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Personal pension need-to-knows

Key points for retirement saving

Personal pensions
Guy Anker
Guy Anker | Edited by Martin Lewis
Updated 22 July 2019

Fancy an easy pay rise? Start a pension and you could get one. Not only will the Government top up your pension pot, but if you're employed, your employer may also HAVE to help. 

17 key pension need-to-knows

Note: This guide doesn't apply to final salary schemes where your wage and length of company service determine your retirement income - for basic info go to the Different pension types section. Nor does it cover the humble state pension - always check if you can boost it.

  1. What is a pension plan?

    A pension plan is fundamentally a simple product:

    It is just a pot of cash that you, and your employer, can pay into - and which you get tax relief on - as a way of saving up for your retirement.

    Then, at retirement, you can draw money from your pension pot or exchange the cash with an insurance company for a regular income until death, called an annuity.

    Since 2015, from the age of 55, you've been able to access your pension plan more flexibly, taking as much or as little cash as you like, whenever you like.

    But it's important to understand how saving for a pension affects your income. Effectively you're giving up disposable income now in exchange for a future pay rise (in the form of pension income). As you'll be getting less in your pay packet, consider this carefully when budgeting. See our free Budget Planner tool.

  2. Is a pension REALLY worth it?

    A key plus of a pension plan is the tax relief, which comes in two forms depending on whether you're a basic-rate or higher-rate taxpayer.

    You get some tax back on the money you put into a pension, while gains from the investments you make with that cash are largely tax-free.

    Tax relief on contributions

    You get the tax back you've paid on all contributions, if you're under 75, subject to an annual allowance.

    What tax relief do I get? 
    If you pay the money into your pension yourself, or if it is taken by your employer from your pay packet, you automatically get 20% tax back from the Government as an additional deposit into your pension pot.

    If you are a higher-rate taxpayer you can claim an additional 20%, while top-rate taxpayers can claim an additional 25%. If you are part of a workplace pension, you may not need to reclaim any tax if your employer simply deducts less tax from your pay packet.

    However if you don't reclaim, it won't be paid. Therefore it is important to check if you are in a higher tax bracket. For more information on how to reclaim tax, see HMRC.

    If your employer puts the money in from your pre-tax pay then it's never taxed in the first place, so you still win.

    How does the tax relief work

    Getting 20% tax relief doesn't mean you get 20% back of what you contribute. Instead, the 20% is calculated on your pre-tax earnings.

    So when a basic 20% rate taxpayer invests £80 of their take-home pay in a pension, they'd have actually earned £100 before tax. The tax relief is 20% of the £100 ie, £20. 

    The graph below illustrates the tax boost:

  3. How much should I put in a pension?

    With auto-enrolment workplace pensions, there are minimum contribution levels. But if you can you afford it, you really should be contributing more.

    Before starting, it's worth noting those in debt, especially at high rates of interest, should consider whether it'd be better to get rid of that before starting a pension. Plus, a pension's only one form of retirement planning. Combining it with other methods is often a good plan.

    The basic advice with pensions is to put in is as much as possible, as early as possible. There's a very rough rule of thumb for what to contribute for a comfortable retirement...

    Take the age you start your pension and halve it. Then put this % of your pre-tax salary intoi your pension each year until you retire.

    So someone starting aged 32 should contribute 16% of their salary for the rest of their working life. While 16% of your pay seem a huge commitment, the figure includes your employer's contribution.

    Some additional points follow from this rule of thumb: 

    • Don't delay. If you delay saving into a pension, you'll then need to contribute a higher percentage of your pay to achieve a comfortable retirement. The sooner you contribute, the longer your money has to grow. The compounding effect of investment returns can make a massive difference over the long term.
    • Increase payments. Try to put away a constant proportion of your earnings: as your pay increases, make sure your contributions increase in pound terms by the same percent. 
    • Use the 'pay rise trick'. Most people will be unable to contribute enough at the beginning. So start with whatever you can, but each time you get a pay rise, put a quarter of the extra monthly cash into your pension. 

    For a more accurate way of calculating how much you need to retire, try using the Money Advice Service's pension calculator. It'll ask for information including when you want to retire, how much you and your employer are contributing, and whether you want your pension to be inflation-proof.

  4. How much can I put in a pension?

    There's technically no limit as to how much you can put in a pension - but there are limits on how much tax relief you'll get for doing so. There are three different limits to be aware of:

    • An earnings limit. You get tax relief on contributions up to your annual earnings. Imagine you earned £20,000 each year, but had £30,000 in savings, and decided one day to put all your savings into a pension. Because you're earnings are only £20,000, you would only earn tax relief on the first £20,000 of your contributions.
       

    • An annual limit. This limit really only affects higher earners. You can only get tax relief up to your current annual allowance, made up of the current year's allowance (currently £40,000) and any unused allowance from the previous three tax years.

      Since April 2016, anyone whose total income, pension contributions and employer pension contributions are over £150,000 in a year will get a reduced allowance. For every £2 over £150,000, the allowance tapers down by £1, meaning anyone earning a total income of £210,000 or more will only get £10,000 tax relief annually.

      Those whose income (excluding pension contributions) is under £110,000 will be unaffected by these changes, even if pension contributions take them over £110,000.
       

    • A lifetime limit. The 'lifetime allowance' has gone up to £1,055,000 for 2019/20. What it means is that if your total pension savings (including gains/interest) are over this amount, you face a tax charge.

    This example shows how the annual limits can be used and carried over...

    Current annual allowance = £40,000 (NB reduces to £4,000 if you've started taking money from your pension). But...

    You can top up your allowance for the current tax year with any allowance you didn’t use from the previous three tax years. 

    Say you have been investing £10,000 a year in a pension in recent years. You would then be able to carry forward three lots of £30,000 - a total of £90,000 on top of the standard £40,000 annual allowance. That's £130,000 overall.

    Importantly, money paid by someone else, such as your employer, counts towards those allowances. You can still save more into a pension but you will only get the tax breaks up to the stated maximums above.

  5. What's auto-enrolment?

    Pension for employees are nothing new - they have have been common staff perk, particularly for people working for of big employers, for many years. However, not all employers have offered pensions.   

    Auto enrolment now requires employers to offer employees a pension, to automatically enrol you in the scheme  and, crucially, to contribute on your behalf.  

    From 6 April 2019, the minimum employer contribution level increased to 3%. Under auto enrolment, total contributions must be at least 8%, so if the employer only puts in 3%, the employee has to contribute 5%. See Martin's you’re likely about to get a pay rise, but it may cost you blog.

    You can say ‘no’ to auto-enrolment if you don't want to join. But it's an opt-out rather than an opt-in scheme, so if you do nothing, you'll be opted in.

    We've got a full guide on auto-enrolment, which will tell you everything you need to know.

  6. What's 'salary sacrifice'?

    Paying into a pension gets all taxpayers a tax break. But for an extra and easy bonus, salary sacrifice is worth considering.

    Salary sacrifice applies to a number of workplace benefits such as childcare vouchers or cycle-to-work schemes, not just pensions.

    It's where you give up some of your monthly earnings while your employer puts it towards something else - in this case, pension contributions.

    As it comes out of your PRE-TAX salary and straight into your pension, you pay less national insurance (NI). Your employer will also pay less employer's NI which gives them incentive to operate the scheme.

    • Basic-rate taxpayers: Because your pension contribution comes out of your pre-tax salary, you'll pay less income tax at 20%. You'll also avoid your 12% NI contributions on the amount you sacrifice. This means for every £68 you sacrifice from your pay packet, £100 goes into your pension pot.

    • Higher or top-rate taxpayers: If you pay tax at the higher 40% or 45% rates, salary sacrifice means you don't have to claim back the extra tax relief yourself - as you are never taxed on those contributions in the first place - and you don't have the 2% NI deducted on those contributions either. To deposit £100 in your pension pot, you only have to give up £58 from your pay packet, as no tax or NI is deducted as a higher rate payer. For a top-rate payer, you only give up £53.

    One thing to take into consideration with salary sacrifice is that, as the name suggests, you are deemed to have a salary. This can have knock-on effects: it could reduce your earnings so that you'd no longer qualify for Statutory Maternity Pay, for example.

    In 2019/20, if your salary sacrifice takes your salary below £118 per week, £512 per month or £6,136 per year, you'll be affected. If that's you — think twice before sacrificing.

    It could also affect mortgage applications and other benefits, such as jobseeker's allowance (JSA) and employment and support allowance (ESA).

  7. Should I take my employer's pension?

    If you're employed (aged 22-plus and earning at least £10,000 a year), you'll be auto-enrolled into a pension to which your employer must contribute at least 3% of your salary (within certain limits).  

    This is effectively a pay rise, so beware of giving it up, plus there's no tax to pay on pension contributions (subject to annual allowances, above). It may not be going into your pay packet, but it is cash going towards your future.

    Of course, you may not have the cash to afford the employee contributions, and there's no point getting into costly debt if that's the case. See our free Budget Planner tool to help you decide.

    Another key consideration is whether your existing pension pot already has so-called primary, enhanced or fixed protection. This is where you will have fixed your lifetime pension allowance at a previously higher level (for anyone without protection the lifetime allowance is £1,055,000 in 2019/20). If you have protection you will lose it if you take your employer's pension, so weigh up the benefits.

  8. Aren't pensions a load of rubbish?

    Ignore the criticisms you may have heard about pensions. Many stem from a fundamental misunderstanding of what a pension plan is. It's simply a tax-sheltered wrapper to save money for retirement. Pensions' bad rap mainly comes from investments that don't pay off or high charges (see Martin's blog: The one word that caused the pension crisis).

    A pension plan is tax-efficient savings option that isn't implicitly risky. The risk comes from the investment choice. 

  9. The different types of pension

    Pensions come in all shapes and sizes. The first distinction is whether the pension is a final salary or a money purchase pension.

    Final salary pensions

    These pensions, also called defined benefit schemes or in some cases Career Average Revalued Earnings (CARE) schemes, are largely funded by employers, though staff may also have to pay into them. With these, you get a percentage of your final pre-retirement salary, or when leaving that firm, as an annual income.

    What that percentage is depends on how long you worked for that particular firm. There is normally an 'accrual rate' set by your employer as a fraction of your final salary.

    Say the rate is 1/60th, you get 1/60th of your final salary as a retirement income for each year you worked for that firm. So if you worked for 30 years, you'd get 30/60ths, or half your final salary with that firm.

    Money purchase pensions

    With money purchase pensions, also known as defined contribution schemes, the money you put into your pension plan is invested and what you have at retirement depends on how those investments have performed. 

    When you retire, you either withdraw cash form your plan or swap its value for an annuity - an income for life.

    Most workplace pensions and all personal pensions are money purchase. 

    Pension plans can also be categorised as: 

    • Workplace pension schemes. You and/or your employer make regular monthly payments, with the money invested by a pension company until you hit retirement. There are two types of workplace pensions: trust-based and contract-based pensions. 

    • Trust-based pensions - A board of trustees manage investments on your behalf. The trust fund is kept at an arms length principle, separate from the company. What's more, it allows benefits to be given to your partner or other dependant members.

    • Group personal pensions - This type of pension is with a third-party insurance provider. The snag is that your employer chooses the provider, but these arrangements usually offer you a choice of investments.

    • Stakeholder pensions. These have low and flexible minimum contributions, and capped charges.

    • Self-invested personal pensions (Sipps). These are DIY pensions, allowing you to choose your own investments. Investors prepared to do the legwork themselves can run a Sipp on the cheap, if they use the right provider. Read our guide to low-cost Sipps.

    Don't forget the state pension. This is available when you reach state pension age, currently rising from 65 to 66. While the old-style basic state pension has gone up £3.25 a week to £129.20 for 2019/20, the new state pension (for people reaching retirement age since April 2016) it's gone up £4.25 a week to £168.60 for 2019/20. You build up entitlement to the state pension by paying national insurance (NI) contributions throughout your working life (see the State Pensions guide) - or by being awarded NI credits.   

    The table below shows how the different pensions differ:

    PENSION Can you contribute? Can your employer contribute? Do you invest the cash?
    Workplace pension Yes Yes Yes
    Stakeholder pension Yes Yes Yes
    Sipp Yes Yes Yes
    Trust-based Yes Yes Yes
    Group Yes Yes Yes
    Final salary Yes Yes No
    State pension Yes, by paying NI No No

  10. Who's holding my money?

    With most workplace pensions, your employer chooses a third-party pension company eg, Aviva, but you can still decide the type of risks you want to take with them.

    Typically you'll do this by choosing, and being able to switch, investment funds.  

    If you start your own pension, you choose the manager. If you opt for a Sipp, it will also be managed by another firm but you make the investment decisions (see our Low-cost Sipps guide).

     

  11. How do I get a pension?

    Under the new rules, many people will end up in a company pension so all they need to do is go ahead with what their employer offers. To get any contributions your employer offers, you'll normally need to be part of its scheme.

    If you choose your own pension then you'll need to scour the market for the most suitable plan.

    Unless you are financially savvy, it's usually best to get advice from an independent financial adviser (IFA), given the whole host of pension charges to watch out for. Since January 2013, IFAs can no longer be paid in commission, so you'll have to pay a fee for advice.

    See our Financial Advice guide for how to pick an IFA, including what getting advice will cost you.

  12. How do I get a cheap pension?

    If you don't get a workplace pension, it's time to do your homework. 

    If you have the financial savvy to know what you want to invest in, you can head straight to the pension company and set that up.

    Be aware that this may not necessarily be the cheapest option as group plans (such as with your employer) can be cheaper.

    There are a number of specialist pension discount brokers. Here, you just tell them the pension you want and they arrange it without giving you advice. This means they rebate some or all of the charges back into your fund, effectively reducing the charges compared to going direct. 

    Even though we're only talking about fractions of a percentage point, the compounding effect means your fund could be £1,000s better off over the long term.

    Using this route means you get no advice, which may not be a problem. But if you're confused, unsure, or have complex circumstances, it's best to be safe and see an IFA. It's better to pay a few hundred pounds upfront so you don't end up losing thousands over your lifetime, if you've no idea what to do. Unbiased.co.uk and VouchedFor list local advisers.

    Important! Even if you pay a low set-up fee and/or get some charges rebated, you may still pay what's called an annual management fee charged by the fund manager that looks after your investments, so there are additional costs to consider.

  13. Some of the cheapest firms

    Some companies give you information/brochures on their pension funds, though this is not technically advice, so you don't pay for it. There's no set-up fee, although there will be other ongoing charges.

    These companies are Cavendish Online, BestInvest,  Commshare, Close Brothers, Chelsea Financial Services, Fidelity, Hargreaves Lansdown* and TQ Invest.

    If you do want to take financial advice it'll cost you, so check out our guide on choosing Financial Advisers first.

    Note: The firms mentioned above all offer decent deals, though it may be possible to beat them - it's not a definitive list.

  14. What happens when I retire?

    Once the money is in a pension, it can't be withdrawn willy-nilly. It must stay there until you're at least 55. (There are some extenuating circumstances where you can withdraw the money before 55). At that point, you can take 25% of it as a tax-free lump sum, with the rest ideally providing an income for the rest of your life...

    If you get approached before you're 55, it's a scam known as pension liberation or unlocking. These scams are so damaging the government  banned cold calling about pensions in January 2019.  Firms ignoring this could be fined £500,000.

    For full details of how to release money from your pension legitimately and how to avoid scams, read our guide.

    When your regular work income stops... it's decision time. Ideally, start preparing a few years beforehand.

    Provided you're over 55, you'll be able to take as much of your pension pot as you like, when you like - though drawdowns above the tax-free 25% will be taxed at your marginal rate - so 20% if you're a basic-rate taxpayer, 40% or 45% if you're a higher or additional-rate payer, or the amount you've taken from your pension pushes you into that rate.

  15. You can do anything you like with your cash (you don't have to buy an annuity)

    You can still use your retirement cash to buy an annuity if you want to, but you no longer have to. The pension freedoms that were introduced in 2015 mean that anyone who's aged 55 or over can take their pension money however they want, whenever they want - there's now complete freedom.

    For most people, accessing pension cash at 55 will be too early, so it can just be left where it is. But if you want to, you can access all your pension cash at once - the first 25% is tax-free and the remaining 75% will be taxed as income.

    Assuming you've not taken all your pension out, the remaining options are:

    Option 1: Leave it invested in your pension for when you need it. Do this and it’s important to understand when you withdraw cash you get 25% of each lump sum you withdraw tax free. Eg, if you had £100,000 and took £20,000 out you’d get £5,000 of it tax-free, the rest would be taxed at your current rate.

    Option 2: Take 25% tax free, then buy a flexible income drawdown product.     This is a product you buy that keeps the rest invested so it can still hopefully grow, but you can also use it to take income when needed. 

    The tax here is different, you get the 25% you initially withdraw tax free and then the rest is taxed when you take it – which could be useful if you’re likely to be in a lower-tax bracket once you’re older. 

    Option 3: Take 25% tax free, then buy an annuity.     This gives you a guaranteed income each year for the rest of your life.

    There are different charges on all of these, and it’s important to check them out and always compare different providers. For a quick briefing on all this see Martin's 5 minute pension freedom briefing, or for the full low-down read our Guide to taking your pension.

  16. How safe is my pension?

    With savings accounts, the simple rule is that up to £85,000 per person per institution is fully protected should your bank go bust. This protection's provided by the UK's Financial Services Compensation Scheme (FSCS, see the Savings Safety guide).

    This £85,000 limit has been extended to pensions and investments from 1 April 2019. Previously the FSCS limit was just £50,000, except for annuities – where cover was and remains unlimited.  

    FSCS protection for pensions can seem very complex. This is just a general guide, always check with your provider.

    The FSCS does not generally cover performance losses eg, if the shares you invest in go bust, though it can cover poor investment management.

    The FSCS safety does apply if you lose money due to the pension or investment firm going bust. Usually with pensions, if you buy through a broker it doesn't hold any of the cash, it simply acts as a conduit for you to put the money into whatever funds or investments you want. Therefore in the unlikely event the broker goes bust, your money should be OK, and still held by the fund manager or bank it resides with. The £85,000 protection applies should any of those go bust.

    If protection kicks in, the FSCS will first try to transfer your funds from the failed company to another company.

    For failed IFAs or brokers that mis-sold or provided dodgy pension advice, there may be a claim against the firm for mis-selling via the FSCS. This would be up to the investment limit of £85,000.

    If you've got a defined benefit (final salary) pension, there's a risk of your employer going bust, leaving you with no pension income. In this case, the Pension Protection Fund (PPF) is available and may pay compensation. 

    Cash

    If you have a Sipp and decide to hold the money as cash, you are normally covered under the standard £85,000 cover per person per institution, the same as ordinary cash savings.

    Ask your Individual Sipp provider which bank the cash is held in (often they spread it around up to five). Then check whether any other savings you have are in institutions linked to those used for the Sipp cash, as cumulatively you'll only get up to £85,000 protection in each. See What Counts As A Financial Institution?

    FSCS protection for pensions is very complex, and can vary with each product's structure. This is just a general guide, always check with your provider.

  17. Can I also save into a Lifetime ISA?

    If you're under the age of 40, you can take out a Lifetime ISA to save for your first home or your later years, with the Government adding 25% as a bonus – that’s £1 for every £4 you save.

    The Lifetime Isa isn't meant to supplant pension saving - there's much to be said for having a Lifetime Isa and contributing to a workplace pension.  

    How does it compare to saving into a pension?

    Ideally, you'll be able to save into both to maximise your retirement savings. But, pensions and ISA savings are two different beasts. Both have their advantages, but if you are making a choice there are some things you need to consider.

    If you're employed, it's generally a no brainer to save into your workplace pension. With auto-enrolment, your employer must contribute towards your pension, plus you get tax relief of at least 20% (tax relief means that for every £4 you put into your pension, you get tax relief of £1 - the same boost as with the Lifetime ISA). In combination, these are worth more than the Lifetime ISA bonus. This is especially true if you're a higher-rate taxpayer, as the tax relief provided will be then at 40%.

    But, if you're self-employed, or you want retirement savings that you can access more flexibly than a pension (albeit with a penalty), then the Lifetime ISA's definitely a good alternative.

    There are other advantages to pensions, though. If you lose your job, and need to then claim benefits, pension pots aren't counted as part of your wealth. ISA savings may be taken into account. Similarly, Lifetime ISAs could be forfeit to creditors in bankruptcy, whereas pensions are protected.. 

    For full details, plus to get Martin's view, take a look at the Lifetime ISAs guide.

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