The pension industry has experienced significant changes concerning workplace, private and state pensions in recent years. After decades of minimal regulatory movement, the UK government is in the midst of a long-term plan of reform. There will likely be further adjustments in the future, but it is helpful to highlight the benefits of paying into a private pension today.
Three main types of pension
Before we look at the benefits of paying into a private pension in more detail, it is vital to appreciate the three main types of pension available today:
- Workplace pension
- Private pension (often referred to as a personal pension)
- State pension
The value of a state pension relates directly to national insurance contributions over your working life, whereas it is different with workplace and private pensions. When looking at workplace/private pensions, there are two individual formats:-
Final salary scheme (defined benefit)
While final salary schemes are not as common today due to their running costs and long-term liabilities, there are still some active schemes. As the term suggests, your pension payment in retirement is based on your final salary and years of service. This is the defined benefit. While both the employee and the employer will contribute to a final salary scheme, the employer is obliged to ensure the pension fund is fully funded.
Money purchase scheme (defined contributions)
Today, private pensions and most workplace pension schemes are classified as money purchase schemes. This means that while the contributions are defined, there is no defined benefit, i.e., income levels in retirement are not guaranteed. The eventual value of your pension scheme on retirement will depend upon the level of contributions and investment returns. While “money purchase” relates to the historical activity of buying an annuity on retirement, there is greater flexibility today.
What are the benefits of a private pension plan?
It is essential to be aware of the pros and cons of a private pension plan because actions taken or not taken today can significantly impact your finances in retirement. Some of the main benefits of a private pension scheme include:-
Greater control over investments
As part of a workplace pension scheme, the process of investing funds is traditionally outsourced to a pension management company, with fund members having no input. The situation is different with a private pension scheme set up by individuals with a pension management company. A traditional private pension scheme will likely have the option to invest in various collective investments. While there is a degree of control over how your funds are invested, the number of collective investments available could be restricted.
If we look at Self-Invested Personal Pensions (SIPPs), the situation is very different, with the individual having complete control over how their funds are invested. In theory, this could include:
- Commercial property
- Investment trusts
- Collective funds
- Shares
- Bonds
- Corporate investments
- Land
- Annuities
The breadth of investment options available with a SIPP will depend on the administrator. Consequently, if you want to take a more active role with the investment of your pension funds, it is vital to take professional advice.
There is also the option to take out a stakeholder pension which allows for low minimum contributions, which can be stopped and started at your discretion. This type of private pension does not incur any transfer out fees, and annual charges are capped.
Mobility
The mobility of a private pension scheme is often underrated, but it can enhance the efficiency, administration and management of your pension assets. A recent report highlighted that the average person in the UK will have 12 jobs in their working life and potential membership of 12 different workplace pension schemes. So while there are benefits with a workplace pension scheme, your employer will contribute, a private pension scheme is not impacted by changes in your employment.
In this scenario, it is possible to maintain your private pension plan and join various workplace pension schemes. As a private pension scheme and the modern-day workplace pension scheme are typically “money purchase” arrangements, they can be merged at some point.
Pension contributions
The minimum contribution for a workplace pension is 8%, with a minimum of 3% paid by the employer and the balance by the employee. In some cases, the employer may pay more than the minimum 3%, thereby reducing the minimum contribution required from the employee. If an employer chooses to pay the full 8% into the workplace pension scheme, the employee does not have to make any contributions. There is no maximum contribution for employers or employees.
Tax relief considerations for workplace and private pension contributions are the same, the lower of 100% of their annual earnings or £60,000. When it comes to a private pension plan, there is no minimum contribution; you can make regular or lump sum payments at your discretion. There is also the option to carry forward unused annual pension contribution allowances for the previous three tax year years – as long as you were part of a pension scheme at the time.
Additional contributions
If you have a private pension fund, third parties can also contribute on your behalf. Interestingly, any contributions made by parents, grandparents, etc, will be treated as a contribution by you and, therefore, potentially eligible for tax relief. As someone seeking to help their child with future finances, the long-term benefits and tax relief on pension contributions may be of interest.
Who might take out a personal pension plan?
In theory, whether you are part of a workplace pension scheme, self-employed, a contractor, or even unemployed, you can take out a personal pension plan. However, these types of pension plans are more attractive to the self-employed and contractors due to the flexibility in contributions and mobility.
Summary
The main benefits of a private pension plan are the flexibility and control afforded over both contributions and investment decisions. These are particularly attractive for the self-employed and contractors as a means of tax-efficient saving for the future. It should also be possible to transfer workplace pensions into a personal pension as they are both classed as defined contribution/money purchase arrangements.
When looking to make changes to your pension contributions and potentially amalgamating numerous plans, it is vital to take professional financial advice.
