What is a pension ?
Basically, a pension plan is a long-term investment that helps you invest for your retirement.
You can make monthly, annual or single premium payments into a pension.
It aims to build up a pension fund that you can use to provide an income in retirement. The great thing about pension plans is that because the Government really wants you to provide an income in retirement, they invest money into your pension fund. This is known as tax relief.
How does tax relief work ?
There’s no limit on the total amount that can be paid into this and any other pension plans that you have but you won’t get tax relief over a certain amount.
HM Revenue and Customs (HMRC) allows tax relief on your personal payments to all your plans up to £3600 a year (including tax relief) or 100% of your taxable earnings if greater. You make payments net of basic rate income tax and higher rate tax payers can claim additional relief via their tax return.
Then what ?
Your payments into your pension plan are invested into the funds you choose. You can choose between high and low risk funds, depending on your attitude to risk and capacity for loss.
You can take the benefits of your policy at any time from age 55 even if you are still working.
The main types of individual pensions are :
- Personal pensions
- Stakeholder pensions
- Self-invested personal pensions (SIPPs)
Personal and stakeholder pensions work in a very similar way – although stakeholder pensions have to conform to certain minimum standards set down by government. With personal pensions, you can stop contributions or switch to a different pension provider at any time.
Stakeholder pensions operate in more or less the same way as personal pensions. However stakeholder pensions have to meet the standards below:
Stakeholder pension providers are allowed to charge a maximum charge of 1.5% a year for the first ten years of the plan – this reduces to 1% a year after this. This charge covers the costs of running the scheme, managing your investments and providing basic advice and information.
Low minimum payments
You must be allowed to pay in amounts as low as £20 whether as a one-off payments or a as a regular contribution.
With stakeholder pension schemes, you can choose when and how often you pay into the scheme – you can make regular or occasional contributions with no penalties for missing contributions.
If you want to move your stakeholder fund to another pension scheme there is generally no penalty for transferring. However, if you have invested in a ‘with-profits’ fund then you need to check if your provider applies what’s known as a ‘market-value reduction’ if you switch.
Simple investment choices
Stakeholder pension scheme providers will offer a limited range of investment options and must offer a ‘default’ option into which your contributions are invested.
Self-invested personal pensions (SIPPS)
As the name suggests SIPPS are designed for people who prefer to have more control and choice over the types of investment in their pension scheme. With personal or stakeholder pensions, your investment choices are limited to those offered by the pension provider. SIPPS offer access to a wider range of investments including the opportunity to invest directly in shares and commercial property.