What is a pension? Personal pensions

You can use your personal pension to buy an annuity once you retire

If you don't have the option of a company pension, perhaps because you're self employed, you can still take out a pension in addition to the state pension through a 'personal pension'. 

Personal pensions work by you paying in a set amount each month to your chosen pension provider. Your best bet to find the right provider to suit your needs is by taking financial advice.  

You'll receive a fixed pension pot when you retire, to spend on an annuity or to go into income drawdown - from April 2015 onwards you'll also be able to withdraw the money, although it will be taxed as income. The fund will grow according to your contributions and how the funds the pension is invested in perform. For more on how investments work, visit our guide, How to invest.

Pros of a personal pension

They are ideal for people who don't belong to workplace pensions, such as the self-employed or people who have taken time off work to care for children or relatives.

But personal pensions offer other benefits too – they offer 20% tax relief which they claim back and add to your pot. They also provide a 25% tax-free lump sum on retirement. They are also more portable than company pensions, so you can build up a larger fund without having to transfer old pots.

Cons of a personal pension

They don't offer the extra money in the form of employer contribution that workplace pensions provide, and their management charges may be higher.

Personal pension investments

How much money you have at retirement partly depends on the funds the pension is invested in. Most people opt for the scheme's default fund, but you can choose cautious or adventurous funds, depending on your attitude to risk. Self-invested personal pensions (Sipps) offer a wider choice of investment. Our guide to Self-invested personal pensions has more details on Sipps.

Spending your personal pension

Most people have traditionally spent their pension pot on an annuity, which is a fixed sum of money paid out each year until you die. How much you get each year depends on your contributions, investment performance and your circumstances. For example, you can get a better rate if you suffer from ill health. To learn more about how annuities work, visit our guide,  Annuities explained.

You could opt for income drawdown, where your pension pot remains invested and you take money out each year. This is less predictable, as it depends on stock market performance. From April 2015 onwards you'll also be able to withdraw all the money if you want, although it will be taxed as income.

Self-invested personal pensions

These offer more control and wider investment choice than personal pensions. You can select funds and invest in areas like commercial property.

Sipps offer the same tax relief as personal pensions. They are particularly useful for people with commercial premises, because they can free up funds to re-invest. Sipps also provide inheritance tax benefits.

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