How Do Private Pensions Work?

Please note this blog post was published over 12 months ago and so may not include the most up-to-date information, for example where regulation around investing has changed.

How Do Private Pensions Work?

How do private pensions work?

True Potential Investor are here to help with this handy guide if you would like to better understand how private pensions work…

The fundamental definition of a private pension

Due to the UK’s auto-enrolment rules employers should be offering workplace pensions and automatically enrolling qualifying members of staff into them — unless an individual chooses to opt out. However, pensions don’t just need to come through the place where you work. A private pension can also be set up in addition to or instead of a workplace pension.

Once in place, a private pension is a tax-free pot of money that you, your employer and sometimes the government can pay into as a means of saving up for retirement. It’s up to you whether you want to make regular contributions to your private pension, such as placing a certain amount of money into your pot every month or making one-off payments when you see fit.

Tax relief available on private pensions

One of the most appealing aspects of a private pension is the tax relief that comes with this financial product, which varies depending on if you’re a basic-rate or higher-rate taxpayer. Take note that some tax can be gained back on the money that is put into a pension pot, while gains which are recorded from the investments you make with your funds are also largely tax-free.

So long as you’re under the age of 75 years old, you will receive tax back on all contributions that you make — subject to an annual allowance — and this often goes immediately into your pension pot.

When it comes to just how much tax relief you receive, you will automatically get 20% tax back from the government as an additional deposit when you pay money into your pension through your own means or when it is taken from your pay slip by your employer. An additional 20% can be claimed by higher-rate taxpayers and an additional 25% by top-rate taxpayers.

Not sure which tax bracket you fall into? It’s important to check, as tax relief won’t be paid if you don’t reclaim. This page of the HMRC website has more information which should help.

How much money can a person put into a private pension?

You can put as much money as you want into a private pension, though you need to be aware of the three limits when it comes to how much tax relief you receive.

First, there is the earnings limit. This is where you receive tax relief on contributions to your pension pot up to your annual earnings.

Then there’s the annual limit. This is where you will only receive tax relief up to your current annual allowance — this is the allowance for the current year (set at £40,000 for the 2018/19 tax year), as well as any unused allowance from the previous three tax years.

Finally, we have the lifetime limit. Set at £1,030,000 for the 2018/19 tax year, you will not receive tax relief on further contributions when your entire pension savings — this includes gains and interest — exceeds this amount.

Be aware too that any money paid into your pension by someone other than yourself, which includes your employer, also counts towards these limits.

Are funds in a private pension safe?

A rule in place with normal savings accounts is that up to £85,000 per person per institution is fully protected if a bank goes bust, as provided by the UK’s Financial Services Compensation Scheme (FSCS).

Place your money into either stocks and shares or funds that invest in them though, and you will have a ‘risk-based’ investment instead of savings and so entirely different protection from the FSCS will apply. As this protection for pensions is complex and can vary with the structure of each product, it’s always best to check with a pension provider to see what protection applies to your pot.

It’s important to stress that the FSCS will not protect performance loses. If a company that you have invested in goes bust, for instance, then it’s deemed that that is the investment risk that you have taken. However, protection with investments comes into play if you were to lose money because of the product provider of the investment going bust.

It’s often the case that the provider of the private pension will not hold your money and will instead make arrangements with a custodian to operate accounts in accordance with the Client Money Rules. The pension provider is usually acting as a conduit for you to place your cash into permitted investments or funds and if the provider were to go bust then your money should be fine, as it will still be held by the custodian or fund manager.

Should an underlying fund manager fail financially, your investments will be covered at the relevant FSCS rates at the time, the maximum level of compensation for claims under the Investment Business section of FSCS is £50,000 per person, per firm that defaults, subject to eligibility for compensation.

When can funds in a private pension be accessed?

You are unable to withdraw money from a pension as you see fit once it’s in the pot. As set out during the 2014 Budget, you can only access your pension once you reach your 55th birthday unless for extenuating circumstances which have been detailed by GOV.UK.

At the age of 55, you’ll have the option to take your private pension as one lump sum, use the funds to purchase an annuity — which will act as a guaranteed income for your later years — or keep the cash invested and only take out money when you require it.

If you’re approached with the claim that you can access your pension ahead of your 55th birthday, be aware that this is a scam deemed pension liberation. This guide by will help you to avoid being left out of pocket by criminals.

Now that you know how they work and the benefits of having one, why not open a private pension here at True Potential Investor? Due to our Fully-Managed Investment Portfolios in a Pension, you can have a tax-efficient and long-term investment that will be working as hard as you are for your retirement.

With investing, your capital is at risk. Investments can fluctuate in value and you may get back less than you invest. Past performance is not a guide to future performance. Tax rules can change at any time. This blog is not personal financial advice.

Investing, Personal Finance