What is a Personal Pension?
Personal pensions may be suitable if you're employed and not in a company pension scheme, or as an addition to a company pension. You may also wish to set up a personal pension if you are self-employed or if you are not working but can afford to put aside money for retirement.
You pay a regular amount (usually monthly or annually), or a lump sum to the pension provider who will invest it on your behalf.
Funds are usually run by financial organisations like building societies, banks, insurance companies, and unit trusts companies.
The final value of your pension fund will depend on how much you have contributed and how well the fund's investments have performed. The companies that run these pensions charge you for starting up and running your pension. Charges are normally deducted from your fund in the form of fund management charges.
Contribution Levels and Tax Relief
The Annual Allowance for pension contributions is £40,000pa from 6 April 2017. This figure includes both employee and employer contributions.
Tax relief will continue to be at the individual’s marginal rate. This means that high-earning individuals will be able to receive up to 45% tax relief on their contributions.
You can carry forward unused contributions from the previous three years (ie. back to 2014/2015 for 2017/18), potentially allowing contributions of up to £160,000 in a single year. HMRC has confirmed that you do not need to have made a contribution to a registered pension scheme in a year to be able to carry forward unused annual allowances – an individual must have been a member of a registered pensions scheme during the earlier tax year. The definition of a ‘member’ includes an active member, a pensioner member, a deferred member; or a pension credit member.
If you wish to carry forward unused annual allowance from previous tax years, you will need to have used up the annual allowance for the current year.
For each pound you contribute to your scheme, the pension provider claims tax back from the government at the basic rate of 20 per cent. In practice, this means that for every £80 you pay into your pension, you end up with £100 in your pension pot.
If you're subject to the higher tax rate of 40 per cent (up to 45% with additional rate tax), you'll still get 40 per cent tax relief for any money you put into your pension. But the way that the money is given back to you is different:
- The first 20 per cent is claimed back from HMRC by your pension scheme in the same way as for a lower rate taxpayer.
- It's up to you to claim back the other 20 per cent if you're a higher rate tax payer or 25 per cent if you're an additional rate tax paper when you fill in your annual tax return, or by contacting your Tax Office.
- If you don't pay tax, the most you can pay in with tax relief is £2,880 a year. But you'll still get basic rate (20%) tax relief, meaning the government will 'top up' your contribution so that £3,600 is invested.
- Your pension fund will invest the money you save (including the tax relief amount) in your pension. Your pension fund growth may be free of tax.
- Any rise in the value of the scheme's assets between what you put in, and what they're worth at the end, is called 'capital gains'. This is tax-free.
Drawing your Personal Pension
You can take a pension commencement lump sum of up to 25% of the value of your pension savings, which is currently tax free, when you retire (up to a maximum of 25% of the lifetime allowance). The lifetime allowance for the tax year 2017/2018 tax year is £1 million.
You then have two main options:
- Use the rest of the fund you have built up to buy an annuity (a regular income payable for life) from a life insurance company. This does not have to be the same company that you have your pension plan with.
- Take an income (taxed at your normal Income Tax rate) from the remainder of your fund while it remains invested.
It should also be remembered that under the new pension flexibility rules, one off lump sums may be available to be taken from the pension plan from age 55 onwards. These lump sums will be available subject to the scheme rules allowing, and there will be taxation issues to consider if income is taken.
Putting money into someone else's personal pension
You can put money into someone else's personal pension (eg. your spouse/partner, child etc). They will get tax relief added at the basic rate, but this won't affect your own tax bill. If they have no income, you can pay in up to £2,880 a year (which becomes £3,600 with tax relief).
For example, if you put £80 into a spouse or civil partner's pension scheme, the government would put in £20, so their pension pot would increase to £100. Your tax would remain the same.
The value of units can fall as well as rise, and you may not get back all of your original investment.
A pension is a long term investment. The fund value may fluctuate and can go down. Your eventual income may depend on the size of the fund at retirement, future interest rates and tax legislation.