A personal pension plan is a tax efficient savings plan designed to provide a regular income in retirement. Your contributions will be invested in one or any number of funds with a life insurance company or investment management company. In time the value of your fund should increase until you are ready to receive your benefits, at which point you will use the accumulated fund to generate an income.
One of the great advantages that Personal Pension Plans have over other types of investments is the considerable tax concessions that your contributions and investment funds receive. Firstly, your contributions receive tax relief based on the highest rate of tax you pay. Secondly, where the money is invested, it grows free of Capital Gains Tax. No other UK investments offer these advantages. You can also protect your contributions against inflation, by having them increase year on year, or build in an option called waiver of premium, where the Insurance Company will waive your contributions if you are unable to work due to ill health.
How much should you pay in to a Pension? This really depends upon what existing pension provisions you have already made, and whether you are already a member of an employer-sponsored pension scheme. The following statements assume that you do not currently have any private provision: According to a study carried out in 2001 by the Association of Consulting Actuaries, workers starting a pension at age 25 need to invest a minimum of 10% of their income if they want to retire with just under 2/3rds of their final wage to live on. However, those wishing to retire early or are starting later need to invest much more.
The ACA recommends that those starting a pension at the age of 35 need to invest between 15% to 20% of their salary while those starting at age 45 need to ensure that up to 30% is invested.
The calculator will then estimate for you how much of a monthly pension you can expect when you finally give up work.However, it is important to remember that the calculator will only give you a rough estimate at what you may get back upon retirement.
The new pensions framework that came into effect on 06/04/2006 has altered the complicated set of restrictions upon what levels of contributions could be made to different types of pension schemes, and the different levels of benefits that could be taken from them. The new framework does not alter how these plans work at the underlying level - the main changes are concerned with the levels of contributions into and benefits that can be taken from pension arrangements. See the document on pension simplification
for more clarification.
What was an appropriate personal pension scheme ?
When a person contracted out of the State Second Pension (S2P), and previously the State Earnings Related Pension Scheme (SERPS), and directed the rebates into a personal pension plan, that plan was called an %appropriate personal pension scheme%. Under this type of scheme, the scheme member and their employer continued to make standard National Insurance contributions (NICs) and the government made 'minimum contributions' to the personal pension scheme, which were rebates of some of the National Insurance Contributions already paid by the individual and their employer. The rebates were credited directly to the pension company running the scheme. The rebates were called Age Related Rebates (ARR) and increased from 3.8 per cent to 9.0 per cent, depending on age. There were also 'rebate only' personal pension schemes - in these schemes the only money being paid into the plan was the NIC rebate and any related tax relief.
Please note that contracting out of S2P using a Personal Pension was abolished as of 06 April 2012, and those were contracted-out were brought back into the State Scheme. Any existing pension funds that contain protected rights will stay in force, but no further protected rights contributions will be accepted.
Effectively, the use of the term 'Protected Rights' is no longer relevant, as additional restictions upon what could be done with protected rights funds no longer apply, and any protected rights pension funds are now treated in exactly the same manner as other money-purchase pension funds.
It is now hard to believe before the year 2000, the charges on most personal pension contracts were extremely high. The providers of personal pension plans, such as Life Insurance Companies, extract charges both from the contributions they receive from policyholders and from the value of the fund accumulated from investing these contributions. These charges pay for plan administration, profit, and key services (such as fund management). There was an ongoing debate as to whether personal pension plans deliver investment returns high enough to justify these charges. These structures could be incredibly complex, involving monthly charges, rebates after a number of years, early retirement and transfer penalties, and often hidden charges, that they did have a very serious effect on the performance of the individualÍs pension pot. These charges could reduce an investment that was growing at 7% a year in real terms to 4% or 3% or even less in the first few years of the policy. Obviously, this was a serious disadvantage over the long-term, but as all insurance companies had comparable charges, this was accepted as the norm.
When the Labour Party was elected to government in May 1997, it pledged to reform welfare and private pension provision in the UK. The government was concerned that the cost of providing state pensions was getting out of control. The main reason for this was that the number of pensioners in the UK was increasing because people were simply living longer.
Retirement pensions are paid from current national insurance contributions made by working people. The number of pensioners was simply overtaking the pool of working people, so the government was faced with a choice: either take a continually larger proportion from the working population, or get them to start taking more responsibility for their own pension provision. Thus the government announced its intentions in December 1998 and set out three main objectives:
- To introduce a minimum income guarantee for the poorest pensioners;
- To create a second state pension to replace the state earnings related pension which is aimed at those earning less then £9,000 per annum;
- To introduce Stakeholder pensions as an alternative to personal pensions.
This was originally aimed at those earning between £9,000 and £18,500 and who did not have access to a suitable company pension scheme.
One of the main reasons for the introduction of Stakeholder pensions was the government's perception that the pension industry was basically charging too much for the product it offered. While observers originally felt that this new, government-led charging structure would only have a catchment group of employees earning between £9,500 and £21,600, it has now been acknowledged by the leading players in the industry that this new environment has affected virtually all pensions sold in the UK for both the employed and the self-employed. The press has latched on to the topic with great interest and hardly a week passes without an article about it in a newspaper, especially with the problems relating to the escalating costs of running large Final Salary Pension Schemes. Consumer / IFA awareness and pressure has forced those providers who have not matched the government's requirements in non-Stakeholder pension products to either revise their charges or leave the pensions market. The Stakeholder principles basically focus on simplicity of everything! There are a number of criteria involved in the offering of Stakeholder by a provider, of which all must be met in order for the scheme to be Stakeholder accredited. These are:
- A single annual fund management charge of 1.5% or less
- No bid/offer spread charge
- No member charge and no scheme charge
- 100% investment of money received
- True penalty-free transfer to any approved pension scheme
- A penalty-free stop/start facility to help clients meet other financial priorities
- The facility to increase or decrease contributions or pay lump sums at any time
- A minimum contribution of no more than £20 per member
When can I start to draw an income from my personal pension?
Under current legislation, the benefits may be taken at any time at or after the of 55, unless you are in a 'special occupation' where it is customary for you to retire early, and you have agreement from the Inland Revenue.
What options are available at retirement?
There are a number of different options available when you come to draw your pension. They include: -
- A level pension for life
- A reduced pension, with a tax free lump sum
- An escalating pension
- A widow/ers benefit can be provided for
- A number of other options are also available (such as Drawdown Pension or Investment Linked Annuities)
Please note that from April 2015, you will have more choices about what to do with accumulated pension funds, as the requirement to purcahse an annuity or an alternative retirement product will be abolished, and you will potentially be able to take the whole pension as a cash lump sum (subject to tax)
NOTE: This document is intended to provide a brief overview of the subject. It should not be read as a recommendation to use any particular product, as it does not take into account individual circumstances and attitudes.