Personal pensions: a guide

16 April 2014

If you are self-employed, don't work, or want to supplement your workplace scheme, a personal pension is a sensible way to save for retirement. Although you don't get the benefit of employer contributions you still get tax relief based on the level of income tax you pay. This essentially means it costs a basic rate taxpayer 80p to save £1, while higher rate taxpayers pay just 60p and additional rate taxpayers just 55p.

Your pension provider can claim basic rate tax relief on your behalf, but to claim any further tax relief you are entitled to you will have to contact HMRC and may have to complete a tax return.

What sort of pension should I choose?

There are three types of pension to choose from: stakeholder pensions, traditional personal pensions and self-invested personal pensions - more commonly known as Sipps.

Which approach is right for you will depend on how much you have to pay in, where you want to invest and your confidence in making investment decisions if you aren't getting advice.

1. Stakeholder pensions

Stakeholder pensions were designed as a cheap and straightforward way for lower earners to save for retirement. Charges are capped at 1.5% for the first 10 years (falling to 1% thereafter) and minimum contributions are low at just £20 a month. You can also stop and start contributions if your financial position changes and there are no transfer out charges if you want to move your money into another pension. The downside is that you won't have a fantastic choice of funds to put your money in.

Advisers generally are not big fans of stakeholder pensions. While a 1.5% charge might have been competitive when they were launched back in 2001, costs have fallen so much elsewhere that this no longer represents good value for money. Laith Khalaf, head of corporate research at Hargreaves Lansdown, says: "You could end up paying 1.5% for a quasi-tracker insurance company fund."

However, Justin Modray, founder of IFA Candid Money says they do have a place, particularly for those investors who are not confident making big investment decisions. The key he says is to choose wisely.

"If you are paying 1.5% on a stakeholder pension, that's daylight robbery," he says. "But some are only charging 1%." And while investment choice will never be fantastic, you may get as many as 20 to choose from with some of the better providers like Legal & General and Scottish Widows. "They can be cheap, cheerful and straightforward," he adds. "If you are unsure and nervous about making investment decisions, you can't go too far wrong with a stakeholder. And, if you do decide to move your money, you can transfer out without penalty."

2. Personal pensions

The second option is a personal pension which should have a much wider array of investment funds to choose from, including offerings from a wide variety of fund managers, not just the insurance company running your pension. Most providers will offer a couple of hundred funds but some, including Skandia's Collective Retirement Account, run off a platform and offer more than 1,250 funds.

Minimum contribution levels are higher than stakeholder pensions – varying between £50 and £100 a month – and you can expect to pay between 1% and 2% a year in charges, according to Candid Money. "How the different plans charge will vary – you may have to pay more for external funds."

However Modray doesn't see much value in the traditional personal pension. "The cost of Sipps have come down so much that they've pretty much eclipsed the personal pension." If you want investment choice, you may as well max out with the third option which is a Sipp.

3. Self-invested personal pensions

"The history of Sipps is such that they used to be very expensive, offering access to more esoteric investments, such as commercial property; but a Sipp now can cost pretty much the same as a personal pension," explains Khalaf. And with minimum contribution levels broadly in line with personal pensions too at £50-£100 a month, this range of choice is no longer the preserve of the rich.

Today fully comprehensive Sipps that allow investments in commercial property remain an expensive option. However there are plenty of cheaper Sipps that can be run online from fund and trading platforms (whom you may already have an Isa with) that still offer a pretty impressive range of investments including the entire universe of investment funds as well as investment trusts, shares and exchange traded funds

Many low-cost Sipps such as those offered by Interactive Investor and Hargreaves Lansdown have no set up charges but you will have to pay an annual charge.

This is likely to be a fixed or percentage based fee. "Fidelity charges a flat fee of 0.35% with no charge to buy funds, but you can't hold shares," says Modray.

Hargreaves Lansdown does let you buy shares, but charges 0.45% of your portfolio a year up to £250,000 (or 0.25% from £250,000 to £1 million). There are also no fund dealing charges but a £11.95 sharedealing fee applies per trade (although this does reduce for more frequent traders.

Interactive Investor charges a fixed fee. "It charges £144 a year plus a £10 dealing fee every time you buy or sell a fund or share," Modray adds.

As a general rule, the bigger your fund, the more sensible a fixed fee becomes. "Fixed fees start looking better value at around the £50,000 to £60,000 mark but it does depend on how often you trade," says Modray.

This means it's vital to shop around and check all the charges your chosen provider levies to ensure it matches your investment style.

In addition to Sipp-specific and trading fees, remember you'll also have to pay the annual management charge of any funds you are invested in. Bear in mind that some platforms will offer enhanced discounts on some funds so it pays to factor this into your research process too. "You can expect to pay around 0.2% for a tracker or 0.8% to 0.9% a year for an actively managed fund," says Modray.

Boosting your work scheme with a Sipp

Khalaf says that Sipps can also be a useful way for active investors to boost their pensions as they start to take the place of freestanding AVC plans. "It's a fairly common strategy to max out your employer scheme and then top-up with a Sipp," he explains. Likewise a Sipp can be a helpful tool for job-hoppers. "They are a useful consolidation vehicle for people who've acquired a number of pensions," he suggests.

But while Sipps offer investors a fantastic range of investments at very low cost, Modray says this degree of choice may not always be a good thing. "The choice with Sipps is great but it can be bewildering and people can easily end up with inappropriate and high risk funds. You do have to be reasonably savvy."

Keep charges in perspective

Whichever pensions route you pursue, don't get so bogged down by charges that you fail to think about the bigger picture. IFA Nick McBreen, from Worldwide Financial Planning, warns that while cost will always influence your decision, this isn't the most important element of your pension planning to consider. "The focus on charges has gone bananas. It's your asset allocation and the funds you invest in that will really make the difference."


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