeholder pensions. These are provided through your employer, similar to the workplace pension discussed in the previous article. So you can sort of take them to be a combination of a workplace pension and personal pension. These are alternatives to consider if you do not meet the criteria for your workplace pension.
Your employer chooses the company with which the ‘pension pot’ is invested, and pays into it directly from your salary as they do with a workplace pension, but that’s where the similarities end.
What’s the difference between Stakeholder pensions and Workplace pensions?
You sign an individual contract with the investment company, which gives you more control over your pension than you may otherwise get with a typical workplace pension. The main difference with a stakeholder/group personal pension - as opposed to a workplace pension - is that you choose how the money saved is invested, a choice you may not have with the latter.
Your employer may also choose to contribute a percentage of what you pay from your salary, but they don’t have to. Obviously it’s nice if they did because it means more money invested in your pension, and hopefully more money for retirement.
If your employer offers both workplace pension and group/stakeholder pensions, definitely look at the benefits of each before deciding!
Some of the benefits of stakeholder pensions are that they have low and flexible contributions, which can be a good choice if you don’t earn a lot; they have capped charges – the charges the pension provider chargers for looking after your pension – and they can also choose a default strategy to manage your pension if you don’t want the hassle.
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