Pin your faith on a pension

Personal plans are more flexible than you think, says Clare Arthur

SAVING money in a pension plan is one of the most important financial moves you are likely to make in your lifetime. But in the rush to take advantage of annual Personal Equity Plans and Tax-exempt special savings accounts , it is easy to forget that a pension is also one of the most tax-efficient ways for working people to invest.

The Government encourages people to take responsibility for their retirement funding by making investment in all types of pension tax-free. Whereas money invested in a PEP or Tessa is paid from taxed income, investors receive full tax relief on premiums paid into a pension scheme. This means that a higher-rate taxpayer will benefit from pounds 1 of investment for every 60p he puts in a pension plan.

Money invested in a pension fund also grows tax-free and when you reach retirement age, you are entitled to take a portion of the pension fund as a tax-free lump sum. Nick Bamford, of independent financial adviser Informed Choice, says: "Pensions offer a combination of tax breaks which make them the sensible first port of call when investing."

Once money has been paid into a pension, you cannot touch it until you retire. So you should be careful not to invest any money that you may need to call upon before retirement. That said, at best pensions can be encashed from as early as age 50.

There are two main types of pension - the company or occupational scheme, and the personal pension. Company schemes are run by employers for employees, and the employer sometimes makes generous contributions as part of the employee's remuneration package. Such schemes often include free life insurance and income protection insurance, which pays out if you are unable to work through illness or disability.

Personal pensions are more suited to someone who is self-employed or who changes jobs frequently. The investor can take this type of plan from job to job.

The choice of investment is wide. More than 100 insurance and investment companies sell personal pensions, each offering a range of investment funds to hold contributions.

However, an employee should nearly always take the opportunity to join a company scheme because of the employer's contributions. Some employers may agree to contribute to an employee's personal pension plan, but this is quite unusual.

As with PEPs and Tessas, there are limits to how much you can invest in a pension each year. First, you have to be earning money through employment. Employees who belong to a company pension scheme can invest up to 15 per cent of their annual income each year.

Those who take out a personal pension are subject to a range of maximum contribution limits, which vary according to age and size of salary. Anyone aged 35 or under may invest up to 17.5 per cent of earnings in a personal pension.

This limit gradually rises as the investor gets older, and those aged 61 to 74 may invest up to 40 per cent of earnings.

Martin Mullany, a director of London financial advisers Brooks Macdonald Gayer, says that it is important to invest as much as you can, as soon as you can, in a pension.

"Your pension fund may have to last for 20 or 30 years after you retire, so it has to be very large to pay out a reasonable level of income. The sooner you start saving, the more affordable it will be to save up that fund."

Before setting up a pension you should consider several points:

o Can you join your employer's scheme? You may have to work for a company for a couple of years before becoming eligible to join its pension scheme.

o When would you like to retire? A personal pension allows you to retire from the age of 50 until 75 (those started before July 1988 set the minimum at age 60). A company scheme will set its own rules on when you can retire and take a full pension. Most have traditionally set the retirement age at 60 for women and 65 for men, but since the introduction of new rules to equalise the state retirement age, many companies have raised the retirement age for women to 65 as well.

o How much can you invest? Remember - the sooner you want to retire, the more you should invest now.

o Will your pension contributions be index-linked to keep up with inflation?

o Do you understand all the rules? Pensions are complicated investments, and you should consult an independent financial adviser before you make any decisions.