You should consider a private personal pension if you work but your company does not run its own scheme or if you're self-employed. It's also a good option if you don't work but have money to put away for when you're older.
Even if you are part of a company pension already you may want to set up an additional personal pension to see you more comfortably through retirement.
Your pension provider will invest the money you contribute on your behalf. You can set up regular payments to them - usually on a monthly or annual basis - or make a lump sum contribution.
How successfully your money is invested and how much money you contribute to your pension pot will determine how much pension you get when you retire.
Schemes are administered by banks, insurance companies, unit trusts companies, building societies and other financial management organisations.
These organisations usually deduct charges from your fund to cover the costs of setting up and managing your pension.
Tax relief and the annual allowance
You can receive tax relief on contributions to your pension as long as they don't go over the maximum yearly annual allowance, which was set at £40,000 for 2017/18. Do remember though that the figure includes both employee and employer contributions.
You can carry forward any annual allowance not used in the previous three tax years, as long as you were a member of a registered pension scheme during the year you want to carry forward and you use the annual allowance for the current year first.
You don't need to have made any payments to the scheme during the carry forward year though. This means you could use four years' annual allowance in a year, claiming tax relief on £160,000.
How do tax relief rates work?
Your pension provider will claim tax back for you from the Government at the basic rate of 20 per cent. Effectively for every 80p that you contribute, £1 goes into your pension pot to be invested.
If you are a higher rate tax payer you can receive 40 per cent tax relief, or 45 per cent as an additional rate tax payer. But anything over the basic rate of 20 per cent, which your pension provider takes care of, will have to be claim by you filling in a tax return. Again this money will go into your pension pot to be invested.
If you aren't working or don't earn enough to pay income tax, you can still claim tax relief on pension contributions up to £2,880 a year. Tax relief is added to your contribution so the maximum amount of £2,880 would be worth £3,600 to your pension pot.
The increase in the value of your pension from what you contributed to its final worth - is tax free.
Taking out your pension
When you retire you have the option of taking a tax free lump sum of up to 25 per cent of the value of your pension. It must also be no more than 25 per cent of the current lifetime allowance, which for 2017/18 is £1 million.
You can then either:
- Buy an annuity from a life insurance company, which doesn't have to be your pension provider, with the rest of your pension. This which will give you a regularly paid income for life, or
- Draw an income from the rest of your pension. This will be subject to income tax but the funds will stay invested.
The pension holder will get tax relief on your contributions but you won't be liable for any further tax.
This means that for every £80 you contribute to a partner or child's pension scheme, with tax relief £100 is added.
The same rules as above apply for tax relief, so if the pension holder isn't earning enough to pay income tax the maximum annual allowance that you could pay into their scheme is £2,880 a year. This would be worth £3,600 with tax relief.
Please keep in mind that a pension is a long-term investment and the value can go down as well as up. Your final income will be determined by the size of the fund, interest rates and tax legislation.
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This article (What is a Personal Pension?) is intended to provide a general appreciation of the topic and it is not advice.
For more information please contact Nurture Financial Planning Ltd on 01603 673502 or email firstname.lastname@example.org and we will be happy to assist you.
Article expiry: 05 Apr 2018