In our guide to personal pensions, we want to give you all the information you need to encourage you to open a pension scheme. Today, more UK workers than ever than ever participate in a pension scheme, largely thanks to automatic enrolment, which became law in October 2012. Around 73% of all UK employees reported having a workplace pension in 2017, which was a huge leap from the 47% who reported enrolment in their workplace pension in 2012.
While automatic enrolment forced employers to contribute to their employees’ retirement plans, an increasing number of people don’t have employer pensions. They don’t even have employers. The number of self-employed workers in the UK grew from 3.3 million in 2001 to 4.8 million in 2017.
What’s more, those reaching retirement age today need more money than their parents did when they reached 65. According to Royal London, Brits now need at least £260,000 in the bank if they wish to retire without worrying about money or the need to return to work — and that’s for one person, not a couple. Others say that you need significantly more.
Workplace pensions aren’t your only option for retirement. Personal private pensions are available, and they’re open to almost any UK resident who wishes to start one. What are personal pensions, and who do they benefit? In this guide, we will cover:
- What types of personal pensions are available
- Who can and should open a personal pension
- How to find the right pension provider
- What options you have to use your pension upon retirement.
What is a Personal Pension Fund?
Not everyone can opt into a pension scheme provided by an employer. However, just because an employer pension isn’t an option doesn’t mean you’re locked out in the cold.
A personal pension is a pension plan you choose and arrange for yourself. It’s a plan offered by a pension provider of your choosing. You then choose your contributions and contribute usually via direct debit (but also in lump sums, if desired).
Pensions differ from savings accounts or investment accounts because they offer tax benefits. You do not need to pay income tax on any interest you earn. You can also receive tax back on your contributions, even if you don’t pay tax. The tax benefits and rules are what make personal pensions such valuable retirement tools.
Most pension providers tend to be insurance companies. However, you can also find independent pension providers.
What Are the Tax Benefits of Personal/Private Pensions?
According to the UK Government, you receive tax relief on all private pension contributions up to 100% of your annual income.
If you have a workplace pension, then your employer places your contributions within your pension before deducting tax. That means you don’t pay income tax on your pension contribution.
For those who pay the 20% Income Tax rate, you receive extra benefits. Your pension provider then claims the fund as tax relief. They then add it to your pension pot. The process is called “relief at source.”
The rule also applies in Scotland if you pay 19% instead of 20% in Income Tax. You don’t need to repay the difference to your pension provider.
Most tax relief takes place automatically, but if your pension scheme does not do this, then you may need to claim it on your tax form.
Keep in mind that tax relief only applies up to 100% of your income. So, if you receive an inheritance worth several times your income, you should not simply empty it into your pension to avoid taxes.
What Types of Pension Funds Are Available?
There are many types of pension funds (see below), but most private pensions, including workplace and personal, fall within the two groups: a defined benefit pension or a defined contribution pension.
A defined benefit plan is set up by an employer. Your defined benefit is a set benefit that you receive each year after you retire and begin accessing your pension pot. When you have this type of pension, you enjoy the same secured benefit each year, as set by your agreement with your employer. The vast majority of defined benefit pensions are employer pensions not personal pensions. Though, workers may contribute to the scheme to grow their pot and enjoy more money upon retirement.
A defined contribution pension is one based on how much you contribute over the life of the account and how much the pot grew in the same period. Almost all personal pensions are defined contribution plans that rely solely on what you contribute and the performance of your account.
Who Can Set Up a Personal Pension?
Any UK resident can become a member of a pension offered by a pension provider (i.e., set up a personal pension).
It doesn’t matter if you’re employed, self-employed, or unemployed. You can open one for yourself, or you can even open a pension plan for your children as a way of boosting your tax-efficient savings and passing on some wealth to your child.
Note: Unlike other junior products, pensions for children aren’t accessible until your child reaches age 55 or the current age of retirement when they come of age. So, you can’t set up a pension with your child’s name on it and then use it for yourself. You also can’t use it to pay for higher education or other expenses. It’s still a pension.
Though personal pensions are generally available to everyone, you may find that certain pension providers have their own rules for new accounts. The most common rules revolve around age and minimum contribution. However, the average worker looking to actively save for retirement is generally not excluded.
Can You Have a Personal and Workplace Pension?
Yes, you can enroll in a personal pension even if you are already participating in your workplace pension. There’s no limit to the number of schemes you can be a member of, and you will not be penalised for holding multiple active accounts.
The only restriction is the limit that you may contribute if you want to avail of the tax benefits. The figure stays the same no matter how many pensions you have, so it’s important to add money strategically to make the most of each product without exceeding the total allowed contribution.
However, most earners in the UK won’t meet the upper contribution limits. If you do earn and save enough to meet them, there are plenty of other financial instruments available to you to help ease your tax burden and save for the future.
Who Can’t Receive a Workplace Pension?
The vast majority of workers can enroll in a workplace pension. In fact, auto-enrolment rules say that most employers who offer pensions should put you in automatically unless you expressly opt out. The only exceptions are for those workers who are low earners, are early in their working life or who are already at retirement age.
For example, if you earn less than £10,000 a year, your employer won’t enroll you in a pension scheme. You may ask if you earn over £5,876, but your employer can refuse if you earn less than this.
You also need to ask for permission if you’re under 22 or you’re working past the state pension age. If you’re between 16 and 74, then you may ask and your employer must enroll you.
Finally, those working outside the UK aren’t eligible for workplace pensions.
Why Should You Set Up More than One Pension?
If you have a workplace pension and contribute to the state pension via taxes, why should you contribute to a personal pension as well.
As stated above, there’s no penalty for having more than one pension. What’s more, there are benefits to opening a personal pension, particularly given the political and economic uncertainty that’s facing the UK economy in the years ahead. Diverse portfolios that are actively managed are one way to help insulate your savings from both predictable and unpredictable market turbulence.
What else do personal pensions offer you, even if you already have a workplace pension?
First, personal pensions are more flexible than workplace pensions. These pensions are both flexible and portable with no links to your current employer. As a result, you can contribute freely whenever and wherever you’re working. Given that UK workers change employers every five years (on average), the flexibility offered is a real benefit. It’s particularly helpful for those who are just starting out in their careers and already have plans to leave their employer within the first two years.
Having a second, flexible pension is also ideal because you can optimise it as your situation and the market changes. You can transfer personal pensions between providers to take advantage of market opportunities and more favourable rates. If you like your provider, you can also open up other financial products with them. Those who do this will have the benefit of being able to check in on their investment products regularly and with minimal hassle, particularly thanks to the use of online dashboards.
Finally, having a personal pension gives you the freedom to assess your employer’s pension scheme and opt out if you need to. Some people may find they prefer to opt-out of their workplace pension. Remember that if you do so, you are out for three years before you are auto-enrolled again.
What Are the Types of Personal Pensions?
The three types of personal pension available to you as an individual include:
- Traditional personal pensions
- Self-invested personal pension (SIPP)
- Stakeholder pension
What is a Traditional Personal Pension?
A traditional personal pension allows you to invest in your own pension account with or without an employer.
These schemes are the most basic of the available accounts because you typically only have two investment options: insurance company funds and cash.
What is an Insurance Company Fund?
As mentioned before, most personal pensions are offered by insurance companies, which is what limits their investment product portfolio. As a result, you invest in insurance policy funds.
Insurance company funds are those run by life insurance companies. You might have the offer of a fund run by the insurance company that offers the pension or the chance to invest in funds run by other managers.
As will all funds, your money is pooled.
How does an insurance company fund differ from insurance? Your fund is a financial instrument that fluctuates with the market and according to your preferred investment strategy. Insurance policies and their benefits do not.
For example, if you buy a life insurance product, then you will receive the benefits as stated according to your plan. They will not (or should not) change. An insurance policy fund in a pension product depends on market performance.
What is a Self-Invested Personal Pension (SIPP)?
A SIPP is a financial product that makes it easy for you to choose your own investments within your pension fund. These products allow you to choose your investments as you see fit, without the limitations of a traditional personal pension or a stakeholder pension.
The investments available to you through most SIPP products include:
- Unit trusts
- Investment trusts
- Open-ended investment companies (OEICs)
- Exchange-Traded funds (ETFs)
- UK shares
- Overseas shares
- UK bonds (and other fixed-interest securities)
- Permanent interest-bearing shares (PIBS)
Although you do have many options, it’s worth noting that you can also choose ready-made portfolios if it best suits your needs or level of investment knowledge.
What are the Tax Benefits of a SIPP Product?
Your SIPP works the same way as other personal pensions. You can contribute as you like, and the government pays 20% in through pension tax relief. If you pay the 40% income bracket, then you can claim back more relief on your income tax return. Additionally, your money grows without the need to pay UK income tax or capital gains tax on your SIPP income.
What is a Stakeholder Pension?
Stakeholder pensions may be offered by employers, but you are also free to open one yourself. As with SIPP products, you have more options than just your insurance company’s fund offerings, but your choice is limited in comparison to SIPP products.
One of the biggest differences from a SIPP product is that the UK government regulates the minimum standards, which means the barrier to entry is lower. As a result, you’ll find:
- Limited charges
- No transfer charges (in or out)
- Low minimum contributions
- Flexible contributions
- Default investment options
The default investment option is the biggest difference compared to the SIPP product. A SIPP requires you to make your own choices, but a stakeholder pension gives you a default fund if you decide not to choose.
Is a Personal Pension Different from a Lifetime ISA?
Personal pensions and Lifetime ISAs are both products designed to encourage workers to save for retirement, but they work in different ways and have different rules.
A Lifetime ISA is a financial product available to those between ages 18 and 40. Like other ISAs, it offers a tax-wrapper for your savings and earnings. You are allowed to save up to £4,000 per year between ages 18 and 50. If you max out your contributions each year, you will earn a £1,000 annual bonus from the UK government.
These products are available as a cash ISA and a stocks and shares ISA, which have different bonuses and rules.
Like other ISAs, you can withdraw your money at any time. However, unlike other ISAs, you will pay a penalty if you withdraw before your 60th birthday. The penalty is 25%, which means you’ll get back all the money you put in, but you’ll automatically lose every government bonus. The only exception is for those using Lifetime ISAs to save for your first mortgage deposit. In these cases, there’s no penalty for withdrawing before age 60.
The penalty is steep because like a pension, a Lifetime ISA is designed to serve as retirement income rather than as a simple savings account. You can’t use it to avail of the tax benefits or government contributions as a matter of convenience.
When is a Lifetime ISA a Better Option than a Pension?
A Lifetime ISA can be a better option than a personal pension if you are still many years away from retirement and there’s a chance you may need to access the money early as access is possible, even if you lose the benefit.
Lifetime ISAs also suit you if you have a personal pension and you make the maximum contribution each year. The Lifetime ISA offers a new tax-wrapper for your money.
When is a Personal Pension a Better Option than a Lifetime ISA?
Personal pensions tend to suit workers who already have a workplace pension or for those who pay in from higher tax brackets.
If you have to choose one over the other, it’s worth noting that personal pensions are more flexible than Lifetime ISAs. You can withdraw at 55 if you want to. You can also make larger contributions after age 50. The most you can contribute to the Lifetime ISA is only £128,000, but you can add £1.03m to your pension over your lifetime.
There are also far more options for using your pension either as income or withdrawing as a lump sum when it’s time to retire.
How Much Should You Save in a Personal Pension?
The amount you decide to save largely depends on whether your personal pension is your sole form of retirement income or whether you have additional support, such as a workplace pension and other investment accounts.
As everyone knows, the amount you save is highly personal. It depends on how much you earn, how much debt you have, and how early you want to retire. One rule of thumb is to ensure 15% of all pre-tax income goes into a retirement account. Remember that your pension contributions will grow between now and the day you retire. If you are closer to retirement age, then you will need to save more aggressively.
How Much Does a Personal Pension Cost?
A personal pension typically comes with an annual management charge, but it can also come with other fees such as:
- Administration charges
- Charges for investment funds
- Drawdown funds
Being wary of these charges is critical to maximising your savings. Because pensions are long-term investment accounts, a slight change in charges could eat into a huge amount of your savings.
For example, the difference between a 0.5% annual charge and a 1.5% annual charge is huge. The 0.5% charge will take around 1/10th of your savings after 35 years, but a 1.5% fee will take almost a quarter of it.
The charges also vary depending on your product.
Traditional personal pensions typically assess a fee equivalent to a fixed percentage of your investment. As your pension pot grows, so too does your fee. These products are known for having the highest fees out of all personal pension types.
SIPPs operate differently because of the types of investments available. In most cases, you’ll pay a fixed management fee fee, as you will with a traditional personal pension. You will also pay dealing charges as required. However, you can see an annual charge for funds as low as 0.25% to 0.05% depending on the size of your investment pot. Most SIPP products stop charging once you reach £1-2 million in investments.
Some SIPP providers also offer simplified fees. For example, Vanguard’s SIPP comes with a fee of 0.15% per year with a cap of £375.
Stakeholder pensions have fees assessed by the government. The maximum management fee allowed by the government (as of 2020) is 1.5% each year for the first 10 years. After ten years pass, the fee drops to 1%.
Do I Need a Financial Advisor to Open a Pension?
There is no simple answer to this question because it depends on how close you are to retirement and how much you have to invest.
The short answer is no: most pensions are available without the need to accept financial advice. Many product providers and platforms make signing up for your first pension simple and painless. You typically only need your personal information and your bank account (or debit card) details to open an account and fund your personal pension.
If you are opening your first personal pension as a way of beginning your retirement planning, then you’re unlikely to benefit from financial advice at this juncture anyway.
Even still, financial advisors have their place in retirement planning. You may benefit from financial advice if you:
- Are 40 and over and just beginning to save for retirement
- Are 55 and over and are beginning to think about retiring soon
- Have a lump sum or another significant investment
Remember that financial advisors typically provide consultations free of charge. However, you can spend as much as 0.5.-1.0% of your investment portfolio only advice fees. So, it’s important to ensure that your chosen advisor contributes to your management in a way that warrants the fee.
Where Can I Get Advice About Pensions?
If you have questions about pensions and you’re not sure you benefit from hiring a financial advisor, then you still have options for professional advice.
The Pensions Advisory Service provides free, independent advice about pensions to UK residents. The service comes from the Money & Pensions Service, and it can answer questions about State Pensions, Employer Pensions, and Personal Pensions.
If you’re also contributing to your workplace pension, be sure to talk to your payroll and benefits coordinator about your options.
What Kind of Pension Product Platform Should I Choose?
There are many different pension providers available to you, and your shortlist of providers will likely come down to the type of personal pension you want: traditional, SIPP, or stakeholder.
If you already have an investment account or an ISA, consider first reviewing your current product provider’s pension rates.
If you are reviewing platforms, you may find it helpful to ask the following questions to narrow down your search:
- Does the platform offer the range of investment choices that I prefer?
- Does the pension offer the degree of risk I am interested in?
- Will your investment go into emerging markets or stay largely in the UK?
- Does the pension allow you to hold cash?
Who Offers Private Pensions in the UK?
Some of the firms offering private pensions to UK residents include:
- AJ Bell
- Hargreaves Lansdown
- Fidelity Investments
- Alliance Trust Savings
- Standard Life (now Standard Life Aberdeen)
While you do not need to open a private pension with one of the heavy-hitters above, it is important to ensure that your pension scheme is legitimate. That said, you should also know how to avoid potential pension scams.
How Can I Spot a Potential Pension Scam?
The general rule on any investment is that if it sounds too good to be true, then it is. A pension ‘opportunity’ that offers very high returns can be an unregulated scam. It could cost you your retirement savings.
The biggest scams tend to be overseas property interests. Not all of these investments are illegitimate, but it’s important to be able to spot frauds. Today, it’s easier than ever to spot criminal activity. In January 2019, the UK banned cold calls related to pension products. The only adverts or communications you should receive about any pensions are from the companies you’ve inquired with.
Other tell-tale signs of scams include:
- Unsolicited pitches
- Use of mobile phone contact numbers
- Pressure techniques
- Requests to transfer your whole pension
- Pension loan claims
- Tax loophole claims
- High-return, low-risk claims
Any company offering regulated products will be registered with the Financial Conduct Authority (FCA). You can find all listed companies on its register. The FCA also hosts a ScamSmart website, which provides more information about pension scams and allows you to compare your offer against its list of known scams.
When and How Should I Merge My Pensions?
One of the key questions pension holders have is what to do with your various pension pots when it’s time to retire and begin accessing the account.
You have two options:
- Use each pension individually; or
- Consolidate your pension pots into one
What you choose to do depends on the pension products you have. In some cases, you can transfer a high-cost pension over to a lower-cost product, which saves you money. Merging into an account with a greater mix of investment choices can also be a benefit. It’s also easier to keep track of one pension than it is to look after two or more.
At the same time, there may be costs associated with the merger. For example, some pensions may assess transfer or exit fees that can eat into your savings. These become particularly expensive if you have a mature pension and you’re getting ready to retire.
It’s also important to note whether you might lose any benefits by leaving one account behind.
Your best option is to speak to a financial advisor before making the move, as they can provide specific advice based on your pensions’ terms and value.
How to Use Your Pension Pot
When you reach retirement, you need to decide how you want to use the pension pot you accumulated over the years. In the past, pension distributions almost always took place through set monthly payments, as this catered well to workers’ expectations. It also helped employers, who were able to pay out pensions monthly rather than struggle to come up with a lump sum immediately upon workers’ retirement.
Thankfully, changes that came into effect in April 2015 make using your pension far more flexible than it was in the past. You must still need to reach age 55 before you can touch it (unless you’re in poor health).
Understanding how you might want to use your pension now is important because not all pension providers offer the same options.
Once you have access, you have these options:
- Leaving your pension sit (it will continue to grow tax-free)
- Withdrawing (optional) and purchasing an annuity with the balance
- Withdrawing (optional) and choosing pension drawdown
- Taking small lump sums (tax occurs)
- Taking the whole lump sum (tax occurs)
A financial advisor can help you decide which of these options best suit your financial needs.
When Should You Choose an Annuity?
An annuity is retirement income payment sold through insurance companies to provide a regular income during retirement.
You can use your pension pot to purchase an annuity and ensure you have a steady flow of income throughout your retirement years. These can be set up to begin paying immediately (immediate) or at another fixed point (deferred).
There are three basic types of annuities: fixed, variable, and indexed. Your pension provider may offer all or none of these annuities for you, or you may choose to withdraw and seek out your own annuity choice.
The benefits of annuities are simple: it pays out a guaranteed monthly payment for the rest of your life. However, once you buy one and set its terms, you will have a difficult time changing it. And as people live longer and find themselves facing more complicated financial lives, the inflexibility of an annuity can be a hindrance or even be financially devastating if you’re relying solely on the annuity.
Annuities can also be expensive, as you’ll pay fees for service even though you’re no longer growing your pot. There can also be additional fees if you need to withdraw or customise your annuity after the initial terms.
A financial advisor can tell you whether an annuity is the right choice for your pension.
What is Pension Drawdown?
Pension drawdown is another way to use your pension as a form of regular income throughout your retirement. It differs from annuity because it is far more flexible.
A pension drawdown means your pension remains in the account, and it’s still invested. It gives you the flexibility to continue growing your pension pot even during retirement. You also have more flexible options in regards to what you withdraw and when.
Unlike an annuity, a drawdown is only guaranteed as long as there’s funds available. There’s no guarantee for life. However, if you have the funds available, you can withdraw as much as you need. That means that if you have an emergency or a new investment opportunity arises, you can withdraw as much as you want or need.
In the past, there were two drawdown products. However, if you are starting an account or retiring today, you can only use the pension drawdown option, which removes the limitations on your drawdown.
What Are the Tax Implications of Retirement?
Remember that while saving is tax free, some of the money becomes taxable once you begin to receive your pension.
The first 25% of money taken from your pot is tax-free and never counts as your standard Personal Allowance, which is currently £12,500.
Your total tax bill will depend on your income for the year, including your pension and any other forms of retirement income.
The current tax rules for retirement products include:
- No tax on untouched pension pots
- 25% tax-free on cash-outs for each cash out – 75% taxable on each cash out
- 25% tax-free on whole pot withdrawals -75% taxable on whole pot withdrawals
- 25% tax-free before buying annuity – tax on income from the annuity
If you mix your withdrawal options, then the tax due depends on what you mix.
You can view the current rules on the government’s PensionWise site.
In today’s world, it’s not only easier to start your own pension, but it’s almost essential. Few people spend their entire careers with one employer, and more and more UK workers are looking at self-employment as a means of furthering their career.
If you’re only using your workplace pension and you still have extra cash leftover to save then you might benefit from also opening a personal pension. Don’t worry: there’s no limit to the number of pensions you can have. Though, there is a limit to the tax benefits available based on your contributions, so you need to save intelligently.
Personal pensions offer extra flexibility, and they stay with you no matter where your career takes you. There are many different products available to you, and you can find products that range from hands-on control of your investments to fix-it-and-forget-it options. You don’t necessarily need a financial advisor to start your pension, but you may benefit from advice as your savings grow and particularly as you reach retirement age.