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private pension scheme

Private Pensions – Your complete guide

1) What is a private pension?

A private pension is a scheme in which a person or employer contributes to a fund that is separate from a state or employer pension. A private pension is something that you arrange for yourself.

If you have a private pension, then you may need to make important decisions about how and when you wish to receive your funds.

Private pensions are sometimes referred to as personal pensions. Generally speaking, a personal pension is the same as a defined contribution pension. These are pensions based on how much you have paid in. 

Here is a useful video that explains how a private pension works.

2) What are the two different types of private pensions?

  • Defined contribution pension – This is a pension scheme where your own contributions are invested, and the proceeds are used to purchase a pension scheme or other benefits. A defined contribution (sometimes referred to as a DC) with an employee and/or an employee contributing a set amount.
  • Defined benefit pension – This is a private pension scheme based on salary and how long you have worked at a company. This plan means a defined amount put aside for a personal pension.

3) Where to get private pension advice?

There are many places offering private pension transfer advice. These services range from private companies, charities, and government organisation.

A good place to start is Citizens Advice. Citizens Advice is a network of over 300 charities nationwide which support people on a range of different issues. They can be trusted for impartial and knowledgeable support.

The Money Advice Service is another excellent service. Their website can offer private pension advice free of charge. They also have information on other types of pension schemes.

If you don’t already know it may also be useful to know ‘How much is my final salary pension worth‘, as this will give you a good feel as to whether you need advice.  

private pension advice

4) How does a private pension work?

A private pension is set up by you rather than by your employer. You and/or your employer then set up regular payments into an account which can then claim tax relief. It is also possible to make one-off payments.

The money deposited is then invested in various ways. For example, a private pension scheme might invest in shares, bonds, or cash. 

5) How much can I put into a private pension?

You can put as much or as little as you want into your private pension fund. Private pension contributions can be made via regular payments or on a one-off basis.

However, the amount of tax relief you can benefit from is limited.

6) What is tax relief for a private pension scheme and how does it work?

Private pension schemes benefit from tax relief. This means that a portion of your income that would normally go to the government in tax is put into your private pension plan.

If you are a UK taxpayer there are two limits to your tax relief, though only one will apply to you depending on how much you put into a private pension scheme.

In the financial year 2019-20, the rule was that you would get tax relief on up to all of your earnings or a £40,000 allowance. The lower of these two figures is how much you can claim tax relief from. These figures are known as an annual allowance.

For example, if you earn £30,000 and put £31,000 into a private pension scheme, you will get tax relief on £30,000. This is because £30,000 if the lower of the two figures.

On the other hand, if you earn £100,000 and put £35,000 you will get tax relief on the amount of £35,000. This is because it is the lower of the two figures and still below the £40,000 limit.

Any private pension contributions you make over these limits will be counted as normal income tax.

You will also need to be mindful of the Lifetime Allowance which sets the maximum you can pay into a pension scheme. 

private pension contributions

7) How much can I pay into a private pension?

There is no technical upper limit on how much you pay into a pension.

However, there is a limit on how much you can claim as part of a tax break in a private pension fund. This is known as a lifetime allowance. In the tax year 2019-20 the lifetime allowance was a fund of up to £1,055,000 in a private pension fund without being liable for tax.

It is worth noting, though, that once you withdraw from a private pension plan you will pay a 25% tax rate if paid as income or a 55% tax rate if paid as a lump-sum.

8) What is the difference between pension providers?

Private pension providers are quite varied, and many companies offer a variety of different services to those seeking a personal pension. These variations exist between types of investments, minimum investment, and fees.

The annual allowance and lifetime allowance exist the same across all private pension providers. Therefore, as long as the company that you decide to start a private pension with is accredited, you don’t need to worry about variations in tax allowance. However, this should always be checked with each company prior to entering into an agreement.

The range of minimum investment is large. Some companies have a minimum of investment of £1 whereas others have a minimum monthly investment of £25. The amount you are able to invest each month can alter which company is right for you.

Some private pension schemes allow you to choose from a very small number of funds in which to invest, as low as 5, whilst others have up to 2,500 different options.

9) What is the risk between different investor options?

There are many types of risks associated with private pension schemes. These risks can be big or small. It also matters what type of private pension you have opted into: whether defined contribution or defined benefit.

There are three major risk factors associated with private pensions:

  • Contribution risk – the risk that the person(s) paying into a pension do not deposit enough funds to last into retirement
  • Accumulation risk – sometimes asset values do not perform as expected or schemes can default. This risk can be mitigated by choosing lower-risk investment options. However, all investments carry some risk.
  • Annuitisation risk – this concerns defined contribution pensions and involves the various risks associated with projecting life-expectancy and the value of a private pension.

10)   Who is the best pension provider?

If you decide to opt into a private pension a key part of your pension planning will be deciding which provider to use. In the UK there are many private pension providers and there are services online which can help you to decide which is the best fit for you.

The main things to consider are:

  •   How do I wish to deposit funds – is this on a monthly or one-off basis?
  •   If monthly, how much am I able to deposit each month?
  •   How much risk am I willing to accept in the investment of funds deposited?
  •   Are there any ethical considerations when thinking about what type of companies your funds will be investing in? Some pension firms now offer ethical investment options which means that your funds will be invested in companies that are more sustainable, for example.

Therefore, there is no simple answer as to who the best pension provider is. There are many price comparison websites, such as Go Compare, who list providers next to each other in order for you to compare their key characteristics. Ultimately, it is down to you who you decide to create a private pension with. But, there is advice out there to help you find your way. 

pension plan

11)   Are your private pension funds protected?

Private pensions are protected as long as the company holding your pension pot is certified by the Financial Services Compensation Scheme (FSCS). This means that should the pension company that you have deposited money with run into trouble, then all or a portion of your deposits are safe.

The normal level of protection given by the FSCS is £75,000 per person, per institution.

Complications do arise, however, depending on whether you have already retired and, if so, how you have used your pension savings since retirement. Nevertheless, protection is available up to a certain amount regardless of these variables.

If you have savings in a pension fund that then collapses, you can be protected for up to 90% of your pension savings.

Lots of people worry about the possibility of their pension plans being lost. However, there is a low risk of this happening. More advice is available on the government website Pension Wise:

12)   Are pensions worth it?

The simple answer is YES.

The main advantage of a pension plan is tax relief.

This tax relief comes in two forms. Tax back on money paid into a pension. Followed by tax back on all annual contributions if you’re under the age of 75.

This means that you will have more money invested, and so generating a bigger pot for your retirement, compared to keeping money aside funds in a normal current account at a bank.

13)   How to do pension planning

Planning a pension can seem like a daunting prospect. There are lots of companies offering many different types of services and so picking the right option for you may need some careful planning and preparation.

A good start is to decide on how much you can contribute to a pension fund. Would you like to invest on a one-off basis, or would you prefer to deposit smaller amounts over a long period of time?

Once you have decided this then you can begin to look at companies that offer services right for you. Not all companies are designed for monthly instalments and, likewise, not all companies offer one-off deposits.

If you are depositing on a monthly basis then it is important to check that the company you have in mind has a minimum deposit level that is right for you. For example, some companies have a minimum monthly deposit of £25.

The next important step on your pension plan is to think about how you would like to invest. That could be in a higher risk strategy which might create larger wields in the long-term, or in a more low-risk way that would have better security and safety. This is something that you will want to work out with the pension provider you pick.