Introduction to personal pensions What is a personal pension?
What is a personal pension?
Personal pensions are defined contribution pensions. You choose the provider, who invests the money you pay in and gives you an accumulated sum on retirement - with which you can buy an annuity or go into income drawdown. You can read more about these options in our guide, income options for pensions under the 2015 rules.
Since April 2015, you've also been able to withdraw as much of the money as you want when you reach 55, although it is taxed as income.
Stakeholder pensions are also a type of personal pension. They work in a similar way, but they have to conform to certain government standards, such as low charging structures and clear T&Cs.
If you don’t have a company pension, personal pensions can be a good alternative way of saving for retirement.
How personal pensions work
How much you get at retirement depends on the performance of the funds in which the money has been invested, and any charges have been deducted. Our Beginner's guide to investments has more detail on how charges work.
Your pension provider will claim tax relief at the basic rate and add it to your fund. If you’re a higher rate taxpayer, you'll need to claim this rebate through your tax return.
Although your total pension pot should increase each year you continue to pay into the scheme, there is no way of accurately predicting what the final total will be and how much pension income this will provide.
Personal pension investments
Unlike those who belong to a company’s defined benefit (DB) pension scheme, members of a personal pension some choice as to where their pension contributions are invested.
Many opt to for the scheme’s ‘default fund’, but some will want to be more cautious, investing in cash funds and corporate bonds, while others may prefer a more ‘adventurous’ mix, with equity and overseas growth funds.
However, as you near retirement, it’s wise to alter your asset allocation into more cautious investments, such as gilts. This is because you want to lower the risk of your investments performing badly and having less time to make up any losses. This is called a ‘glidepath’.
Those who want a wider choice of investments, including commercial property, often opt for a Self-invested Personal Pension (Sipp). Our guide has more information on how Sipps work.
Taking a tax-free sum
Before buying an annuity or going into income drawdown, you can take up to 25% of your pension savings as a tax-free lump sum. This could be a good idea if you have debt to pay off, such as a mortgage, but it will reduce your retirement income.
The earliest you can draw a pension or take a lump sum is from the age of 55.
Other personal pension benefits
As well as providing a pension fund, some personal pension schemes offer additional benefits to their members. The most common is a ‘death before retirement’ payment to your spouse, civil partner, or anyone else you nominate, if you die before reaching pensionable age.
Your accumulated pension contributions may also be refunded. If you have ceased paying into the scheme at the time of death, your accumulated contributions will be returned, and normally the investment growth they have achieved.
Should I get a personal pension?
Personal pensions are an obvious choice for the self-employed, or those who don’t belong to a company pension scheme. 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.
Alongside the tax relief and opportunity to take a lump sum, another plus of personal pensions is that they’re portable. Unlike company schemes, 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 personal pensions
- Personal pensions are self-funded. There is 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.
- Charges can be higher than those paid by members of occupational schemes or 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 Sipp offers a wider range.
Protection for your personal pension
Pension arrangements based on defined contributions are protected by the Financial Services Compensation Scheme (FSCS). The FSCS is financed by an industry levy.
The FSCS protects investments with providers who are authorised by the FCA, and the level of protection depends on the type of the investment. It’s designed to protect against the insolvency of a direct provider - the FSCS does not pay compensation for poor investment performance.
- Income options under the new pension rules - what you can now do with your pension pot
- What's happening with the state pension - the new flat-rate state pension in 2016
- The Which? Money Helpline - Get expert advice on your personal pension
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