16/10/2019

10 mins

What is a Personal Pension?

A personal pension is a long-term savings vehicle that you use to put money away for retirement. Once you’ve stopped working, you can use your pension to fund your lifestyle in your later years.

The earliest you can access a pension is age 55, at which point you can opt to draw money from your pension pot or exchange it for a regular income for life, known as an annuity.

A personal pension is a type of defined contribution pension scheme. This means that the income you receive in retirement is defined by the contributions you make throughout your working life and the performance of your investments, less any fees and charges.

Types of Personal Pension

There are three main types of personal pension you can take out as an individual:

Basic personal pensions
Charges vary with basic personal pensions, but you should get access to a wide array of funds and can make regular contributions into the pension.
Stakeholder pensions
Stakeholder pensions have minimum charges capped by legislation. You’ll get access to a reduced array of investments compared to a basic personal pension, but a stakeholder pension will offer a default investment strategy if you don’t want to pick your investments.
Self-invested personal pensions (SIPPs)
SIPPs tend to be more suited for experienced investors, especially those who want to make larger contributions. You’ll get access to a far wider range of investments than either a stakeholder or basic personal pension and charges are likely to be higher than under these options.

Get Tax Relief on Pension Contributions

To incentivise and reward pension saving, the government offers pension tax relief at your highest marginal rate on payments you make into the pension scheme providing you’re under 75 and within your annual allowance.

Everyone gets 20% tax relief (the basic rate of income tax) automatically on their pension contributions ‘at source’. If you’re a higher (40%) or additional (45%) taxpayer, you’ll need to claim back the tax relief on your tax return. Don’t forget to do this; after all, it’s free money!

This means a £100 gross pension contribution requires an investment of:

£80 for a basic rate taxpayer
£60 for a higher rate taxpayer
£55 for an additional rate taxpayer.

Even if you’re not working or have very low earnings you can still pay into a pension. If you’re not earning at all, the maximum amount you can pay in each year is £2,880, which the government will top up to £3,600 with tax relief.

Do I Need a Personal Pension?

For most employed people, you’ll likely have been automatically enrolled into a workplace pension under auto-enrolment. This will be a pension arrangement that both you and your employer make contributions to. The addition of employer contributions is incredibly valuable as it will allow your pension to grow faster.

If you’re offered a place in a workplace pension with employer contributions, the vast majority of people would be best taking their employer up on this.

This said, even if you’re employed, this doesn’t stop you opening your own personal pension on the side to supplement and boost your pension savings. Your employer may even offer to pay into your personal pension, although they’re under no obligation to do so.

Pensions for the Self-Employed…

Meanwhile, if you’re self-employed, a contractor or a director, you won’t have a pension arranged for you by an employer. You’ll have to make pension arrangements for yourself. It’s here you can use personal pensions to bridge the gap.

While you won’t get pension contributions from your employer, directors and contractors can get notable tax relief on pension contributions made via their limited company.

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How Do I Open a Personal Pension?

You can open a personal pension yourself without any advice, but there’s a lot to consider to ensure you’re getting it right and making the best move for your retirement. For example, you’ll have to take into account:

Which type of pension is best for you
Should you opt for a stakeholder pension, a personal pension or a SIPP?
Which provider is best for you
Especially in terms of fees and charges, which range from annual management fees to charges for leaving the provider and withdrawing your pension at retirement.
How much you should be contributing
What can you afford in terms of contributions and how will this impact your income, both today and in retirement?
What you should be investing in
Especially if you’re thinking of opening a SIPP, which has the widest array of potential investments, where should you be putting your money?
Your appetite for risk
Similar to choosing your investments, you should also consider your appetite for risk to determine where it’s best to place your pension savings.
Whether you can take your pension as desired at retirement
Does your provider allow for pension drawdown? What about uncrystallised funds pension lump sums (UFPLS)?

With so much to consider when setting up a pension — after all, you’re essentially arranging something that will have a huge hand in your financial future — you can see why many people are concerned about getting it right.

John Spink
Head of Financial Planning at Drewberry

How Much Should I Save into a Personal Pension?

How much you should be saving into a pension depends on the retirement you want to have.

Our Pension Pot Calculator below can work out how much your pension might be worth at retirement given its current size and the contributions you’ll be making across your working life based on three different rates of growth.

This should enable you to see if you’re going to be able to afford the retirement you want or whether you need to make any adjustments to meet your goals and aspirations.

While the calculator can help, it’s no substitute for speaking to an expert and getting a proper financial plan.

At Drewberry, we have the in-house financial modelling software necessary to map out your retirement down to the last penny, showing you exactly what’s going to be affordable and giving you forewarning to make any adjustments to your savings if required while there’s still time.

Will I Have Enough Money at Retirement?

Drewberry has produced an extensive guide on what a good pension pot at age 55 looks like, whether you’re planning to purchase an annuity or enter pension drawdown.

Essentially, if you were 67 tomorrow and looking to retire on an income that replicates the average UK wage then, also taking the state pension into account, you’d need a pension pot worth £370,500 to buy an annuity and almost £600,000 for pension drawdown.

However, when it comes to pensions and retirement planning, there’s no one size fits all approach. It pays to have personalised advice so you know exactly where you’re heading in retirement and can make any adjustments necessary during your working life if it appears you’re not going to get the retirement you deserve.

Pension Pot Calculator

How much will your pension be worth when you retire? Use our Pension Calculator to work it out and get a free copy of our Guide to a Richer Retirement.

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