Private pensions and self-invested personal pensions (SIPPs)

Kim Jones
Kim Jones
Updated 28 September 2022  | 5 mins read

Key points

  • Private pensions are an alternative or addition to workplace pensions offering tax advantages to save for your retirement
  • With a standard, or personal pension, the provider invests in their choice of a range of assets designed to grow your investment with time
  • Self-invested personal pensions (SIPPs) are a type of personal pension that gives you more freedom and choice on what you invest in
  • Compare fees and features of pensions before you decide what to opt for and take financial advice if necessary

Investing in a private pension or a self-invested personal pension (SIPP) is a tax-efficient way to save for your retirement. But what are these types of pensions and do you need one?

The maximum state pension for tax year 2022/23 is just £185.15 per week, or £9,627.80 a year.

If you want a larger income to live off in your retirement, then you’ll need to think about saving or investing for your future.

For most people, this means investing in a pension plan designed to provide you with a regular income, a lump sum, or a combination of both, which you can access from age 55.

Many people have a workplace pension in place that’s arranged by their employer.

Here, a percentage of your pay is taken from your salary and put into the pension scheme every month. In most cases, your employer also contributes money into the pension for you. And the government adds money into your workplace pension in the form of tax relief.

It’s important you keep tabs on how your workplace pension is performing, so you know what to expect from it. You can ask your pension provider for an estimate of how much your pension will be worth by the time you plan to retire. If you feel it won’t provide enough of an income for you, you may need to look at other savings or investments.

Of course, some people aren’t entitled to a workplace pension. For example, the self-employed, those that don’t work or who earn less than a certain amount per annum, plus people who work abroad.

If that’s the case for you, or if you want to supplement your workplace pension savings to boost your retirement income, then a private pension (sometimes called a personal pension) or a SIPP can offer a tax-efficient investment option for your retirement.

What is a private pension?

A private, or personal pension, is a product you set up with a bank, building society or insurance company and pay into to save for your retirement.

You can make regular monthly contributions, or one-off payments into your personal pension plan. The pension provider then invests the money on your behalf in their choice of a range of assets like shares, bonds and property to spread and manage risk. The value of your pension when you retire will depend on how much you’ve paid into it and how the investments have performed.

As is the case with any investment, there are no guarantees and the value of your investment can fall as well as rise.

Most pension companies offer a standard, default pension plan along with other pension plans, or funds, with different risk profiles. So you can choose a plan to suit the level of risk you’re happy with.

What is a SIPP?

A SIPP is a pension plan which works in a similar way to a personal pension but, rather than leaving it to your pension provider to decide where your money is invested, you can pick your own investments. You can also choose to pay a financial adviser to take care of managing things on your behalf.

SIPPs offer a flexible way of investing, with hundreds of different assets to invest in, but they can be a complex way of managing your savings. They’re mostly for people who understand financial markets, have some knowledge of investing and who can spend time researching the markets.

Like a personal pension, the value of it will depend on how much money you’ve paid in and how well your investments have performed over time.

How do personal pensions work?

A standard personal pension is run by a pension fund manager (or a group of pension fund managers), who invest the money you contribute to your pension into a range of assets they choose.

When you add money to your pension, the government does, too, in the form of tax relief.

The amount of tax relief you receive depends on your income tax bracket.

For example, basic rate taxpayers get a 25% top up to pension contributions, up to an annual allowance.

So, if you pay in £100 to your pension, the government adds in a further £25.

Your pension provider will automatically claim this basic rate tax relief for you and add it to your personal pension pot.

If you’re a higher rate taxpayer, you can claim any additional tax relief you’re due on your annual tax return.

Tax relief applies to contributions up to £40,000 per tax year.

When you reach the age of 55 you can access money from your pension pot and there are a number of ways you can do this.

  • You can take out up to 25% of your pension tax-free - either as a lump sum or in separate amounts. You can then leave the rest of your money invested and withdraw it as and when you want to. Anything left in your pension pot when you die can be passed on to whoever you wish
  • Alternatively, you can use some or all of the money to buy an annuity with an insurance company which will provide you with a stable annual income until you die or for a fixed period. The insurance company that you sell your pension pot to could end up paying out more - or less - than the amount in your pension pot, depending on how long you live
  • You don’t have to touch your pension when you’re 55. You can leave the cash in your pension pot to let it grow until you’re older or until you retire

All decisions come with tax implications - and you should speak to a financial adviser or make an appointment to talk with the government’s MoneyHelper Pension Wise service if you’re unsure about how to take your pension.

How does a SIPP work?

A SIPP works in a similar way to a personal pension. But you have more control of where your money goes and can choose from a wider range of investments like UK and overseas shares, trusts, funds and bonds. You can change what you invest in and add to your investments whenever you want.

With a SIPP, you can make all investment decisions yourself or you can pay a professional like a financial adviser to help you choose your investments and manage your fund.

As is the case with a personal pension, the government tops up your pension contributions in the form of tax relief and you can access funds from the age of 55 if you wish, in the same way as you can with a personal pension.

What types of pensions are available?

There are three types of pension plan.

The state pension

This is the regular payment you get from the government when you reach state pension age - currently 66 and rising to 67 by 2028. The amount you get is based on your previous National Insurance contributions. It currently stands at a maximum of £185.15 per week.

A workplace pension

All employers must offer a pension scheme. You’re usually automatically enrolled into one as an employee, though you can choose to opt out.

The two main types of workplace pension are:

Defined contribution

Here, a percentage of your pay is taken from your salary and put into the pension scheme every month, along with employer contributions and government tax relief.

The amount you receive when you retire will depend on how much has been paid into the pension and for how long, as well as how the pension investment fund has performed.

Defined benefit, or final salary pension

The sum you receive on retirement is based on your salary and how long you’ve worked for the company.

In recent years, there are fewer employers offering this kind of pension scheme.

Private pensions

Here, you have two main choices: personal pensions and SIPPs. Both are types of defined contribution plans where the amount you receive when you retire will depend on how much you’ve paid into your pension and for how long, as well as how your investments have performed.

Personal pensions are administered by a pension fund manager who picks the investments, while SIPPs give you more choice over how and where you place your investments.

What investments can you hold in a SIPP?

A SIPP allows you to choose from a really wide range of investments including:

  • Stocks and shares
  • Funds
  • Investment trusts
  • Gilts and corporate bonds
  • Exchange Traded Funds (ETFs)
  • Commercial property

How much pension do I need to retire?

The earlier you begin investing or saving for your retirement, the more your pension pot is likely to be worth when you retire.

Some financial experts suggest putting away about 15% of your annual pre-tax salary if you start saving in your twenties.

But you can start saving whenever you want. If you’re older, you can boost your pension pot by contributing larger sums of money into your fund every month. Or you can think about delaying your retirement until your pension funds are larger.

What should I consider when planning a pension?

Pensions can be complicated and when you’re looking at the options, it can feel mind-boggling at first. There’s a lot you need to consider and understand, so if you have any doubts about the type of pension that would suit you, then it can pay to use the services of a financial adviser to help you plan ahead.

The type of pension you ultimately decide on will depend on things like your age, how much money you can afford to invest and your attitude to risk.

You also need to know that pension plans come with charges which will vary depending on the provider and can include things like a set-up fee, annual management fee, platform fee (for SIPPs), exit fees and drawdown fees.

What about taxes?

You won’t be taxed on money in your pension until you withdraw it from your pension pot.

Then, you can usually take out the first 25% tax-free. After that, any further money you take from your pension will be subject to income tax.