How to start a private pension – and give your retirement fund a boost

Saving for retirement is something we know we should all be doing, but knowing where to start can often feel overwhelming – especially with so many options to choose from.

While workplace pension schemes should usually be your first port of call (since most people will be enrolled into these schemes automatically), many people – including the self-employed – won’t have access to such arrangements.

For these individuals, and those who want to give their retirement savings a further boost, a private pension may be the right option.

Here, Telegraph Money explains how these types of pensions work, and how to go about choosing the best one to suit you.

In this guide, we cover the following: 

• What is a private pension?
• What types of private pension are available?
• How does a private pension work?
• Who might want to open a private pension?
• What are the benefits of a private pension?
• How do I start a private pension?
• How much should I save?
• When can I access my private pension?
• Choosing the right private pension

What is a private pension?

A private pension, also sometimes called a “personal pension”, are plans that you open up yourself to save for retirement.

These wrappers work in the same way as “defined contribution” workplace pensions, but can require more effort and admin as your deposits won’t be automated, and you may need to make more decisions about your investments. 

In many cases, it may also require you to submit an annual self-assessment tax return.

What types of private pensions are available?

There are different types of private pensions to choose from. The best one for you will depend on things such as the amount of control you want to have over where your money is invested, and the charges you are willing to pay.

Stakeholder personal pensions 

These are “simple” investment plans with low and flexible minimum contributions and low charges, which typically come with a limited range of investment fund choices.

These types of pensions are offered by a wide range of investment platforms, as well as pension firms and life insurance companies. They must meet set government standards to ensure they offer good value to savers.

Self-invested personal pensions (Sipps) 

With this type of pension, you get a lot more control over how your savings are invested – it’s a much more “hands-on” approach. A Sipp can hold a wide range of assets, including individual stocks and shares, investment funds and commercial property. 

Sipps are offered by investment platforms and asset management companies, and some have high minimum investment levels – so it’s important to check that you’re able to meet these requirements. 

Platform and trading charges mean fees are likely to be higher than those with a standard personal pension, and costs will vary depending on your trading activity, what kind of investments you have, and the size of your pot.

How does a private pension work?

Unlike a workplace pension, you will not usually get employer contributions paid into a private pension (unless you have a special agreement with your employer). But what you do get is upfront tax relief on your contributions.

You get this relief at your marginal rate of tax. For a basic-rate taxpayer this is 20pc, and for a higher-rate taxpayer, this is 40pc. For an additional-rate taxpayer, it’s 45pc.

You’ll also benefit from having more control over who runs your pension, the funds it’s invested in, and your options at retirement.

Who might want to open a private pension?

While private pensions are important for self-employed individuals who don’t get access to a workplace scheme via an employer, they are not only for people who fall into this group.

Anyone looking to slot more money away for later life might want to consider one. That said, before starting a private pension for yourself, you should check if it makes more sense to do so.

Jason Witcombe, chartered financial planner at Empower Partners, said: “Most workplace pension schemes are low cost, have decent fund choice options available – and will allow employees to top them up. Therefore, your work pension should be your first port of call when deciding on additional contributions.”

In other words, if you have the option to pay more into your workplace pension, it may be more beneficial to focus on topping up that pot rather than opening a separate account – particularly if your employer will increase their contributions to match your own.

What are the benefits of a private pension?

Private pensions offer you a tax-efficient, flexible route to build up a fund for your retirement, and come with a host of benefits.

Tax relief 

As mentioned above, you get tax relief on contributions.

Alice Haine, personal finance analyst from Bestinvest by Evelyn Partners, said: “As an example, for every £1,000 gross contribution paid into a pension by a 40pc taxpayer, the net cost is just £600, giving the pot a generous £400 bump-up in tax relief.”

Growth is tax-free 

In addition to tax relief, money invested in a pension can also grow completely free from income and capital gains tax. The compounding of these tax-efficient returns can be a significant benefit.

Flexibility 

Private pensions are flexible in offering choice of investments.

Tom Selby, director of public policy at AJ Bell, said: “For those who aren’t sure about which investments to pick, lots of firms now offer a simple range of diversified funds aimed at different risk appetites and preferences. In addition, private pensions are also flexible in offering a choice of ways to take an income when you are ready to access your fund.”

25pc tax free 

When you come to take money out of your pension, you can have up to 25pc of it tax-free (subject to Lifetime Allowance limits). The rest, when you draw it down, will then be subject to income tax.

Pensions on death 

When you pass away, pensions are extremely tax-efficient. In certain circumstances, they can be passed on to your beneficiaries completely tax free.

Mr Witcombe said: “If you were to die before age 75, your beneficiaries would not even have to pay income tax on withdrawals from the inherited fund.”

How do I start a private pension?

You can start a private pension any time you want, irrespective of whether you are working, self-employed, or out of work.

Before opting for any particular product or provider, spend time thinking about whether you want a low-cost straightforward savings plan where investment decisions will be made on your behalf, or whether you want to be more involved with a Sipp.

Mr Selby said: “It takes just minutes to set up a private pension with your chosen provider. The fastest method is usually online.”

You’ll just need a few details, such as your NI number, bank details, and information about your employment. Once you’ve opened your pension, you should then be able to set up a standing order for your monthly contributions.

Is it too late to start a private pension?

While the best approach to pension saving is starting as early as you can – as this will hopefully mean you can ride out the peaks and troughs in the stock market and build a retirement pot that matches your expectations – it’s never too late to begin.

Ms Haine said: “Younger workers thinking about cutting back on pension saving to meet other everyday costs should consider that decision very carefully. The first pound you save is the most important as that can turbo-charge a pension pot thanks to the compounding effect over time.”

That said, someone turning 60 and still working – with no pension savings – is better off starting a private pension than not.

Mr Selby said: “Even if you don’t start saving until later in life, the tax benefits on offer – and flexibility of access from age 55, rising to age 57 in 2028 – mean it would still be a savvy financial decision.”

How much should I save?

There is no “right” amount that you should contribute each month. Your choice will depend on a number of factors, such as your retirement savings goals, when you plan to access your pension, how old you are when you start saving, and your investment returns.

The Pensions and Lifetime Savings Association (PLSA) has some helpful research on how much you need to put away. According to estimates from the PLSA, a single person who owns their own home will need an income of more than £43,000 a year for a “comfortable” retirement this year. This is up from £37,300 in 2022-23. 

To help you work out how long your pension pot might last (and whether you need to save more), try the calculator below:

Mr Witcombe said: “There are various ‘rules of thumb’ you can follow, such as dividing your age by two, and putting in that number as a percentage of salary.”

This might mean, for example, that someone aged 50 would aim to pay in 25pc of their earnings.

Mr Witcombe added: “In reality, it comes down to affordability and personal circumstances. If paying into a pension makes sense, the answer is usually ‘as much as affordability and pension rules allow you to.’”

Don’t forget to factor in the annual allowance, though. This is a cap which applies across all contributions you make – including private pensions, SIPPs and workplace pensions – set at £60,000.

While this is far in excess of the amount that many people could reasonably expect to pay into a pension, it can be an issue for higher net worth individuals.

Crucially, once you’ve got your pension plans in place, you then need to review them regularly against your retirement plans – to check you’re still on track. If not, you need to take steps to fill in the gaps.

When can I access my private pension?

You can usually access the money in a private pension from the age of 55 (rising to 57 by 2028). While this could be seen as a “downside”, it may be better to see this as an advantage of pension pots, as it removes the temptation to withdraw funds early.

Take money out too soon, and you’ll end up with a lot less for retirement.

While it is possible to access your pension savings early (before 55), this will usually only be permitted in very exceptional circumstances, such as getting diagnosed with a terminal illness.

Ms Haine said: “At 55, you can withdraw 25pc of your pension tax-free. Withdrawals on the remaining 75pc of pension savings are taxed at your marginal income tax rate.”
There are different options to consider.

Ms Haine added: “At retirement, you can consider drawdown, where the pension remains invested while you take an income from it. Or, you can use your pot to buy an annuity which will provide you with a guaranteed income for life. Alternatively, you can choose a combination of the two.”

Further, savers can also choose to stay invested and continue to add to their pension with tax relief applied to contributions up to the age of 75 – though the amount they can invest will depend on whether or not they’ve initiated drawdown.

Choosing the right private pension

When it comes to setting up a private pension, you’ll need to choose a provider offering the plan that best suits your circumstances.

Mr Selby said: “It’s important to consider carefully the ‘value-for-money’ of your provider. This should incorporate things such as choice, flexibility, service, online functionality and crucially, costs and charges. Even relatively small differences in costs and charges can add thousands of pounds to your fund in retirement.”

Keeping costs down should be a priority when picking your private pension. This is why it’s important to shop around the market to ensure you choose the firm that is best for your needs and preferences.