We take a look at how personal pensions work and how they can help you to make the most of your retirement.
According to a report by Scottish Widows, almost half of Brits in their 30s and 40s aren’t saving enough for retirement.
If you're ineligible for a workplace pension, or you're self-employed, then you might be worrying about the days when you'll be relying on your pension packet.
Well, fear not - we're about to talk you through the world of personal pensions.
What is a personal pension fund?
A personal pension is a pension plan you arrange for yourself. This means you find the scheme you want to join, and you decide what contributions you want to make.
Any interest you earn on your personal pension plan is tax free. You also get tax back on your pension contributions up to £40,000 or 100% of your total annual income (whichever is the lowest).
Even if you don't pay tax, you can still benefit from the tax relief. You can currently save up to £2,880 a year and get 20% tax back on your contributions. For example, if you saved the full £2,800 it would bring your annual contribution up to £3,600.
Who can set up a personal pension fund?
Anyone can set up a personal pension fund.
While most people will be eligible for a state pension when they retire, it’s unlikely to be enough to let you carry on the lifestyle you've had during your working life. As of 2017/18, the highest UK state pension is £159.55 a week (£8,296.60 a year). By contrast, you’d make £300 - almost double - if you worked a standard 40-hour week on the current minimum wage. That's why starting a personal pension is the main option for people who are self-employed or ineligible for a workplace pension.
However, if you want to, you can start a personal pension fund to supplement your state pension and your workplace pension.
if you earn less than £10,000 a year (you can still ask to be enrolled - and your employer cannot refuse - if you earn more than £5,876 a year)
if you’re under 22 or over the state pension age (you can ask to be enrolled - and your employer cannot refuse - if you’re over 16 or under 74)
if you work outside the UK
How do you choose a personal pension plan?
First things first, you need to decide what kind of plan you want to start. There are a few different options for personal pension schemes:
Defined contribution schemes. With these pension plans you make regular payments to build up your pot of savings. Your contributions are invested into stocks and shares for you and the pension company oversees your investments.
Stakeholder pension schemes (SHPs). These are a type of defined contribution scheme. SHPs have low minimum contributions, and you can stop and start your contributions when you want. The charges the pension provider can impose are also capped at 1.5%.
Self-invested personal pensions (SIPPs). These are completely do-it-yourself, so tend to be more flexible and can lead to higher returns. However, they are riskier so are best suited to people who have experience with investing.
You can open a Lifetime ISA if you’re under 40. You can pay in up to £4,000 a year and the government will throw in an additional £1,000. However, the amount you save in a lifetime ISA will count towards your overall annual ISA limit.
Once you’ve decided which kind of plan is right for you, there are three key things to watch out for.
1. Whether there are any fees and charges
Some pension funds charge setup fees to open your account.
The vast majority of plans also charge management fees. This can be a percentage of your pension pot (ranging from 0.2% to as much as 1%), a flat fee or even both. Fees tend to get lower the more your pot grows in value.
2. The rules on contributions
Most pension funds have specific rules on how much you have to contribute and how often. You may need to pay in a lump sum in order to open the fund (Nutmeg, for instance, requires an initial investment of £5,000). And some pension providers will also require you to pay in at least a minimum amount each month.
Other providers - NEST, for instance - are more flexible. They don’t have minimum contribution requirements. This means you can take a break from contributions and resume when your financial situation improves.
3. Where your money will be invested
Pension providers usually offer a range of investment options depending on the level of risk you’re prepared to take. Pension funds usually classify your attitude to risk as either cautious, balanced or adventurous. The riskier the investments, the more profit you stand to make. But there's also a greater chance that you could lose money too.
Most pension providers have a default fund. If you don’t personally choose where to invest your money, it will get invested in the default fund. The default fund may not suit your attitude to risk, so it’s best to at look at the options available. You could always consider seeking help from an independent investment advisor.
How much should I put into my pension fund each month?
Most personal pensions rely entirely on the contributions that you make. This means the more you put in the more you’ll get out of them when you do retire.
If you're trying to work out exactly how much to contribute to your personal pension, you could use your age as a rule of thumb. So if you're employed and starting your pension, halve the age that you are currently. You can then contribute this much as a percentage of your pre-tax salary each year until you retire. So if you're 30 years old, you might want to start contributing 15% of your salary into your personal pension fund. If you're able to, it's worth starting your retirement fund as early as possible, so your money has longer to grow.