Personal Pensions: Another Way to Save for Retirement
A personal pension is a private pension that you set up yourself, outside any schemes you are eligible to through your workplace.
A personal pension is an alternative way to save for your retirement if you don’t have access to a workplace pension. It gets you a top-up from the government every time you pay money in, and can help pave the way to a more financially secure retirement.
What is a personal pension?
A personal pension is a form of defined contribution pension. It is a great option if you are self-employed or don’t qualify for a workplace pension.
Everything you pay into a personal pension is subject to tax relief. That means whatever you pay in, your pension provider will claim 20% from the government to refund the basic-rate income tax you have paid on your contribution 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
Unlike with a workplace pension, there are no employer contributions in a personal pension, so many people opt for a workplace pension first if they qualify for one.
How does a personal pension work?
First, you choose your pension provider. Then you decide what your pension will be invested in by selecting from their fund range, based on how much risk you are prepared to take on. For example, you may get to choose between a default, cautious or adventurous fund.
If you want to have complete control over what you invest in 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 traditional personal pension.
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 pot. Higher-rate and additional-rate taxpayers can claim their remaining tax relief back via their tax return.
You can pay up to 100% of your earnings into your pension each year up to a limit of £40,000 (known as the annual allowance). The limits are different if you earn more than £150,000, have already withdrawn money from a pension or earn less than £3,600 a year.
There is also a limit on how large your pension pot can become. The lifetime allowance states that your pension pots can’t be worth a total of more than £1,073,100. If you exceed this or any of the allowances, you’ll have to pay an additional tax charge.
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 wealthy 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.
When can I access 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 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 best 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 of you running out of money.
Once you start accessing your personal pension it is a good idea to get financial advice in order 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.
What happens to my personal pension when I die?
If you die without having accessed your pension, it can usually be passed on to your beneficiaries tax-free.
Generally, anyone under 75 and drawing an income from their pension can pass on the drawdown 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 dependents may get an income paid to them, or a lump sum paid to them or they may get nothing at all.
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 the balance across all your pensions cannot exceed the lifetime allowance, which is currently £1,073,100 and you can’t pay more into your pensions than the annual allowance (£40,000).
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Ruth is a freelance journalist with 15 years of experience writing for national newspapers, magazines and websites. Specialising in savings, investments, pensions and property. Read more