Personal Pension Plans Guide – Pensionfinder
A personal pension is a way to save for retirement, using the income it provides to supplement the basic state pension. It’s ideal for people who cannot join an occupational pension scheme, such as the self-employed.
Small companies that do not offer a company pension scheme may offer a group personal pension.[link GPP] With this type of plan the business creates personal pension plan for each participating member of staff, who in turn should benefit from the lower fees usually associated with a group personal pension plan.
Keen investors my want to take out a Self-invested personal pension (Sipp) which enables them to select where their pension pot is invested rather than leaving the decisions to the fund managers.
Generally pensions, including a personal pension, are considered to be the best way to save for retirement because of the tax relief the Government gives on contributions.
How they work
A Personal pension is a defined contribution pension scheme, so the amount of pension someone can expect to get on retirement is not defined from the outset as they are for defined benefit schemes.
With a personal pension the holder makes contributions to their pension plan. This money, and any tax relief given, is invested via investment funds. Over time the pension pot builds up. What they can expect to receive on retirement from this plan will depend on how much money was paid in (less any administration fees) and the investment returns achieved by the pension plan’s fund.
At retirement the policyholder will use their pension pot to buy an annuity [link to annuities], which will give them a guaranteed income for the remainder of their life. So the amount they receive in retirement will also depend on the annuity rate, which is the factor used to convert the pension pot into pension income in retirement.
Rules governing personal pensions
To take out a personal pension plan you must be resident in the UK and aged less than 75. With a personal pension you can retire at any age between 50 and 75. After 6 April 2016, the minimum retirement age increases to age 55.
There are no limits on how much you can contribute to a personal pension, although there are limits to how much tax relief you will receive on you pension contributions.
With a personal pension, the provider will claim tax relief at the basic rate and add it to the holder’s pension fund. However, higher-rate taxpayer should claim the additional tax relief they qualify for on their tax return.
Upon retirement the holder can generally take up to 25% of their pension pot fund as a tax-free lump sum. The rest would be used to buy an annuity or used for income drawdown before buying an annuity at 75.
The tax benefits associated with saving in a pension plan are the main advantage of a personal pension. Tax relief on pension contributions means that the Inland Revenue top ups your payments with an additional money. For example, if you are a basic rate taxpayer a contribution of £80 will get tax relief of 20% or £20, this adds up to a total contribution of £100 being paid into a pension plan.
Higher-rate tax payer (those on a 40% tax) may able to claim additional tax relief on their tax return. However, from April 6th 2011, those earning more than £150,000 annually will only receive tax relief on contributions at the basic rate of tax. There is special legislation to prevent individuals from making extra large contributions before the 2011 deadline.
You can also take out up to 25% of your pension savings as a tax-free lump sum on retirement with a personal pension.
You should have some flexibility with regards to which investment funds you use for your pension savings. You will be able to select the right investment funds for your requirement based on their performance and your attitude to risk.
The main disadvantages of a personal pension are that the policyholder carries the risks of investment. The returns generated by your pension fund will depend on the prevailing market conditions, the amount paid in and the skill of your fund managers.
With a personal pension you must use your pension pot to buy an annuity by the age of 75. Annuity rates can fluctuate, just like the stock market. So, you may have to buy an annuity at a poor rate, which means your pension income will be reduced.
Some of the annual fees for personal pension plans can be quite high and these can eat into your pension savings. It is important to shop around to find the right personal pension plan for your needs – and be sure to compare charges and performance. You may find it useful to get independent advice before selecting a personal pension provider.