According to the Pensions and Lifetime Savings Association, the average UK pensioner needs at least £12,800 a year to meet the minimum living standard.
At just over £10,600, the State Pension doesn’t cut it now and is unlikely to do so in the future. A private pension scheme is seemingly necessary for a comfortable retirement.
Private pensions are a type of pension that you or your employer set up for, as opposed to the state pension.
Private pensions can be defined contributions or defined benefits.
Personal pension pots also qualify for tax relief but don’t offer all the tax perks of a workplace pension.
Private pensions are great as additional retirement income for regular employees or a safety net for the self-employed.
What Is a Private Pension?
Unlike the state pension, you or your employer can set up a private pension to save for retirement. The rules for making contributions and saving vary depending on the plan.
How Do Private Pensions Work?
Private pensions can be:
Workplace or group personal pensions that your employer sets up for you
Personal pensions that you set up for yourself
Now let’s get into the difference between the two.
Workplace pensions include obligatory auto-enrolment. They also pick the provider and do most of the work, while you can decide on the details of the scheme or fund. Both you and your employer make regular contributions to the pension pot, while the provider manages the investments.
Personal pensions, on the other hand, require you to set everything up for yourself, and your employer usually has nothing to do with it (although they are allowed to contribute).
There’s another division of private pensions you need to know:
Defined benefit (you get a guaranteed amount of money for life, workplace only),
Defined contribution (you build up a pot, and the money gets invested, your pension size depends on money paid in, the market and so on).
While defined benefit sounds simple and safe, most of us get defined contribution pensions.
The pensions that you set up for yourself are always defined contribution pensions. This means:
You contribute to a pot of money for a number of years,
You pay charges for keeping your money in the fund,
You or the pension fund manager invest the money to grow,
It may increase or decrease in value depending on market circumstances,
When you reach your retirement, you decide the withdrawal terms so your pot lasts to cover your needs.
When Can I Access My Pension?
People can currently access their pension from the age of 55 (will be 57 after 2028). This is the so-called normal minimum pension age.
Hopefully, you won’t need to use the money before that. However, there are some cases in which you can access your pension earlier:
Early medical retirement,
You qualify for a protected pension age,
Your personal pension scheme allows it (usually with high penalties).
Benefits of a Private Pension
Saving for retirement
Although there are other ways to save for retirement, a private pension is a financial product designed solely for the purpose. Also, with a personal pension, you get additional safety if you’re self-employed or a homemaker.
Tax relief
Saving into a private pension lets you pour back tax relief directly into your pension pot. At the basic taxpayer rate (earning below £50,270), you get 20% (19% in Scotland), while you can claim extra tax relief on your return (another 20%) if you’re a higher-rate taxpayer (earning above £50,271).
Flexibility
Private pensions offer flexibility in terms of deposit size and frequency, as well as independence in investment choices, allowing you to find a solution that is ideal for your needs. Additionally, you have the freedom to choose how to access the funds once you reach the pension age.
Types of Private Pensions
The types of private pensions include standard personal pensions, stakeholder pensions, and self-invested personal pensions (SIPPs). Personal pensions can also be arranged by workplaces as workplace pensions, which are known as group personal pensions.
Standard Personal Pensions
Most pension providers offer standard personal pensions with different investment profiles available. They usually come with a wide range of investment choices.
- Wide range of investment choices
- Suitable for self-employed people with a regular income
- No cap on annual charges
- Might be better to invest in a workplace pension if you have an employer
Stakeholder Pensions
Stakeholder pensions are ideal for self-employed people and people with lower or irregular incomes. The charges are legally limited to 1.5% per year for the first ten years, and 1% afterwards. It's also worth noting that you can usually transfer your pension for free.
- Capped charges
- You can transfer your pension for free
- Low and flexible minimum contributions
- Limited investment choice
- They are not very common, only a few pension providers offer them
SIPPs (Self-Invested Personal Pensions)
Individuals with investing experience who want independence in making their investing choices can make the most out of a SIPP account. They have the widest investment choice of all pension plans, but also higher fees. Full control over investments also means you will have more work managing the pension.
- Full control over investments
- The widest choice of investments
- Potential for higher returns
- More management on your part
- Often higher fees
- Potential losses in case of an investment mistake
Setting Up a Private Pension
If you're interested in starting a private pension, you have two options: conducting your own research or seeking guidance from a pension adviser. The government also provides some free options to assist you. Regardless of your choice, there are several important factors you need to take into consideration.
Compare Pensions
Starting your pension is one of the most important financial decisions you’ll make, so make sure to shop around before settling for a pension plan. You can choose to do this on your own or contact a pension adviser who can set you up with a pension that’s best for your needs.
If you do choose to do it on your own, remember to ask providers for a key facts document. It summarises the most important information on their pension plan. If they fail to provide this document, it creates grounds for complaint.
Explore your investment options
First, think about the way you want to handle investments. A SIPP offers you full control, whereas standard personal pensions can give you some investment choice, or offer you a choice of several funds that follow different investment strategies.
For example, if you’re early in your working life, you can choose funds that are higher-risk but promise higher returns, and move to low-risk funds as you age.
Stakeholder pensions have a limited choice of investment assets that are usually low-risk, but this can come at the cost of potentially lucrative investments.
As a pension is a long-term investment, make sure you are comfortable with the level of risk you’re taking.
Consider charges
The costs of keeping a pension pot will depend on the combination of all these charges. Common charges include:
set-up fees,
administration fees,
transfer charges,
management charges,
penalties for early access or missed payments.
While charges may seem low on paper, they accumulate over the years and can take a significant cut into your pension. If you have several pensions, it’s often best to transfer them all into one pot to save on fees. Also, funds with a wider investment choice typically come with higher fees.
Stakeholder pensions have limited charges, although they are not always the cheapest on the market.
Transfer your existing pensions
There is no limit to the number of pensions you can have, but keeping track of all of them can be a hassle. This is why it’s easier to combine pension pots into one or two larger pots. It can also save you money by reducing the number of administration fees and other charges you need to pay.
While stakeholder pensions can be transferred at no cost to you, other pension schemes often come with transfer charges. Make sure to have a long-term strategy before you commit to several pensions so you don't lose valuable benefits or money as you change providers.
Nominate someone to inherit your pension
You’ll need to decide who inherits your pension when you pass away. Get familiar with what your pension scheme allows in this case, as some payments are only available to dependants, like your spouse, civil partner, or a child under 23.
Choose a payout option: annuity or drawdown
Not all pension schemes offer annuities or guaranteed regular income, or they may not have the best rates. This is important to check as once you settle for some types of annuity, like a lifetime annuity, there’s no way to change your decision.
On the other hand, if you opt for a drawdown pension (taking lump sums and keeping the rest invested), you can, and should, review your decision and compare rates and conditions regularly as you can change your provider. This can help you get better value from your pension pot.
Are There Alternatives to Private Pensions?
Stocks and Shares ISAs
Stocks and shares ISAs are useful if you need to save money for larger purchases, such as houses or cars. One benefit to S&S ISAs is that you can withdraw money more easily before 55. However, pensions have the benefit of tax relief, with the government practically adding money into your pension pot (that would otherwise be paid through income tax).
Savings
Savings accounts have the advantage of setting a fixed date and using your money when you need it. This makes them more flexible than pensions which can be accessed without penalties only after age 55.
However, you’ll be missing out on the 20% government tax relief that you’d get with a personal pension. In the end, it all comes down to what you want to achieve with your investments.
Property
While property, especially buy-to-let, is a valuable asset, saving for retirement is still better achieved with a personal pension. Along with tax relief, pensions have lower volatility as they invest in diverse assets, while property can pose risks. Also, apart from charges, pensions do not come with further costs, such as repairs or taxes.
In a nutshell, private pensions are a necessity in the UK. With different types of pension schemes, you can choose how and where to invest, how to make contributions, and how to withdraw money in the end.
The abundance of private pension plans also makes it difficult to choose. Here are some further resources:
Good luck with your pension planning!
