Personal And Stakeholder Pensions

Personal pensions give self-employed people, or those working for companies without company schemes, a crack of the pensions whip.

Essentially, they are defined contribution schemes into which the holder pays a percentage of their salary. These payments then go into an investment fund, run by an investment or insurance company. Prior to April 2006 your contributions we're limited to a percentage of your salary, with the percentage rising according to your age. Nowadays you can put in up to your annual salary each year (subject to a maximum of £215,000 for this tax year).

The payment is treated as if it was made 'net of basic rate tax'. This means that the government pays an additional £28.21 per month into your pension for every £100 you pay. That's because £28.21 is 22% (the current basic rate of tax) of the total of £100 plus £28.21.

If you are a higher rate taxpayer you get tax relief up the 40% level as well. This means you will get an additional tax refund of £23.07 for every £100 you pay in. The sums here are that 40% of £128.21 is £51.28. Take away the £28.21 added by the government mentioned above and you're left with a refund of £23.07.

The fund grows and then, on retirement, you can take up to 25% of it as a lump sum and the remainder is used to buy an annuity to provide an income and you pay income tax on these proceeds. So personal pensions aren't so much a way of avoiding tax, as is often thought, but of deferring tax.

Several years ago, in a bid to make personal pensions viable for more people, the Government changed some of the rules. The main change was that you no longer have to earn an income to contribute to a personal pension. The precise rules are a little complex, but most people are able to contribute up to £2,808 per annum to a personal pension, even if they have no earnings of their own. On top of this, the Government adds a contribution calculated using the basic rate tax (i.e. 22% as stated above), making a total of £3,600 per year. This is particularly useful for people going through career breaks, but contributions can be made on behalf of non-working partners or even your children.

On top of these changes, the Government introduced the concept of stakeholder pensions. Basically this means that pensions meeting certain requirements, on costs and terms, can call themselves 'stakeholder pensions'. You can apply for a stakeholder pension yourself or through your employer. Firms with five employees or more have to offer their staff a stakeholder scheme or alternative pension arrangements and some companies make additional contributions to their employees' stakeholder pensions.

The idea is that, while a stakeholder pension may not necessarily be the cheapest personal pension on the market at any given time, it should be a flexible product of reasonable value that is easily understood. Pension managers can only charge fees of up to 1% of your pension fund per year, or 1.5% for schemes started after April 2005. There can be no up-front charges. You can stop and start your payments whenever you like over the years. You can take your stakeholder pension with you if you change your job, and you can switch it to a different provider whenever you want without penalty.

At the moment about 6.5m people are contributing to a personal pension of some description, putting in an average of around £2,000 per year. Just under a quarter of these are classed as stakeholder pensions.

For more information on your options, the Financial Service Authority's decision tree on stakeholder pensions can be a helpful guide.