A personal pension attracts some major tax advantages - and if you are saving towards retirement it makes sense to channel a large part of the money into your pension rather than into other forms of saving. Pension plans are tax-efficient in two ways. First, you get tax relief on the premiums which you pay into your pension plan. Then, when you reach retirement, there's no tax to pay on the capital growth - and you can also, if you wish, take up to 25 per cent of your accrued personal pension fund as a tax-free lump sum.
If you are 35 or under, the tax rules allow you to put 17.5 per cent of your salary into a pension plan; this amount rises with age, reaching 40 per cent of net earnings for those aged over 60.
If your earnings at age 35 are, say, pounds 35,000 a year, this means that you can put pounds 500 a month into your pension plan, and the tax relief is allowed on a percentage of gross salary plus taxable benefits.
With earnings of pounds 35,000 plus a further pounds 10,000 in benefits - car, health insurance and so on - you would be able to make pension contributions of pounds 650 a month.
In simple terms, all this means that for every pounds 75 you put into a personal pension, the Government adds another pounds 25 to make it up to a round pounds 100. If you're in the 40 per cent tax bracket, for every pounds 60 you put in your pension, the Government will add pounds 40.
You can pay in monthly amounts, or put in a larger lump sum once a year. That means you can contribute to your pension when you can afford to. The Inland Revenue allows you to catch up on past years' pensions contributions; you can put in the maximum allowable amounts up to six years later.
However, the value of your personal pension can be seriously affected by charges. As a recent investigation by The Independent revealed, there are substantial differences in the amounts which pension providers charge: and these can have as much impact on the size of your final pension "pot" as the investment performance of the fund concerned.
Pension providers generally offer a range of funds with different potential for growth and different levels of risk. It makes sense to go for growth in the early years before switching into safe but steady investments later on.
How do you decide which pension to choose? There are some simple rules to follow.
First of all, make sure you invest with companies you can trust: what is their financial strength, and what's their recent track record? And do look in detail at the charges - the higher they are, the less money will be invested on your behalf.
Charges vary, but they often include an initial sum, annual management fees, and monthly administration charges. An annual 1 per cent management charge may seem small at just pounds 10 for every pounds 1,000 in your fund. But work out the figures for yourself to see how quickly that can grow to a make a major dent in your final pension pot.
When you finally reach retirement, the tax man will also have a say in the amount which you can draw in cash. You can take out a lump sum from your pension pot when you retire, which in simple terms is roughly equivalent to 25 per cent of the fund.
The rest of the money must be used to buy an annuity to give you a retirement income, which must not be more than two-thirds of your final salaryReuse content