Private Pensions Explained


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By Sarah Watts
Updated on Thursday 26 August 2021

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It’s now common knowledge that a state pension should not be solely relied on for your retirement income, and financial experts recommend additionally taking out a private pension - also known as a personal pension - to boost your income.

What is a private pension?

Private pensions are a type of savings scheme where you build up a nest egg of cash for your retirement.

A private pension in the UK typically means you’ve arranged a personal pension for yourself and a workplace pension means a private pension scheme that’s been set up for you by an employer.

All UK employers are now legally obliged to offer a workplace pension scheme to their employees (see eligibility criteria on GOV.UK website). However, if you’re self-employed, it’s your responsibility to arrange your own private pension scheme.

You might like: Why you should save into a pension

How does a private pension work?

A private pension scheme works in the same way as a workplace pension whereby you typically pay monthly contributions to a pension scheme and your pension provider will apply tax relief to those contributions.

The only main difference with a workplace pension is that your employer will also very often make contributions alongside your own.

There are two primary types of private pensions:

  • Defined contribution: this can be a private or workplace pension that is based on the amount paid in.
  • Defined benefit: typically a workplace pension based on your wages and the length of time you’ve been employed.

Defined contribution pensions

These pensions are generally stakeholder or self-invested personal pensions (SIPPs) and are also known as money purchase pension schemes.

Contributions made by you and/or your employer are placed into investments like stocks and shares and the performance of those investments will affect the value of your pension pot, causing it to fluctuate (go up or down).

Defined benefit pensions

Occupational, company or work-based pension schemes can also be referred to as ‘career average’ or ‘final salary’ pensions.

Everytime you are paid a salary, a percentage of your wages is automatically placed into your pension scheme.

More often than not, your employer will also pay a contribution towards your pension every payday and all contributions are very often subject to tax relief (view the government private pension contributions page for full tax relief details).

Is it worth having a private pension?

Yes, it most definitely is worth having a private pension plan, especially if you want to enjoy your retirement years and not have to worry about making ends meet for the duration of your retirement.

It’s not a good idea to rely on your state pension alone for a retirement income as this will barely be enough money to live on. If you want to afford nice holidays, meals out, a car or perhaps treat your grandchildren to special days out or gifts then you should make sure you have a private pension fund set up as early as possible in your working life.

Because most private pensions enjoy tax relief up to £40,000 and most employers contribute to workplace pensions, most pensioners will very often get more money out of their pension pot than they paid into it.

Can I set up a private pension?

If you live in the UK and are less than 75 years old then yes, you can set up a private pension.

Where do I get a private pension?

If you are 22 years old or more, earn at least £10,000 a year and live and work in the UK, then you should be offered a private [workplace] pension by your employer.

You can have more than one pension and can take out an additional personal pension (or pensions) separately from your workplace pension. You should bear in mind that if your pension pots exceed your annual allowance then you’ll start to pay tax.

If you currently have no workplace pension and need to arrange your own, you can find an abundance of private pension schemes to choose from on the internet or you could employ an Independent Financial Adviser to find a pension for you.

How to set up a private pension

To set up a private pension you should:

  • Seek professional advice if you need help or do not fully understand how a pension scheme works, how much you should pay into one or are struggling to decide what companies offer the best private pension plans. You will usually have to pay a fee for advice from an Independent Financial Adviser but you can get general guidance for free.
  • Decide how much you’ll need to pay into your pension to comfortably enjoy your retirement.
  • Use an online pension calculator to gauge what income you can expect to receive from a pension when you retire.
  • Consider flexibility of contributions, especially if you’re self-employed and your income fluctuates.
  • Shop around and compare deals and prices on comparison sites and also get quotes directly from pension providers who may not be on comparison sites.
  • Request an FCA regulated ‘key features document from every pension provider you’re considering taking out a pension with as this document summarises all of the important stuff you need to know about a plan.
  • Make sure you can afford the contributions before committing to a plan.
  • Check all fees payable including administrative, transfer or management fees and also penalties for missed payments.

Where to get private pension advice

Independent Financial Adviser (IFA)

You can get private pension advice from an IFA but this advice will not be free as IFAs can no longer claim a commission from the provider, so check what their fee is at the outset.

You should also check that an IFA is regulated by the Financial Conduct Authority (FCA) and their name or business is on the FCA’s Financial Services Register.

The Pensions Advisory Service (TPAS)

Alternatively, you can get free private pension advice and information from TPAS. However, TPAS can usually only give general guidance about pensions but this may be sufficient advice for some. They can also help out with complaints.

How much should I pay into a private pension?

According to moneysavingexpert.com, to calculate a percentage of your income that you should pay into a private pension, you should:

  • Start with what age you are when you take out a pension;
  • Halve your age;
  • Pay that percentage (half of your age) of your pre-tax wages into your pension until retirement.

For example, if you take a pension out at the age of 30 and earn £30,000 per year, you should pay 15% of your salary (that’s £4,500 per year) into your pension fund every year until you retire. This works out at £375 per month - perhaps a little steep for some!

According to a Which? Survey, retirees said they need around £2,170 a month per household which equates to £26,000 a year to comfortably live off.

Obviously, some people will need or want more of an income than that and others will be able to manage on less than the estimates we’ve outlined above.

To be as accurate as possible, you should scrutinise what your spending is like now, consider what you will no longer be paying at retirement (i.e. a mortgage) and try to gauge how much money you will need to comfortably live on when you retire.

When working out your retirement budget, remember to include your State Pension and any other benefits, etc, making up your income and deduct the cost of the following outgoings:

  • holidays
  • a car or public transport
  • entertainment
  • clothes
  • meals out
  • groceries
  • utility bills
  • medical fees (prescriptions, dentists, etc)
  • birthdays and Christmas
  • subscriptions
  • anything else you will want to enjoy the rest of your life that costs money

Can I get a state pension and a private pension?

Yes, as long as you have paid NI contributions for 10 years or more, you will be entitled to a state pension and whatever you have accumulated in a private pension (or pensions) will have no impact on the amount of state pension you receive.

How do I draw my private pension?

  • You cannot normally draw on your private pension until you turn 55 years old (click on our linked article to read about the dangers of early pension release).
  • You have the option to draw out 25% of your pension fund as a tax-free lump sum.
  • If you take 25%, you’ll have 6 months in which to use up the remaining 75% which is usually taxed.
  • You can use some or all of the remaining 75% to buy a product that provides you with a guaranteed income for the rest of your life (very often referred to as an ‘annuity’).
  • You can invest some or all of the remaining 75% to get an adjustable/regular income (very often referred to as a ‘flexi-access drawdown’).
  • If your pension provider doesn’t provide you with the withdrawal, product buying or reinvestment options you would like, you can transfer your pension to a different provider.

You might also want to read: New Pension Rules Set to be Enforced in February 2021 - What does this mean for you? or Saving for Retirement: Pensions and Alternatives.


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