When you consider that you could be retired for upwards of 30 years, it’s easy to see why saving for later life is so important. But how do you get started?

Designed to provide you with an income whenever you stop working, personal pension plans are one of the most popular ways to save for retirement.

Generally used to supplement the basic state pension there are no limits placed on the amount you can set aside in a personal pension plan, and the added bonus is that you’ll receive tax relief on any contributions up to your personal allowance.

It is even possible for others to pay money into a personal pension plan for you, which means that partners and family members can help you to save for retirement too.

The amount you pay into a personal pension is entirely up to you – a rule of thumb is that you should aim to contribute half your age as a percentage of your salary – and are known as defined contribution pensions.

You’ll usually take out a personal pension plan with a bank, building society or life insurance company into which you’ll make regular contributions over the course of a number of years – generally these will be deducted from your wages at source.

Your chosen pension provider will then take your money and invest it in one or more funds with the aim of growing your pension pot.

You’ll receive a yearly forecast which will tell you how much your pension pot is currently worth and what you can expect to receive at retirement if you keep making contributions at the current rate.

In the past it was incumbent upon the retiree to then purchase an annuity which would guarantee them an income for life, but since April 2015 the pensioner can take some, or all, of their pension as a lump sum and can take control of generating an income from their pot in their retirement.

Stakeholder pensions are another type of personal pension and although they work in a similar way, they have to conform to certain government standards, such as low charging structures and clear terms and conditions.

‘a rule of thumb is that you should aim to contribute half your age as a percentage of your salary’

The amount you receive at retirement depends on the level of your contributions, the performance of the funds in which the money has been invested, and the amount that has been deducted to pay for the management of the pension fund.

As well as the fund being free from both income and capital gains tax you can receive tax relief on contributions of up to 100% of your earnings each year – providing this is less than the annual pension contribution allowance.

This means that if you pay the basic 20% rate of tax, you’ll receive an extra £20 for every £80 that you contribute to your private pension plan. This also applies to higher rate tax payers although the elevated relief will only apply to the amount of income that is subject to tax at the 40% or 45% rate.

When you make a contribution to a personal pension, your provider will claim tax relief at the basic rate on that amount and add it to the fund; higher rate taxpayers claim this rebate through their tax return.

As long as you continue to make contributions, the size of your overall pension pot should continue to increase, but all the time the performance of the fund is subject to the vagaries of the investments that comprise it, it is difficult to predict what the final total will be with any accuracy, and therefore what income this will provide in retirement.

Personal Pension Investments

When selecting a personal pension scheme the saver will be given some choice as to where their pension contributions are invested; as ever with greater risk comes the potential for greater reward, but volatility could mean that a fund comprising more risky investments could be in the doldrums just when you need to cash in.

‘As retirement looms it makes sense to shift the balance of your investments toward more cautious investments, such as bonds and gilts’

Most schemes will have a default fund, but some investors will want to be more cautious, investing in cash funds or corporate bonds, while others may prefer to be more adventurous, investing in equity and overseas growth funds.

As retirement looms it makes sense to shift the balance of your investments toward more cautious investments, such as bonds and gilts which guarantee returns, thereby lowering the risk of your investments performing badly when you have less time to make up any losses.

The DIY investor wishing to take personal control of their investments and benefit from a wider range of investments, including commercial property, may consider a Self-Invested Personal Pension (SIPP) which is explored in depth elsewhere on this site.

At Retirement

Upon reaching age 55 the pension holder is able to take a tax free lump sum of up to 25% of the value of their pot before buying an annuity or going into income drawdown.

This may make sense if you have debt to pay off, such as a mortgage, but it should be weighed against the detrimental effect this will have upon your income in retirement.

Benefits of Personal Pensions

As well as delivering a pension fund upon retirement, some schemes offer additional benefits such as a ‘death before retirement’ payment to your spouse, or nominated beneficiary, if you were to die before reaching pensionable age.

If you have ceased paying into the scheme at the time of death, your accumulated contributions will often be returned, and normally the investment growth they have achieved.

Is a Personal Pension for me?

Despite the fact that under auto enrolment all employees will have access to a workplace pension scheme by 2019, a personal pension may be a good choice for the self-employed, for those who don’t currently belong to a company pension scheme, or for those that wish to supplement the income they expect to get from the state or their auto enrolment scheme.

Unlike company schemes, personal pension schemes will often allow you to vary your contributions, paying in more when you are able to afford to, and taking a break from contributing when cash is tight.

A further benefit of personal pensions is that, unlike company schemes, they are portable which should allow the saver to accumulate a bigger pension pot without the need to transfer preserved pensions from prior employment.

Drawbacks of Personal Pensions

Contributions to a personal pension are entirely your own – there is no employer’s contribution to boost your pot; if you subsequently join a company with a contributory company pension scheme that may be a better bet, whilst keeping your personal pension in the background.

One of the key factors to consider when choosing a personal pension scheme is its charges, as even seemingly innocuous fees can deliver a very considerable drag to the performance of your pension fund over time.

Personal pension charges can be higher than those paid by members of occupational schemes or group personal pensions; stakeholder personal pensions have their annual fees capped at a maximum of 1.5% for the first ten years and 1% thereafter.

Some personal pensions may have limited investment choices and limited scope to change the risk profile of your investments as you approach retirement; SIPPs offer a wide range of investment opportunities and absolute freedom in terms of individual choice, although with that, of course, comes personal responsibility.

The FSCS protects personal pension investments with providers who are authorised by the FCA in the event of their insolvency – it does not pay compensation for poor investment performance.