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Published 15 April 2024
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Personal Pensions: What Are They and How Do They Work?

A personal pension is a private pension that you can set up for yourself, outside any workplace scheme. Open a personal pension plan and your contributions could be boosted by tax relief too.

Preparing for retirement is always important, and a personal pension can help you along the way if a workplace pension isn’t available to you. The plans that personal pension providers offer can be straightforward and flexible to try to make it as easy as possible to save for your retirement.

What is a personal pension?

A personal pension is a form of defined contribution pension. It is an option if you are self-employed or don’t qualify for a workplace pension, but it is also possible to open a personal pension plan to sit alongside a workplace pension if you so wish.

How a personal pension works

What you pay in is invested to try to grow the pension fund you will have at your disposal at retirement – tax relief on contributions provides a valuable boost as well. The value of your personal pension will depend on how much you have paid in and the performance of the pension funds that you invest in.

You will usually have the ability to monitor your progress online and switch investments if you see fit. Your personal pension provider will also send you an annual statement with details of how much your pension is worth.

» MORE: Everything you need to know about pensions

How does personal pension tax relief work?

The contributions you make into a personal pension are eligible for tax relief. That means your pension provider can claim 20% from the government as basic-rate income tax relief and add it to your pension pot. So if you pay in £80 yourself, a total of £100 will be added to your pot once tax relief has been applied. If you pay the higher or additional rate of tax, you can claim the remaining tax relief you are entitled to through your tax return.

» MORE: All about pension tax relief

Are there limits on personal pension contributions?

You can pay up to 100% of your earnings into your pension each year up to a limit of £60,000, while still benefiting from tax relief – this is known as the annual allowance. The limits are different if you have adjusted earnings above £260,000 a year, have already withdrawn money from a pension or earn less than £3,600 a year.

Although the lifetime allowance was abolished in April 2024, lump sum allowances have been introduced, meaning you may incur a tax charge if you exceed certain limits.

For the 20245/25 tax year, the ‘lump sum allowance’, which is related to the benefits you take from your pension, stands at £268,275 and the ‘lump sum and death benefit allowance’ is £1,073,100. However, if you have certain lifetime allowance protections in place, the limits could differ.

» MORE: Pension contribution rules and limits

Who can contribute to a personal pension?

Anyone can contribute to a personal pension, so you could pay into your spouse’s pension to ensure they have an income in later life. Non-taxpayers can pay a maximum of £2,880 into a pension each year, which after tax relief at a rate of 20% will be boosted to £3,600.

These rules also extend to children, meaning parents can set up a pension for their child. This is also something grandparents may want to do, but the account would need to be opened by a parent or guardian.

» MORE: How to set up a pension for a child

Can my employer pay into my personal pension?

If you set up a personal pension for yourself, your employer is not obliged to pay into it. For this reason, if you qualify for a workplace pension, it may be preferable to join this rather than arranging your own personal pension.

However, some employers may still offer to pay into a personal pension that you have set up on your own or a previous scheme you are part of. Ultimately you need to check with your employer about their policy to be sure of your personal situation.

When can I draw my personal pension?

When you turn 55, you can start to access your personal pension; this will increase to 57 in 2028. You can take 25% of your pension as a tax-free lump sum, or you can make smaller withdrawals where the first 25% is paid tax free and the remaining 75% taxed at your own marginal rate of income tax.

Although it is your age rather than your working situation that dictates when you can access your personal pension, it is sensible to avoid dipping into it before you retire if you can. This not only maximises the amount of time your money has to grow but it also reduces the risk that you will run out of money.

Once you start accessing your personal pension, it is a good idea to get financial advice to make sure you use your pension savings wisely and endeavour to make them last as long as possible.

There are a number of options to turn your pension pot into an income including buying an annuity or going into income drawdown, or a combination of both.

» MORE: Taking an income using pension drawdown

How to open a personal pension

Opening a personal pension plan should be relatively easy if you follow these steps:

1. Choose a personal pension provider

Different personal pension schemes might carry different fees and charges, all of which will affect the final size of your pension pot. Annual fees can be fixed or a percentage of your fund – fixed fees are usually preferable for large pots, and a percentage charge might be preferable for smaller pots. Expect to be charged for trading in and out of funds as well.

2. Make your investment choice

The investment options on offer can vary between personal providers. So if you have an idea of the type of fund you would like to invest in, make sure it is available through the personal pension plan you are considering. If you are not sure where to begin, personal pension providers usually offer ready-made investment portfolio options, based on how much risk you are prepared to take on. For example, you may be able to choose between a balanced, cautious or adventurous fund.

However, standard personal pensions may not offer all investment options. If you want to have complete control over where you invest and the ability to put your money into shares, investment trusts, gilts, bonds, commercial property or exchange traded funds (ETFs), you might want to consider getting a self-invested personal pension (SIPP) rather than a simple personal pension.

» MORE: What is a SIPP?

3. Contributing and managing your personal pension

To open a personal pension, you will need to have your bank details and National Insurance number to hand. Once your personal pension is set up, you can choose to make regular contributions via a direct debit as well as one-off payments. Your pension firm will claim basic-rate tax relief from the government and automatically add it to your pension pot. Higher-rate and additional-rate taxpayers can claim their remaining tax relief back via their tax return.

Who offers personal pension schemes?

When looking for a personal pension provider, insurance companies, banks, building societies and brokers are all options to explore. Shopping around for your personal pension plan is essential to make sure you are getting a good deal in terms of charges and that the investments you want are on offer.

What happens to a personal pension when you die?

Generally, if someone dies under the age of 75 they can pass on the pension benefits tax-free. If you are over 75, there will be income tax to pay on what is passed on.

If you die after buying an annuity with your pension pot, what happens will depend on the type of annuity you have bought. Your dependants may get an income or a lump sum paid to them or they may get nothing at all.

» MORE: Learn about your pension and passing on

How many personal pensions can I have?

There is no limit on the number of personal pensions you can have. This means you could have a personal pension as well as a workplace pension and a SIPP.

But remember you cannot pay more into your pensions overall than your annual allowance and continue to benefit from tax relief – you don’t get an annual allowance for each pension.

WARNING: We cannot tell you if any form of investing is right for you. Depending on your choice of investment your capital can be at risk and you may get back less than originally paid in.

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