FOOL SCHOOL
Personal Pensions And Stakeholders

December 6, 2004

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

Essentially, they are defined contribution schemes into which the holder pays a percentage of their salary (rising from a maximum of 17.5 per cent at the age of thirty-five or below to 40 per cent at the age of sixty or above). These payments then go into an investment fund, run by an investment or insurance company.

The payment is treated as if it was made 'net of basic rate tax'. In English this means that the government pays an additional £28.21 per month into your pension for every £100 you pay (if you want to know the sums 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. (Again for fans of maths 40% of £128.21 is £51.28, less the £28.21 already paid by the government leaves a refund for you of £23.07. Phew!).

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

Back in 2001, in a bid to make personal pensions a little more useful and exciting, the Government changed some of the rules. The main change is that you no longer have to be earning 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 by the consumer. Pension managers are can only charge fees of up to 1% of your pension fund per year (although it appears that this cap will be set at 1.5% for new schemes started in April 2005 and beyond). 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.

For more information on the options, why not try the Financial Service Authority's decision tree on stakeholder pensions.

> Find out more about pensions here.