What is a Private Pension? Personal Pensions Explained

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The key benefit of saving into a private pension is tax relief. Contributions receive 25% tax relief for those on the basic rate, and they are free from inheritance tax if you start accessing your pot before you reach age 75. You can also take 35% of your pension tax-free once you reach age 55, but you cannot draw before this point, or you’ll pay hefty penalties.

For most people, relying solely on the basic State pension will not provide a suitable standard of living in retirement. Supplementing your retirement income with a private personal pension can mean the difference between just surviving and really living.

Typically, private personal pensions are defined contribution arrangements (sometimes called money purchase), which means the account holder bears all the investment risk. The size of the final pot depends on what you paid in and how well the investments performed.

Private personal pensions differ from workplace pensions set up by an employer into which they will also contribute.

Different types of private pension

Private pensions are usually one of three types:

  • Personal Pensions: Personal pensions are offered by major pension providers offering access to a range of asset classes, which are invested on the member’s behalf once they have chosen their funds. Charges vary between providers, as do contribution levels.
  • Stakeholder Pensions: Stakeholder pensions have low and flexible minimum contributions, and charges are capped at 1.5% a year of the value of your pension pot in the first ten years, then 1% a year. Stakeholder pensions offer a default investment strategy, which take away the need to make investment decisions.
  • Self-invested personal pension (SIPP): Self-invested personal pensions or SIPPs operate like a standard personal pension but offer more flexibility with the investments. They are generally more expensive than their other private pension counterparts, and you need to understand how investments work, research where to put your money, and spend time managing your portfolio.

Related Guide: Best SIPP Providers Compared, Ranked & Reviewed

Investments you can hold in a private personal pension

You can invest in a wide range of financial markets with a private pension including:

  • UK shares
  • International shares
  • Funds
  • ETFs
  • Bonds
  • Property
  • Cash

Investment accounts like Hargreaves Lansdown, AJ Bell and Interactive Investor will give you the most control over what you invest in where you can choose exactly what shares, funds and bonds to invest in.

Whereas robo-advisors (or digital wealth managers as they like to be called) like Wealthify, moneyfarm and Nutmeg let you invest in pre-made portfolios consisting of ETFs which cover a diverse range of markets including shares, bonds, and stock market indices. The downside is that you cannot pick individual shares, but the main benefit is that if you are not a confident investor or don’t have the time to research your own investments they do the hard work for you.

You can deposit funds into your private pension by debit card or direct from your bank, and you can opt to increase – or decrease – contributions when you need to, if minimum payment levels are not breached.

Anyone can open and pay into a private pension, and you can also pay into other people’s plans. Your employer can also pay into your personal pensions, but they do not have to. They are only obliged to offer and contribute to a workplace pension scheme.

Most private pension plans can be opened online. Providers will ask you to complete a form and the plan can be open within minutes. You will need to think about how much you can afford to pay in – some providers will ask for minimum payments – and decide on the amount of investment risk you want to take.

Private pensions tax benefits

Private pensions are arguably the most tax-efficient way to save and invest for retirement in the UK.

  • Government top-up: When you pay into a personal pension from your net pay, the Government automatically adds 25% as a top-up for basic rate tax relief. If you’re a higher or additional rate taxpayer, you may benefit from even more tax relief.
  • No capital gains tax: In addition, any returns made on the investments in your pension are free from capital gains tax.

Advantages of private pensions

  • Tax relief – private pensions are the most tax-efficient way to save for your retirement
  • Compound interest – the earlier you invest the greater your potential returns can be
  • Employer contributions – your employer will top up your pension contributions
  • Guaranteed retirement income – if you buy an annuity to provide you with regular income

Disadvantages of private pensions

  • No access till 55 – when you invest in a private pension you cannot access your money until you are 55
  • Underperformance – if you choose your own investments you run the risk of picking investments that do not perform as well as those chosen by a professional investment manager
  • Complex – private pensions are not for everyone so if you do not understand pricing structures or suitable long-term investment products that can be hard to understand

Private pension annual allowances:

The Government sets limits on how much you can pay into your pension, there is an annual alliance, lifetime and money purchase allowance.

  • Annual allowance: The annual allowance is the limit of how much you can contribute to your pension each year and still receive tax relief. This is currently set at £40,000 a year.
  • Lifetime allowance: There is also a lifetime allowance, currently set at £1.0731 million. After this level, a lifetime allowance charge is applied at 25% if the pot is retained to pay benefits. If the member takes the pension as a lump sum, they will pay 55% on the amount that exceeds the lifetime allowance.
  • Money purchase allowance: If you take more than your tax-free cash from your pension through flexible retirement income or as a lump sum, you may only receive tax relief on contributions to your pension pots of up to £4,000 a year, instead of the normal £40,000 annual allowance. This is known as the Money Purchase Annual Allowance.

Fees & charges for personal private pensions

Fees and charges vary considerably between providers. Moneyfarm charges 0.35% while Nutmeg’s fee is 0.75%, but the services and fund choices will also vary between providers.

It is important to remember that low fees do not necessarily mean the best value. Paying lower fees for poor performance may prove a false economy, but excessive fees can decimate a pension fund. For example, assuming a pension pot value of £50,000 growing at 5% a year, reducing your charges from a high level of 1.2% to a very reasonable 0.4% could save you £23,000 over 20 years. Make sure you explore precisely what is included in the costs and what impact these have on the likely final pension pot.

Some providers charge for setting your pension up, but this is not a universal charge, so it makes sense to shop around.

Other charges include platform fees, which cover the administration of your pension. They’re usually charged as a percentage of the money you’ve saved.

  • Annual Management Charge: The annual management charge (AMC) pays for running and administering your plan, and for investing contributions. The AMC is charged as a set amount or as a percentage of the value of your pension investments. Each investment tends to have a different annual management charge to reflect the type of investment fund. Some are more specialist or are more actively managed, and they often have higher charges. An annual charge above 1% is generally considered expensive for a basic personal pension. For fully managed SIPPs with significant fund charges and financial advice included, fees can often exceed 1%.
  • Exit Penalties & Fees: It is likely that you will pay an exit fee if you want to transfer your pension to a new provider. These vary from company to company – and even between products within the same provider – and can be as much as 10%, which might negate any benefit of leaving. You may also incur an early exit fee to cover the long-term management and handling charges over the life of the pension. Exit fees and penalties are not always clear, so it is important that you read the small print before making any decisions.
  • Ongoing fund management charges: There is also an ongoing charges figure (OCF), which covers the day-to-day costs of running an investment fund that is included in your pensions. It’s usually charged as a percentage of the value of your investments.

Accessing your private pension

As soon as you reach age 55 (rising to 57 in 2028), you can access private personal pension savings.  The rules allow you to take 25% tax-free and the remaining 75% is taxed at your marginal tax rate. There’s also generally no inheritance tax payable on a personal pension unless it’s first accessed over the age of 75.

The amount in your retirement pot will depend on your contributions and how well the market has performed.

There is a lot of flexibility about how you take the money out of your pension, but what you can do will vary depending on your provider.

Private pensions can be taken as a lump sum or remain invested, allowing you to draw what you want when you want (this is known as income drawdown). Income drawdown costs vary and can include Set-up/ administration fees, charges for the withdrawal of a tax-free lump sum and then fees for each additional withdrawal, as well as ongoing management charges.

PensionBee offers flexible drawdown and does not charge you fees unless you decide to make a full withdrawal of your pension within one year of your first transfer. If your pot has been with them for less than a year and you wish to withdraw it in full, they charge a fee of £480.

Hargreaves Lansdown also offers a drawdown with no set-up fee and does not charge if you aren’t withdrawing or you are holding cash. The yearly charge for holding investments is 0.45%

It is no longer compulsory to buy an annuity, but they are an option if you want a guaranteed income for life.

Private pensions versus SIPPs (Self-Invested Personal Pensions)

Private pensions often invest in funds managed by investment professionals whereas SIPPs are managed by you.

A SIPP is a type of personal defined contribution pension that allows the member to choose where to invest their contributions. Unlike in a traditional personal pension where investments are limited to those offered by a pension provider, a SIPP might offer access to a broad range of asst classes, including stocks, bonds, commodities, commercial property, private equity, and even fine wines or classic cars. The range of assets offered will vary between providers.

A SIPP provider administers the SIPP on the member’s behalf. They provide access to a range of funds, take the contributions, and ultimately pay out the pension. The provider charges for this service and fees vary between companies.

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