Personal Pensions Explained: Complete Guide to Personal Pensions in the UK

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What Is a Personal Pension?

Personal pensions are investment plans that you can open independently and contribute to in various specified ways. The process begins by selecting a pension provider and deciding the terms of contributions that will be added to the asset based on the types of pensions the provider offers. Personal pensions are an important part of planning for retirement, especially for individuals who do not have an employer-provided pension plan. This might be the case for someone whose employer is not mandated by law to provide for pension contributions or for those who are self-employed.

If you decide that you would like to begin a personal pension, you have some freedom in deciding what kind of scheme is in your best interest and determining the specifics of your pension contributions. You will also able to pick the specific investments for your contribution from whatever funds are offered by a provider.

Many people have the notion that personal pensions are only for the elderly, but this view is overly simplistic. Personal pensions are designed to enable you to save up for your own retirement. In some types of plans, this can include contributions from your employer or even from the government, while others are maintained solely by the person controlling them.

What Are the Benefits of Personal Pensions?

The benefit of a personal pension is that it allows a person of retirement age to withdraw money from the pot for any of their needs. You can also sell your pension in exchange for an annuity, which simply means that an insurance company will provide you with a regular income for the remainder of your life. Contributing to a pension requires dispensing with some extra earnings now in order to guarantee future income, so it is important to keep this in mind when planning contributions and fitting them into a budget.

The tax relief is immediately available, and most pension assets are tax-free; this means that there is a great incentive for you to contribute. Whether you pay a basic tax rate or a higher one may also make some difference in immediate results, so this is another key factor to consider.

Once you have selected a pension scheme and begun to contribute, your provider will claim a tax relief. This amount will also be added to your pension. Those who are taxed at higher rates may need to claim their tax rebates through their tax returns. It is also important to remember that the interest gained on the principal amount of the personal pension is completely tax-free, and tax rebates are provided for up to 40,000 pounds or 100 per cent of your total annual income, depending on which is lower. Currently, the law provides for up to 2,880 pounds added to pensions per year, with a 20 per cent rebate on the amount of contributions, which is another benefit for those who may not even pay into the tax.

Since the passage of the 2014 Budget, you can withdraw from your pension at the age of 55 with no restrictions. As of April 2015, holders of personal pensions have even more freedom to decide when and how to use the money invested in their scheme.

It is wise to bear in mind that personal pensions are an investment. As such, their value may go up or down over time with market fluctuations. Experts often say that the smartest way to invest is over the long term, which helps to insulate personal pensions from normal or abnormal market fluctuations. It is always prudent to consult with a financial adviser before making any investment decisions.

How Personal Pensions Work

A personal pension pot is built by the contributions you make to the asset combined with government-provided tax relief and returns on the pension investment. Defined contribution pensions can be broken down into two basic categories or modes: the time when you are contributing (that is, during your professional career) and the time you are collecting (after you have retired). While you are contributing to your pension, the asset is most likely invested in stocks, bonds, and company shares. You usually have the choice of which investments to make based on what your pension provider offers. The goal of any pension is to build up the highest possible amount of funds before you reach retirement age. The more money added to the pot over the course of your career, the more funds will be available to you to use as you like during your retirement.

The amount contained in a personal pension at the time of your retirement is reliant on a variety of factors. These include:

  • When the pension was begun.
  • How long you have contributed to it.
  • How successful the selected investments have been.
  • How much your employer is required to invest.
  • What your pension scheme provider has charged in fees through the life of the pension.
  • How much you have contributed over the course of your career.

Types of Personal Pensions

There are various kinds of personal pensions, which can often become overwhelming for people who are new to retirement investing. But this can be beneficial, as it gives a wide range of options that can be tailored to your needs and plans for retirement. Below are the common types of personal pension schemes you may see available.

Self-Invested Personal Pensions

A self-invested personal pension scheme (or SIPP) is the most independent option, and it allows for the maximum freedom for you to decide your investments. You can cut provider costs by doing the majority of financial forethought and planning on your own instead of relying on your provider to walk you through these choices. This kind of personal pension is best suited for those with a good understanding of investments or who have access to a reliable financial adviser to help them learn more about their options.

SIPP Guide

Read: SIPPs Explained: Complete Guide to Self-Invested Personal Pensions

Trust-Based Pensions

A trust-based pension is a scheme in which investments are managed for you by a board of trustees. This kind of personal pension enables you to pass on pension benefits to your partner or dependants. If applicable, your employer can also contribute to a trust-based pension.

Stakeholder Pensions

A stakeholder pension (or SHP) is similar to the pension offered by many employers; it differs in that it has lower minimum contributions and tends to be more flexible with capped fees. SHPs are actually a type of defined contribution pension scheme. Stakeholder pensions require a default investment choice, which means that you do not decide where your money will be invested. You can start or stop your contributions whenever you decide to do so, and the fees your provider can charge are capped at 1.5 per cent.

Workplace or Employer Pensions

A workplace or employer pension scheme is one in which both you and your employer make monthly contributions to the asset until you hit retirement age. There are two kinds of employer pensions, trust-based and contract-based.

Group Pensions

A group pension is one that involves an insurance provider, chosen by your employer, often giving you the ability to choose which investments you would like to make without requiring that the provider act in the interest of the investor.

Defined Contribution Pensions

A defined contribution pension scheme involves regular payments that contribute to the pension, which are then invested into shares and stocks on your behalf. Your pension provider will manage your investments for you.

What Are Some Other Considerations?

It is important here to say a word about state pensions. State pensions are a small income provided by the government once you reach the state retirement age. This pension is earned by paying into the national insurance during your career.

Those deciding which personal pension will best fit their needs and desires during retirement ought to be careful to observe:

  • What fees might be charged by their provider.
  • What rules exist for contributions.
  • Where the money added to the pension will actually be invested.

Many pensions can charge you a variety of setup fees simply to begin your pension account. In addition, the vast majority of pension providers will also charge fees for managing pension assets. This means that you need to carefully choose your provider and weigh the benefits and costs of each one. These provider charges might be either a flat fee, a certain percentage of the total amount of the pension pot, or even both.

Fees tend to decrease as the pension pot increases but are not guaranteed to do so. This is another crucial factor to keep in mind when opening a personal pension since fees can make a real difference in the amount left in a pot by the time you hit retirement age. The goal of a personal pension should be for a retiree to have the maximum earnings and growth available to them for whatever they need or want after they end their professional career.

There are many other rules on pension contributions that regulate how much you must contribute to the pension scheme, the schedule of regular contributions, and whether you must pay a specific lump sum upfront to begin your personal pension. Some pension providers have set rules that necessitate minimum payments on a monthly basis, while others do not. Those that do not require a minimum monthly payment can be especially beneficial in times of unforeseen financial difficulty since there will not be a problem if you find that you cannot keep up with your planned investments.

Different types of pensions also have their own unique rules for how much control you will have over where your money will be invested. Pension providers tend to offer a wide array of choices for investors depending on the amount of money they want to contribute as well as the kinds of financial risks you are willing to take.

This risk aversion is usually broken into three categories: adventurous, balanced, and cautious. Risky investments offer the opportunity to generate more profit but could also result in more dramatic losses. Safer investments, on the other hand, will generate slower profit growth but are naturally far more dependable and predictable. Providers often select default funds for holders of personal pensions who do not want to pick their investments for themselves, though these funds will not be what every investor wants out of a pension asset.

How Much Should I Expect to Add to My Pension Each Month?

Since personal pensions are built primarily on individual contributions, the more an investor adds to a fund, the more they can likely expect to collect when they reach retirement age. A common guide is for you to use half your age as the ideal percentage to add to your personal pension monthly to be sure you are saving enough for your retirement years. This amount can also account for any investments made by an employer or the government. The sooner a pension is begun the better since it will have more time to accrue interest. This is why it is erroneous to say that pensions are only for the elderly.

While minimums often exist in various kinds of personal pension schemes, it is likely a good idea to exceed what is required to build the asset more quickly and increase its profitability over time.

There are many aspects of retirement planning that need to be considered before beginning a personal pension or any other kind of long-term investment. It is always wise to consult an investment or financial adviser who can help work out the best solution for you before you invest. Advisers can help you consider debt, income, the age you would like to retire, and other key factors that could otherwise be overlooked or misunderstood.


Neil has been in the Finance Industry for over 19 years and within that time has undertaken roles within personal and commercial lines insurance. Currently he is a Senior Underwriter in the London Insurance Market where he has worked for 15 years.