Personal pensions are essentially private pensions, which give you the power to choose your own provider. Your decision might be based on how they're investing the money, as well as what kind of rates you can receive to build up your investment ready for when you want to cash it in.
How personal pensions work
How much you'll receive when you retire will largely depend on the performance of the funds in which you have invested. As of April 2015, it's now possible to withdraw what you want from the pension from the age of 55, although you should be aware that this will be treated by HMRC as a taxable income. Your provider will claim tax relief at the basic rate and add it to your fund, but if you're a higher rate taxpayer, you'll need to claim a rebate for this via HMRC.
Although your total pension should increase year-on-year as you continue to pay into it, there is no way of accurately predicting what the final total will be
The great thing about personal pensions is that they give you a degree of freedom to choose where to invest your money. Often there will be a 'default fund' which you can opt for and your money will be used to make investments with the aim of increasing your savings with interest earned. Some people prefer to be more cautious and choose to invest their money into cash funds, and corporate bonds, although many providers offer the chance to mix between the two to balance the risk and reward.
As you near retirement you should consider moving your funds across into less risky schemes such as government gilts. The idea behind this is that they offer a lower rate of interest, but with a riskier investment, you're going to have much less time to recoup your losses.
Those who want a wider range of choices, often opt for a Self-invested pension (SIPP). For more information on this, have a look at our 'Guide to SIPP Pensions'
Aside from the actual pension fund itself and it's generated interest, some pension providers also offer a number of other benefits. One of the most common is a 'death before retirement' clause, which basically means that your spouse or nominated person can collect your returns after you've gone.
Another benefit is the option to withdraw up to 25% of your pension (from the age of 55), tax-free. This might be handy if you have a mortgage to clear off, or other debts, thus saving you money on repayment interest.
Whilst it's good to take charge of your future with a personal pensions, there are a few drawbacks
- They are self funded, whereas a workplace pension your employer would normally pay a contribution as well to boost your pot. Obviously workplace pensions aren't an option if you're self employed etc.
- Charges can be higher that those paid by members of occupational schemes
- Some have limited investment choices as to where exactly your money is invested. A self invested personal pension (SIPP) offers a wider choice though, and may be something you want to consider if this is important to you
You'll be reassured to learn that all pension arrangements based on defined contributions are protected by the Financial Services Compensation Scheme (FSCS). The FSCS protects schemes with FCA authorised providers, depending on the type of investment. That is to say, it chiefly protects against the insolvency of an pension provider, but does not insure against poor investment choices or performance.