A Simple Guide to Private Pension Plans
It should be clear from all of the changes being made to the UK pension system that the government is encouraging individuals to provide as much of their own retirement income as possible. Consumers investing in private pension plans are better suited to provide for their retirement than the government. Indeed, changes to the state pension make it more important than ever before for workers of all ages to begin investing privately.
Fortunately, we have many different options when it comes to setting up private pension plans. In the paragraphs below, you will learn about the different kinds of pensions, how to invest in them, and what things to look out for. Always do plenty of research before investing in any pension scheme, as making the wrong decision could limit your earning power or actually cost you money in some circumstances.
3 Types of Private Pensions
When we speak of private pensions, we are talking about those pension schemes that are separate from the state pension, military pensions, and qualifying recognised overseas pension schemes (QROPS). There are three types of private pension plans to consider. These are:
- Workplace Pension – The most common private pension plan is the workplace pension offered by an employer. These plans can be either defined benefit or defined contribution schemes. Thanks to auto-enrolment, almost every UK worker will be involved in a workplace pension by 2018 – except those who specifically opt out of their employer's plans.
- Stakeholder Pension – A stakeholder pension is a plan you invest in through a third party, such as a bank or insurance company. Sometimes employers will offer stakeholder pensions as one option; most of the time consumers choose and purchase stakeholder pensions by themselves. The Money Advice Service recommends stakeholder pensions to individuals looking for a scheme with flexible contributions and limited charges.
- SIPPs – Self-invested personal pensions (SIPPs) have recently become very popular due to changes in the pension laws. A SIPP gives the saver maximum control over how his/her money is invested for the entire life of the pension. Some investors manage their SIPPs without any help from administrators other than conducting transactions on their behalf. Others utilise the advice of administrators for sound investment decisions.
Please bear in mind that both stakeholder pensions and SIPPs are defined contribution schemes. What does this mean? It means that the amount the plan eventually pays out is directly tied to investment performance. If your investments do well, your retirement income will be what you expected or higher. If your investments do not perform well, you may receive less retirement income.
By contrast, a defined benefit scheme pays a guaranteed amount of income in retirement regardless of investment performance. These kinds of schemes were once very popular, especially among government pension schemes. They have since lost their lustre due to their inherently expensive nature.
Establishing Your Pension Plan
Establishing your pension plan is not too difficult regardless of the type of pension you choose. If you choose a workplace pension, it will be the easiest of all. Your employer will let you know when your enrolment period begins along with your options for investing. You simply complete the paperwork and you are done. Contributions are automatically deducted from your pay. Every year you should have the opportunity to choose your investment options for the next 12 months.
Should you opt for a stakeholder pension or SIPP, you have a little more work to do. The first step is to decide between the two types of pensions. With that decision made, it pays to take a few weeks or months to research what is currently available. Your insurance company may offer what appears to be a very attractive stakeholder pension while a private pension fund as a good-looking SIPP. It helps to investigate both.
When researching private pension plans, pay attention to:
- required contribution amounts (if any)
- administrator/provider history
- investment opportunities offered by different plans
- track records of those investment opportunities
- annual charges and transaction fees
- early exit charges and fees.
Pay particular attention to the area of charges and fees. These are both a normal part of pension investing, but they should not be excessive enough to severely hamper your earning power. Administrative and transaction fees should be reasonable enough as to not severely inhibit the principal amount you are investing every year. As for early exit fees and charges, pension providers sometimes include them in their plans to dissuade investors from exiting prior to retirement. You need to be aware if any such charges apply to a plan you are considering.
Think about Contribution Levels
Deciding on the right kind of private pension and choosing a provider are the first two steps in the process of setting up a pension. The third and final step is to carefully consider contribution levels. This is one area in which the advice of a certified financial advisor can be invaluable.
The whole point of investing in a pension is to provide enough income in retirement to live the sort of lifestyle you want to live. Unfortunately, the average pension saver in the UK is not saving enough to do that. This is understandable, given the fact that most investors really have no idea how much they will need to guarantee a comfortable retirement.
Sit down with a certified financial advisor and discuss your future goals. Your advisor will take into consideration what you currently earn, how much you want to have at retirement, and the various ways to get you from here to there. Together you can find a comfortable contribution amount that will help you achieve your goals without forcing you to live as a pauper today. Keep in mind that if you do not put away enough, you may:
- run out of money in retirement
- be forced to sell your home to pay your bills
- be forced to rely too heavily on the state pension
- become a financial burden to your children or grandchildren.
Withdrawing Money from Your Private Pension
Assuming your private pension does as well as you anticipate, you will have a number of options at retirement. Prior to pension reform, the most common option was to use the money in your pension fund to purchase an annuity. An annuity is one way to guarantee yourself a specific level of income during retirement regardless of how long you live. Of course, there are multiple annuity choices to consider.
Pension reform has changed things considerably. Pensioners no longer have to purchase an annuity and, in fact, fewer are doing so. You can now access your pension in other ways, including:
- Cash Lump Sum – You take your entire pension pot as a single cash lump sum. It would be subject to a certain level of taxation, which will be discussed in the next section of this article.
- Pension Drawdown – The rules relating to pension drawdown have changed. You can now gradually draw down your pension based on predetermined income levels or by taking the money as you need it.
- Bank Account Strategy – As George Osborne, Chancellor of the Exchequer at the time pension reform was announced explained, you could use your pension pot like a bank account. Take money out when you need it and leave the rest alone to continue earning. Alternatively, do not touch it at all until after you have exhausted other forms of income.
Please bear in mind that accessing your pension funds through one of these options will subject you to a certain level of taxation no matter when you decide to do it. The first 25% of your pension pot is tax-free; the remaining 75% is taxed at your normal rate in whenever year you receive it. The same rules apply whether you take a single lump sum, or you draw down your pension incrementally.
Also, remember that you still cannot access pension funds prior to the age of 55 unless you have a qualifying medical condition. Any early access can result in taxation and other charges upwards of 75% of your pot. Be very careful of anyone offering to liberate your pension prior to your 55th birthday.
We hope you found this simple guide to private pension plans helpful. Please do not hesitate to look through our entire library of documentation for answers to all of your pension questions. And, as always, utilise the services of a certified financial advisor capable of giving you the sound advice you need.
Our panel of FCA Approved Pension Experts Will Help You:
- Free Initial Assessment of Your Current Pension Funds
- Find Out Your Projected Retirement Income
- Understand The Most Appropriate Alternative Investments
- Find Out How The Latest Pension Changes Affect You
- Release Cash From Your Pension
- Discover The Benefits of Changing Pension Providers