Setting Up a Personal Pension
The pension plans which were originally introduced in 1988 have radically changed over the years. They are now an extremely flexible savings plan which both qualify for tax relief on the premiums paid in and grow completely free of tax whilst the money is invested. Add to that considerable freedom in how to choose to take the benefits including a quarter of the money being paid tax free it is hard to find a better incentive to save.
Personal pensions work by making a lump sum contribution or regular payment into a plan usually monthly and they grow tax free to retirement. Additional contributions can normally be added at any time and you can take a payment holiday or freeze your contributions whenever you need.
Your contributions are normally topped up with tax relief from HMRC at your highest rate of income tax (marginal tax rate). So if you pay tax at 20% your contribution of £100 will cost you only £80. If you are a higher rate tax payer you can claim back additional tax relief through your tax return.
There are many choices and important considerations to take into account if you are considering setting up a personal pension including the charges, premium minimums and limits, investment options and transfer costs should you want to move the scheme to another provider in the future. For larger investments you should consider a self-invested personal pension which will provide an even wider range of investment options which can include property.
What is the maximum I can save in my pension?
Tax relief is available on contributions to your pension up to £40,000 per annum, known as the annual allowance, and you can top up the contribution with any allowance you didn’t use for the previous three tax years. The Annual Allowance was £50,000 (tax years 2011/12, 2012/13 and 2013/14).
For contributions over £3,600 and up to £40,000 per annum you must have gross earnings at least equal to the amount of the annual total contribution to qualify for tax relief on the whole amount. You will qualify for a tax benefit of 20% of your contribution up to £2,880 per annum even if you don’t pay any income tax. A £2,880 contribution will put £3,600 into your pension pot.
You can even continue to contribute to a pension when you are receiving a retirement income, but in this case your Annual Allowance reduces to £10,000 per annum and you will pay tax on any contributions over this amount. You cannot top this allowance up with unused relief from previous years.
Over your working lifetime you can build up a pension pot of up to £1.25m although this is being reduced to £1m from April 2016. You will pay tax, up to 55%, on any pension savings above this limit so it is important to monitor your contributions if there is any likelihood of breaching this limit, now or in the future.
A pension is a long term investment so it is worth taking time now to consider all your options.
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