Introduction to personal pensions Personal pensions - do I need one?
Why have a personal pension?
Personal pensions are an obvious choice for the self-employed, or those who don’t belong to a company pension scheme.
They allow you to build up a pension pot and buy an annuity when you come to retire.
Unlike company schemes, many personal pension schemes will let you vary your contributions, paying in more when you are able to and taking a ‘contributions holiday’ when times are hard.
- Pension contributions enjoy tax relief: what you pay is treated as a payment net of relief at basic rate. The provider claims basic rate relief and adds it to your plan. If you pay tax at a higher rate, you claim further relief through self assessment. The effect is that if a contribution of £80 is paid into your pension fund, a 20% tax refund is added, making the total invested £100. For personal pension scheme members this is particularly significant, as it boosts the size of contribution going into their pension ‘pot’ each year. This allows them to buy a bigger annuity when they retire and maximise their pension income. They don’t escape tax altogether though, since pension income is taxable. Essentially you avoid tax ‘on the way in’ but pay it ‘on the way out’.
- Personal pensions allow you to take a 25% lump sum tax-free on retirement.
- Personal pensions are portable: unlike company schemes that people often leave behind when they change employer, you can keep the same personal pension. This allows you to build up a larger pension pot, without the need to transfer preserved pensions from company schemes.
Drawbacks of a personal pension
Unlike company pension schemes, most personal pensions are self-funded. There is usually no employer’s contribution to boost your pension pot. If you become an employee of a firm that runs a contributory company pension scheme you may do better to join this instead of going it alone.
- Personal pension charges can be higher than those paid by members of occupational schemes or Group Personal Pensions (GPPs). Stakeholder personal pensions have their annual fees capped at a maximum of 1.5% for the first ten years and 1% thereafter.
- Some personal pensions have limited investment choices. A self invested personal pension (SIPP) offers a wider range.