Personal Pension Plans
One popular method of saving for retirement is to use a “personal pension plan”. This is a tax-efficient savings vehicle for building a fund from which to take a lump-sum and/or income in retirement.
It offers a number of tax benefits which will be covered later in this article.
What is a Personal Pension?
A personal pension is a regulated investment plan into which regular and single premium pension contributions can be made. Money paid into a personal pension plan by an individual qualifies for tax-relief at source – basic rate relief is given – for example, invest £80 per month and £100 per month is actually credited to your pension plan.
The pension company effectively reclaims basic rate income tax from HMRC on your behalf.
Higher rate taxpayers may be able to gain an additional 20% tax-relief on their contributions by completing an annual tax return.
Money invested in a pension plan is typically invested in a fund or funds – these are usually pooled investment/pension funds where the fund manager takes the money of all those invested in the fund and buys a wide range of stocks, shares, property etc depending on the nature and aims of the pension fund.
These investments could be shares, government stocks, corporate bonds, fixed interest investments, commercial property etc. both here in the UK and overseas. The choice of where and into which funds to invest is down to the policyholder.
Alternatively they may choose to invest in a managed fund – which may be a “fund of funds” – in this scenario a fund manager will invest in a range of other pension funds in line with that funds investment goals and a stated attitude to investment risk.
How much can I invest?
It is possible to invest up to 100% of your salary/earned income in to a personal pension plan, although there is an annual maximum contribution allowance of £235,000 and a lifetime allowance of £1,650,000 – the implications of exceeding these allowances will be covered in later articles.
How do they work?
Your money is invested, either on a single or regular basis, into a fund(s) which you hope will grow between now and retirement. At retirement you have options in terms of taking benefits
Under normal personal pension rules it is possible to take up to 25% of your accumulated fund at retirement as a tax-free lump sum – this is known as a “pension commencement lump sum”
The remaining fund is then applied to provide you with an income in retirement and there are two main options open to you in respect of taking this retirement income from your pension plan.
Most people will be familiar with a “pension annuity” – this is an income for life. Basically you exchange your remaining pension fund, after tax-free cash, for an income for life from a pension company.
This income is taxable in retirement, but remember that even retired people continue receive a personal allowance against income tax.
You don’t have to take your pension annuity with the company with which you built up your pension pot – under the “open market option” you are allowed to shop around for the best pension deal – more information on annuity purchase will be given in a separate article at a later date.
Warning – before transfering your personal pension plan to another providers for a “better” annuity rate you should enquire as to whether your current plan contains guaranteed annuity rates – these are sometimes in excess of those available on the open market and over the years we have seen some in excess of 9% per annum depending on the basis on which you take your pension – always seek independent financial advice before taking or transferring benefits to another pension provider.
The second option is known as “unsecured pension” (previously known as “income drawdown” – this is riskier than annuity purchase as your pension fund remains invested and you effectively draw an income from your pension fund.
The government sets limits on the amount of income you can drawdown under this type of arrangement and typically the level of income available is greater than that available under an annuity.
There is a risk though – recent stock market drops have seen many “income drawdown” holders see large reductions in the size of their pension funds, a fall in value which has been escalated by them taking a fixed level of income from the pot – this fixed income becomes an increasingly burden on a falling pension fund.
You should seek specialist advice if you are considering using the “income drawdown” option due to the nature of the risks involved as this type of pension benefit might not be suitable for you.
When can I take pension benefits?
Benefits under a personal pension used to be available between the ages of 50 and 75 – this is changing however and the earliest retirement age is moving to 55 from 6th April 2010.
Tax benefits of a personal pension
As mentioned already, you receive tax-relief on premiums paid into a personal pension plan. Indeed even with out income, a person can contribute up to £3,600 gross per annum into a personal pension and still receive tax relief on premiums invested – in this scenario you would actually invest just £2,880 and the pension provider would reclaim the difference from the HMRC (tax man) on your behalf.
The pension fund grows in a tax-efficient manner with all gains under a personal pension plan being free of capital gains tax.
Choice of investment
Most providers offer a wide range of funds into which you can invest your money. You should consider taking independent financial advice to help in choosing a pension provider and investment portfolio – the adviser will discuss your aims and goals with you, as well as your attitude to investment risk as this will help determine the choice of funds most suited to your requirements.
SIPP – Self-Invested Personal Pension
A SIPP is simply a special type of personal pension plan – it operates in just the same way as a personal pension plan in terms of tax-efficiency, contribution limts, access to benefits etc, it’s main difference being that it has a much broader range of options in terms of where you can invest your pension money: –
Stocks and Shares
Futures and Options
Unit Trusts and OEICS
Traded Endowment Policies
The range of investments under a SIPP is therefore considerably wider than under a personal pension plan. With some specialist SIPP’s however the charges incurred can be higher.
You do not have to keep your personal pension plan with one provider, and indeed you can have more than one personal pension plan at any one time.
From time to time you may consider moving to another provider – for example, the new provider might have a wider fund choice, more competitive charges, better customer service.
Before transfering to another provider it is important to take Independent Financial Advice to ensure that you are not giving up any valuable guarantees under the existing pension plan, such as a guaranteed annuity rate with your current provider.
This article has given an insight into the workings of a personal pension plan and in subsequent articles we will consider some of these areas in greater depth.