The basics of private pensions
In a nutshell
• You get free money from the government (hallelujah)
• Basic rate taxpayers get a free £20 for every £80
• Higher rate taxpayers get £20 more on top
• The money is locked away until you’re 55+ (57 from 2028)
• As always there are caps and limits, so read on...
OK. So pensions are boring... but free money is not! It's quicker and easier than ever to set these things up. Any of us can set up and run a private pension online from contributions of just £50 a month.
Our income in retirement is kind of like a cocktail with three shots: State Pension + work + private pensions. You should ideally be topping up the first two with some private savings as well to set aside as much as possible for those later years.
Is a private pension right for me?
15% of UK adults have a private pension account - we think it should be more! - but it may not be the best route for you if you have more pressing financial priorities.
PENSIONS IN YOUR 40S, 50S AND BEYOND - AUDIO GUIDES
Learn AND laugh about pensions with audio guides from Holly Mackay, Founder of Boring Money, and Tom Selby, Pensions Expert at AJ Bell.
Listen to our Pension Planners' series of tips, guides and Q&As at Pension Planners.
How strong is your retirement cocktail?
You dont have to be a master mixologist to create this triple shot pension highball. In this video Holly takes you through all you need to know.
HOW MUCH DO I NEED?
Most of us simply don’t have a clue what we need to retire on. Or what the number in our pension savings actually could mean for an annual retirement income.
Here are some basic rough numbers because you often tell us you want some anchor points as a sense-check. The usual caveats apply as we don’t know your situation, what markets will do, what the Government will do, how long you’ll work for blah blah.
State Pension. Take the number of years you’ve worked for and multiply by £4.75. That’s a rough sense of your weekly State Pension. Thirty years? Could be an annual pension of about £7,400.
Workplace Pension. Check out your statements for a projected retirement lump sum. Or use the Money Advice Service pension calculator. As a rough guide, a 40-year-old on £30,000 a year might build up £120,000 based on minimum contributions by the time they retire. All sorts of caveats here folks so a rough guide only.
Private Pensions. The last component. What do you project you will have saved by retirement age based on your contributions today?
We used the Money Advice Service calculator. Based on a 50-year-old earning £50,000 a year, with a pensions saving stash of £70,000 already and assuming minimum workplace contributions, the calculator suggested a retirement lump sum of £125,000. Add this to the State Pension from age 67, and the estimated annual income was £12,750.
Either use the calculator to get your estimate. Or divide your total anticipated pensions savings lump sum at retirement by 20, and add the State Pension to this, to get your total retirement cocktail number.
If it’s not big enough we can delay retirement and work longer, or pay in more to a pension today. Unfortunately there aren’t any other more palatable options!
WHAT IS A SIPP?
SIPP is just an off-putting name for a sort of DIY pension which you manage yourself, typically online. It stands for ‘self-invested personal pension.’ As the name suggests, SIPPs were really invented for all those people who were fed up of their pensions disappearing into an information black hole which spewed out an unintelligible 25-page snail mail report at you once a year.
To understand SIPPs, you have to get rid of this idea that a pension is a complete thing in its own right. A pension is just a container with its own set of tax rules and access rules about the money inside it. What actually goes into this container is not necessarily an opaque decision which you hand off to a distant ‘propeller head’. Every time you put some cash into the SIPP, you then decide what investments to buy with your cash, and therefore you control how your retirement savings are deployed.
As a quick reminder on the “why would I bother with a SIPP” question, it’s the bribe of free money from the Government who need to incentivise you to save so they lessen the pain of millions of broke 100 year olds to sort out. Basic rate taxpayers get £20 for every £80 put in. Higher rate taxpayers can claim a further £20 back on their tax returns.
Visit our pensions Best Buy pages where we’ll tell you who we like and also share the feedback from 1,000s of pensions customers today.
How much can I pay into a Pension?
The maximum amount you can pay into your pension scheme in a tax year, assuming you are earning more than £3,600 per annum, is 100% of your earnings. But for tax relief purposes, the current annual allowance for most people is £40,000, so you can’t go beyond this. This is what is known as a first world problem, along with Waitrose running out of avocados.
If you get your hands on a lump sum of money – inheritance, sell a business, get a whacking bonus – then you can use previous years’ allowances and contribute more, so read up on that.
The rules for higher earners are more complex. Anyone whose total income is over £150,000 a year will get a reduced annual allowance. For every £2 earned above £150,000, the allowance tapers down by £1, resulting in anyone earning over £210,000 receiving an annual limit of £10,000 in tax relief.
Higher earners take note – the lifetime allowance is £1,073,100 for the 2021-2022 tax year and will remain frozen at this figure until the 2025-2026 tax year. This means there is no point in saving more than this into a pension before you retire or you get taxed to the max.
Although this lifetime limit sounds like loads, if you start saving early and your investments do well, it could impact you. Middle managers in the public sector, for example, are not immune! A senior teacher? High up the healthcare career ladder? Worth thinking about whether this will impact you.
If you’re 40 now and saving into stocks and shares in your pension, don’t forget to factor in stock market growth! For example, £350,000 over 20 years with an average return of 5% will get you to the million pound mark.
At the lower end of the earnings spectrum, don’t be put off by these high numbers. You can also start a pension with a direct debit for a relatively small amount such as £50 a month – sometimes less. It really is worth starting as early as you can – even if you think that your tiny little dribbles won’t make much difference.
How much should I pay for a pension these days?
There are three basic elements to the charging structure:
Admin fees – annual administration fee for providing the pension - this will usually be between 0.35% and 0.5% each year and will be levied by the company you open up the account with.
Dealing charges – fees charged when you buy or sell funds or shares. It’s normally about a tenner to buy a share and buying funds is usually less or free.
Fund manager fees – an annual charge from the fund manager for managing your investments. This will apply if you buy managed funds inside your pension which is the typical structure. This is usually about 0.75% every year.
Most people wonder why it can’t just be bundled together as a single and simple fee but the regulator has been clear that it wants people to know what they are paying for what parts of the overall service. Much like the Ryanair model where you pay to have a sandwich and a pee!
All in, I don’t think any of us should be paying more than about 1.3% a year. So £13 on every £1,000 invested. The biggest variable will be the investment charges and these will vary from lower-cost ‘passive’ funds to higher cost ‘active’ funds. If you’re in what is called a ‘passive’ solution then you should be paying less than 1% all-in.
What can I put into my SIPP?
You are allowed to put some cash, shares, investment funds and other assets into your SIPP. The whole concept is to deliver choice. You can’t put residential property in there – like a holiday house – but you can sometimes include commercial property. At that point it all gets horribly complicated and you’ll need a good financial adviser.
Most of us will be happy to choose a decent range of funds. It depends on how much money you have in here, but as a rule of thumb between 8 to 12 investment funds should be enough. Enough to spread the risk around different sectors, regions and asset types – but not so many as to completely dilute the decisions or value a fund manager is adding.
Confident savers may prefer to choose their own range of individual shares but we wouldn’t suggest this path for the newer investor.
If you don’t want to research a pool of funds and you aren’t sure what to do, look at using a single multi-asset fund. This is a great way to start for the less confident who are starting to save small(ish) and regular amounts into a SIPP.
HELP ME CHOOSE
Our Best Buys page will show you who we rate and why. We also segment the providers according to who is the most helpful for less experienced and less confident investors.
PENSION DRAWDOWN - TAKING THE PLUNGE
We asked our readers to share their experiences...
Trying to pick a drawdown provider can be a difficult task. Although we do a lot of work behind the scenes at Boring Money, it is easier for us to test general investment accounts and ISAs with test accounts. We can’t open up test drawdown pension accounts yet because we’re not at that stage and couldn’t possibly open up over 30 pensions! Imagine the stress!
This is why we rely on readers for feedback. We asked our readers who have chosen or set up a drawdown account, whether advised or self-directed, to share their experiences and feedback. Here is a warts-and-all summary of what our readers have experienced. They are reader opinions shared in good faith – but not regulated or personal advice and not verified for technical accuracy. (I know you all get that, but I feel compelled to labour the point!)
Our general reviews of providers can be read on our Best Buys pages.