What Exactly Is a Private Pension?
A private pension, also known as a personal pension, is a type of defined contribution or “money purchase” pension, meaning that your pension pot will be based on your contributions and how well the investments have performed.
Private pensions for self-employed work just like workplace pensions, although they are set up by the individual rather than the employer. you can choose to either set up regular monthly contributions or make a one-off payment into your pension.
Your pension provider will invest your contributions in a range of assets, including properties, bonds and shares. When you are 55 years, you can choose to buy an annuity, withdraw your pension as a lump sum or leave it invested and take out cash amounts when you need it.
According to the Pension Rules introduced in 2015, you can access and use the money in your pension pot from the age of 55. It is highly advisable you hire an independent financial adviser to help you work out which investment option or options will offer you and your dependants a reliable and tax efficient income when you retire.
What are the Benefits of Having a Private Pension?
- Compound Growth
One of the significant benefits of having a pension is the compound growth your funds will earn throughout your working life. The growth you earn on your fund is re-invested and starts earning itself, which is also re-invested again and so on. The benefit of this compound re-investment can be quite big, especially if your working life could be up to 30 to 40 years.
- Tax Relief
You will get tax relief if you pay into a private pension. Your pension provider will claim this at the basic rate and add the funds into your pot. If you are a basic rate tax payer will get a tax top-up of 20% on the contributions you make into your pension. For example, if you pay £4,000 into your pension, HMRC will add another £ 1,000, bringing your total contribution to £5,000.
If you are a basic rate taxpayer, you can claim up to 20%, while higher or additional rate taxpayer can claim up 25% extra pension relief via tax returns. Tax relief helps you to build your pension fund before you retire. It helps you to get more for less while you are working.
- Guaranteed Income
Once you reach the age of 55, you can choose to take up to 25% of your pension benefit tax-free and then buy an annuity to guarantee you an income throughout your life. There are many types of annuities available and they can vary greatly. However, they are all meant to provide a monthly or a weekly sum for you to live on throughout your retirement life. Annuities are just one option. You can also leave your funds invested and withdraw from your pension fund as and when you need to via flexible drawdown.
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Who Should Open a Private Pension?
Anyone looking to boost the retirement income they get from the state pension, which is upto £8,546.20 per year, should open a private pension. You can pay into a private pension even if you have a workplace pension. If you do not have a workplace pension, maybe because you’re self-employed or you opted out of your employer’s pension scheme, then opening a private pension is an ideal way of planning your retirement.
How Much Will I Get From a Private Pension When I Retire?
Private pensions are money purchase schemes. This means that your private pension pot will largely depend on the total contributions you have made, the period each contribution has been invested, level of charges, as well as the investment growth over this duration.
When Can You Withdraw Money From a Private Pension?
Under the new pension rules, you can only start drawing your retirement benefits when you reach the age of 55. You can withdraw up to 25% of a pension pot tax-free, either a lump sum or in smaller installments adding up to 25 %. Regardless of how big or small your pension pot, everyone is entitled to take a quarter of their savings without paying income tax.
Can I Cash in My Private Pension?
Under the April 2015 Pension rules, you can take the whole of your private pension pot as cash in one go if you want. However, you must have attained the age of 55. If you choose to do this, you may end up being tax heavily and run out of money in retirement.
When you take your whole pension pot, you are merely closing your pot and withdrawing it all as cash. Only the first 25% of the pot will be tax-free. The remaining 75% will be added to the rest of your income and taxed at the normal rate. Before cashing in your private pension pot it is important you speak to a regulated financial adviser.
How Much Tax Do I Pay on My Private Pension?
Once you have taken the 25% tax free lump sum, the remaining 75% will be added to your annual earnings for income tax purposes. The total amount of tax you pay on your private pension will depend on your gross taxable income. If your total income is NOT more than standard personal allowance for the tax year, you will not pay any income tax. The personal allowance for the tax year 2018-2019 is £11,850.
The HM Revenue & Customs will always notify you when your personal allowance changes. Note that you are only taxed on income that your personal allowance. If you are receiving income from your private pension pot, your pension provide will calculate how much tax you have to pay, using your Tax Code. They will deduct the tax before paying any pension benefits to you.
Can I Take My Private Pension and Still Work?
Yes, you can take your private pension and continue working. Your earnings will not reduce the pension you will receive. However, the combination of your pension and earnings will increase your taxable income, meaning you are likely to pay more taxes. Therefore, if you are working and paying taxes, your tax code will be set to reflect the amount of pension you are getting.
These are just some of the most important details to know about private pensions. For more information about, contact us at Hilltop Finance.