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Private pensions explained

Understanding your pension options

Read time: 5 minutes

Thinking about how you'll fund your retirement when you stop working? Private pensions are one option to consider

We've teamed up with chosen partner Profile Pensions to help you choose the right private pension plan. They can help you track down and combine your old pensions if you decide it's in your best interests to do so and help you choose the best investment plan for you, using funds from the whole of the market. You'll also get your own dedicated pension adviser to answer any questions you may have. 

As we are living longer – and are healthier and more active in retirement than ever before – it means we need to plan - and save more to fund our later years. 

With concerns about the low level of the government’s State Pension more people are turning to private pensions to ensure they have the funds to enjoy a comfortable retirement. But what are private pensions, and how do they differ from other types of schemes? 

What is a pension?

Pensions can sound complicated and confusing but are simply a wrapper around your long-term savings. The major benefit of a pension over a standard savings or investment account is that you get tax relief on the contributions you make into the pot – which means an extra cash boost for your savings. 

There are different types of pension schemes – the State Pension, workplace or occupational pensions and private or personal pensions.

You can’t usually access a private pension plan until the age of 55 (expected to rise to 57 from 2028). Workplace pensions often have an older retirement age, such as from 60, and the State Pension can usually be accessed from age 66 or older, depending on your date of birth. You can find out your State Pension age through the government’s website.

What types of pensions are there? 

There are three main types of pension – the State Pension, workplace pensions and personal or private pensions. 

  • The State Pension is paid out automatically by the Government when you reach your State pension retirement age. The weekly amount you’ll receive is based on the National Insurance contributions you’ve made throughout your life

  • Workplace pensions are offered by employers and typically both employee and the employer make set contributions throughout the employment period. This money is then investment in a range of assets, such as the stock market or bonds and the aim is it should grow in value over time. If your employer is offering to pay into your works scheme it is usually a good option for you to join – as effectively the employer contributions are like extra pay. The two main types of workplace pension scheme are money purchase and final salary pensions. With a money purchase plan (also known as defined contribution pension and the most common type of workplace scheme), the amount paid out on retirement is dependent on the level of contributions you’ve made into the pension and the investment performance. Pensions linked to your final salary (also known as defined benefit) are rare now and are typically very valuable to the employee as they tend to be more generous – and more predictable – than money purchase schemes, paying out a proportion of your final or average salary

  • Private or personal pensions are set up through a pensions or investment company. You can open a private pension and make contributions into the pot as you wish - either regularly or as a lump sum, subject to certain maximum limits. You can usually choose how your money is invested, but typically personal pensions will invest in a range of stock-market linked funds as well as other assets. In some cases you can consolidate old private or workplace pension schemes into a new private pension if you decide this is the best option for you 

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What is a private pension?

Private pensions - often referred to as personal pensions – mean a pension set up by an individual rather than through an employer or workplace. 

You can set up a private pension with a provider of your choice – typically a pensions or investment company. They may offer plans where the investments and funds are chosen for you, or you can select the investments yourself to put in your pension wrapper.  

The money paid into a private pension is usually invested across several different assets and funds – so this way you’re spreading the risk. These assets tend to include stocks and shares, bonds and cash. The proportion of each will depend on your attitude to risk. 

There will usually be annual fund management and other charges on your private pension, as is the case with most pension and investment products. Always ask your provider about charges – so that you can compare the fees. 

When can I access my private pension? 

You can take the proceeds from a personal or private pension from age 55 (this is expected to rise to 57 from 2028). The money can be taken as a lump sum (but only 25% can be taken tax free), or you can use the cash to buy an annuity – which will pay out a regular income for life. 

Alternatively you can keep your pensions pot invested to withdraw at a later date or keep some invested while withdrawing a flexible income.  

Is a private pension worth it? 

As the State Pension age continues to rise, and the amount paid out by it alone may not afford a decent standard of living, more people are considering private pensions, particularly if they are self-employed or don’t have a workplace pension. 

There are several benefits to a personal pension (many of which are also benefits of workplace pensions), including: 

  • Tax relief: Money saved into a personal pension is subject to tax relief up to maximum permitted limits (see below) - which means a cash boost from the government

  • Access: At age 55, (expected to rise to 57 from 2028) 25% of a private pension fund can be withdrawn as a lump sum – tax-free. Withdrawals from the remaining 75% of the fund can be made to suit your needs and will be added to your overall income for tax purposes

  • Spreading risk: Private pensions tend to offer a wide variety of fund and investment options, with the individual able to choose based on their appetite for risk

  • Availability: Anyone can open a private pension regardless of their working status. You can be an employee (with other pension schemes), be self-employed or not working at all and still invest in a personal pension 

What is tax relief on pensions?

When saving into any pension in the UK, the government boosts the amount you save in the form of pension tax relief. It’s sort of like a reward for investing in your future. 

In England, pensions tax relief is paid at the highest rate of income tax you pay – so either (basic rate) 20%, (higher rate) 40% or (additional rate) 45%. It means that for every £100 in your pension pot this would only cost you £80 with government tax relief paid at 20% - this is for basic rate taxpayers, for example. Higher rate taxpayers would earn even more. Non taxpayers can get the 20% tax relief. Your private pension company will claim the tax relief on your behalf.  

In Scotland, income tax bands vary slightly and so the pension tax relief could be even higher – making it even more of an incentive to save! It is important to note there are rules regarding the amount you can contribute into your pension.  

There is a cap on pension tax relief which currently stands at 100% of your income with a maximum of £40,000 of contributions per tax year (for 2021-22). Any pension contributions made over this maximum limit will be taxed at your relevant income tax banding.There is also a lifetime allowance (LTA) of £1,073,100 which is the maximum value of pension benefits you can  build up without incurring an additional tax charge. If you are unsure as to whether these rules apply to your contributions, you should seek professional advice.

What's the difference between a private pension and a self-invested personal pension?

A self-invested personal pension (known as a SIPP) is a type of private pension where you make all the investment decisions, rather than the pensions provider, about which funds and assets you put your money into. This gives you more control and flexibility over your long-term savings because you can pick and choose where you invest. 

In contrast with a 'standard' private pension you’ll usually be offered a few different investment options – but you won’t have the same level of choice and flexibility within the different fund wrappers.

As with many pension options, it is a good idea with a SIPP to seek the advice of a specialist pensions financial adviser, to ensure you’re investing in a way that suits your attitude to risk. 

How much should I put into a private pension?

How much you should pay into your pension pot depends on a range of factors – such as your income, your age now and at what age you want to retire. 

You also need to think about what level of income you might need in old age – taking into account your State Pension and any other pensions and savings you may have. 

As a general rule of thumb, financial advisers recommend saving either 10 times your average salary or 12.5% of your monthly income - whichever is higher. Generally, personal pension investors are aiming to receive around 60-70% of their final working salary from their pension when they retire. Think about what day to day costs and outgoings you’re likely to have in retirement, looking at your current lifestyle and read more in our guide to retirement planning.

But remember many in retirement may want to travel more or take up new hobbies, which could lead to higher expenditure.  

How can I calculate my pension?

With our pensions calculator, you can get an idea of much you might have saved in your pension pot by retirement. All you have to do is answer a few questions, then you'll see an estimate of what to expect from your pension at retirement, including your estimated annual income.

How do I start a private pension?

Setting up a private pension can be quick and simple online. But it is a good idea to take some time to do your research first. You don’t need a financial adviser or broker to arrange a private pension. But getting expert and impartial advice is a good idea if you're not a confident or experienced investor - although this will come with an added cost. 

We have teamed up with chosen partner Profile Pensions to help you choose the right private pension plan. They can help you track down and combine your old pensions if you decide it's in your best interests to do so and help you choose the best investment plan for you, using funds from the whole of the market. You will also get your own dedicated pension adviser to answer any questions you have. 

Capital at risk. This website does not constitute personal advice. If you are in doubt as to the suitability of an investment please speak to a financial adviser. Prevailing tax rates and reliefs are dependent on your individual circumstances and are subject to change. Ltd is an Introducer Appointed Representative of Profile Pensions, a trading name of Profile Financial Solutions Limited which is authorised and regulated by the Financial Conduct Authority. FCA number 596398. Registered in England & Wales, Company Number 07731925. Registered office address: Norwest Court, Guildhall Street, Preston, PR1 3NU.

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