UK personal pensions

 describes how UK investors can use pensions to support saving for retirement. UK pension regulations effectively enforce long-term investments in these plans. While pensions can have other ancillary benefits, they are not suitable to use for different savings goals.

Pensions are one of the most tax-effective ways to save for retirement in the UK, but they are subject to a huge number of complex, unstable, and confusing rules, regulations, and restrictions. Annual movement of goalposts is the rule rather than the exception. You also need to pay close attention to the potential for exceeding the annual allowance or the lifetime allowance. If you exceed these allowances, excess tax charges can easily produce marginal tax rates of well above 50%, and rates of 100% or more are possible in the worst cases.

Introduction
Personal pensions are private pensions that you arrange yourself. You pay money into a pension fund which you use to buy a regular income when you retire.

These types of pensions are known as defined contribution pensions, and if you have one you make your own decisions about what investments you hold in it. The other main type of UK pension is a defined benefit pension (or sometimes, final salary). This is a workplace pension set up by an employer. In a defined benefit pension, the pension trustees take all the investment and other financial decisions.

Defined benefit pensions are now uncommon outside of the public sector, and are outside the scope of this page. Most employers now set up group personal or stakeholder defined contribution pensions for their employees.

Types of UK personal pension
There are several type of personal pension:
 * Stakeholder Pension
 * These must follow strict government limits, so that they offer low charges and low minimum contributions. Over time, stakeholder pensions have fallen out of fashion, because the charges on more general personal pensions and SIPPs has reduced so that they are now competitive at relatively low asset levels.
 * Personal Pension
 * These are pensions with limited but adequate fund choices. They operate without the restrictions of stakeholder pensions, and are usually offered by large insurance companies. Their annual charges are generally modest, and they are a good choice if you have little or no interest in managing your own investments.
 * Self Invested Personal Pension (SIPP)
 * This is the type of pension offered by UK investment platforms. They behave as a simple wrapper around a vanilla-looking trading account that can hold stocks, ETFs, funds or OEICs, and perhaps bonds directly. They range in price from economical to expensive. The more "boutique" varieties are pricey, but these allow you to invest directly in things like property, private business ventures, and so on.
 * Employer Group Personal Pension (GPP)
 * These are personal pensions set up in partnership with an employer. The employer makes contributions to the pension as part of their payroll. There is also an employer match (of varying generosity). You can usually transfer other plans in. You may also be able to transfer out while still at that employer, and you can certainly transfer out after you have left this employer.

The following sections suggest how to hold index tracker funds effectively and efficiently in these types of pension.

Personal pensions and stakeholder pensions
Typically, large life insurance companies such as Aviva and Aegon offer these pension types. Their costs vary, but generally hover around the 0.3% to 0.5% level for everything (that is, the investment platform and the fund management). You usually face additional charges for more specialist fund options.

These pensions are likely to offer only limited fund choices, but what they do offer may be entirely adequate. Often, the funds they offer are 'rebadged' versions of retail level funds offered by the usual fund managers, for example 'Aviva Pension BlackRock 50:50 Global Equity'. BlackRock owns iShares, so even though this fund is superficially an Aviva pension fund, it is a good passive index tracker choice (in this case, a fund that is 50% UK stock and 50% ex-UK stock). BlackRock is a reputable index fund provider.

The pension provider will provide you with fund information for each fund offered, but it is sometimes hard to uncover. Life insurance company platforms are usually not as fully featured as the main UK retail investment platforms, but again are generally adequate.

When you look at the choice of funds, do not confuse limited with inadequate. Most of this type of pension will offer only a small selection of funds, but in that selection there is almost always a usable number of good index tracker funds.

Self Invested Pension Plans (SIPPs)
For index tracker funds, a SIPP is the easiest type of pension for you to manage. The "mass-market" SIPP is the place to look, for example Vanguard, Hargreaves Lansdown, Interactive Investor, AJ Bell, and iWeb. SIPP costs are tolerably low.

Most mass-market SIPPs offer an extensive range of OEICs and full access to ETFs, meaning that you can easily hold Vanguard, HSBC, Fidelity, and other index tracker funds and ETFs inside these SIPPs. Vanguard is an exception; its SIPP currently offers only Vanguard funds and ETFs. Often, the hardest part with many SIPPs is trying to find the actual Vanguard or other tracker fund you want among hundreds of funds that are available.

UK unit trusts and OEICs generally offer two types of units: 'accumulation', and 'distribution' or 'income' (commonly abbreviated to 'acc' and 'inc' in fund names). The only difference between the two is that accumulation units automatically reinvest dividends into the fund, whereas income units regularly pay dividends as cash into the pension scheme (which you would then generally want to reinvest yourself). As a general rule, using accumulation units in pensions is the most convenient way for you to organise things.

UK direct-to-customer investment platforms split into two general types: flat-fee; and percentage based. For low SIPP values a percentage based platform will be fine, but for higher values, perhaps above £30,000 to £50,000 or so, the percentages become large amounts that compound hugely over a long timeframe, so that you will find a flat-fee platform to be cheaper above these levels.

At the upper end of SIPPs you can find expensive offerings that offer direct investment in property, private business enterprise, and so on. These are specialist options, and unless you want all of the bells and whistles they offer it will be better to stick with the cheaper retail SIPPs.

Employer Group Personal Pensions (GPPs)
Most sizeable employers offer a group personal pension scheme. This is a personal pension for each employee, owned and managed by that employee, but which the employer arranges. Employers will pay into these schemes via payroll, with some level of employer match to employee contributions.

Life insurance companies often (but not always) manage employer GPPs, and so they generally resemble a vanilla personal pension as outlined above. Employers can usually negotiate a discount with the provider, so that the charges you pay on these are often lower than the headline rate if you went to the provider directly, perhaps as low as 0.2% or even less. This can be confusing where the provider offers only 'generic' fund documentation that shows 'indicative' charges of perhaps 1%; this makes the charges look much larger than they in fact are.

Employer GPPs usually have a default fund, and when you join an employer your contributions will go into this fund unless or until you change it. The default fund is generally something relatively balanced, perhaps 60:40 stocks/bonds, and also likely passive, so probably not a bad choice. However, it is worth looking at the details here. For example, some default funds are lifestyled; that is, they transition slowly from stocks to bonds as some (notional) retirement date approaches. This feature is fine if you plan to buy an annuity to cover retirement, but probably unsuitable for direct drawdown. If you expect to draw down your pension directly, rather than buy an annuity for retirement, you probably want to switch into a non-lifestlyed selection of funds instead.

Salary sacrifice arrangements
An employer scheme may allow you to exchange some of your salary for larger pension contributions. This is normally more tax-efficient than making pension contributions yourself. Both you and your employer save on National Insurance payments, and some employers will also pass on some or even all of their National Insurance saving to you in the form of increased pension contributions.

There are limits on salary sacrifice arrangements. For example, you cannot use salary sacrifice to reduce your salary below the minimum wage.

In general however, salary sacrifice arrangements are usually well worth taking advantage of, if available to you.

Auto-enrolment
The government's auto-enrolment rules make it compulsory for an employer to offer a workplace pension scheme, and to automatically enrol employees into it unless they explicitly opt out.

Companies must also make minimum levels of employer contributions into employee pension schemes. Contributions are set as follows:
 * 1% employer and 1% employee up to April 2018,
 * 2% employer and 3% employee from April 2018 to to April 2019, and
 * 3% employer and 5% employee from April 2019.

Standard annual allowance
The standard annual pension contribution allowance for earners is £40,000. You can only pay 'pensionable' salary and earnings into a pension -- PAYE and other earnings count, but investment income, rents received, capital gains and so on do not.

You can carry forwards up to three years of unused allowance from previous years, but you can only use it once you have used your current year's allowance fully, and you must have enough earnings to support it. Also, you must have been a member of a UK registered pension scheme for the years from which you will carry forward.

If you are a non-earner or non-taxpayer, or if you earn less than £3,600 annually, you can contribute up to £2,880 to a personal pension. The pension would then reclaim 20% 'tax relief' from the government to take this up to a £3,600 effective contribution.

Your annual pension contributions are also capped at 100% of your annual earnings, so if your earnings are below the annual allowance then you will be unable to reach it. After age 75, you can make pension contributions but they will not qualify for tax relief.

Money Purchase Annual Allowance (MPAA)
Once you have drawn any taxable money from any defined contribution pension, your pension annual allowance falls permanently to £4,000. Taking only the 25% tax-free 'pension commencement lump sum' does not trigger the MPAA. Neither does taking money from any defined benefits pensions.

When the government first introduced it in 2015, the MPAA was £10,000, but after just two years, in 2017 the government reduced it to £4,000.

Tapered annual allowance
Higher earners have a tapered annual allowance, introduced in the 2016-17 tax year. For tax years 2019-20 and earlier, the allowance reduces by £1 for every £2 earned above £150,000 annually, and the minimum tapered allowance is £10,000, reached when you earn £210,000 or more. For tax years 2020-21 and later, the allowance reduces by £1 for every £2 earned above £240,000, and the minimum tapered allowance is £4,000, reached when you earn £312,000 or more.

The tapered annual allowance is ridiculously complex to work with and to avoid. The tapering takes into account not only all your 'pensionable' earnings, but also any investment income, dividends, rents received, bonuses, and a lot of other non-pensionable earnings. It also takes into account your actual pension contributions, including any employer contributions.

For many people their total income for the year is fiendishly difficult to predict. This means that they cannot know their annual pension contribution allowance until very late into the financial year, or even not until after it has ended. In turn, this may mean that the only way to be sure they do not breach it is to restrict their contributions to the minimum allowance and then hope to use whatever remains, if anything and once calculable, using carry forward in subsequent years.

This is fraught with problems however, particularly where income is highly variable from year to year. It is very easy to miss out on some pension allowance in one year through inability to know exact income for the entire year, then not have enough earnings in later years to allow use of carry forward rules.

The taper also causes huge problems for defined benefit scheme members, although aside from noting this, these pensions are outside the scope of this page.

Tax charges on breaching the annual allowances
If you exceed your annual allowance, you have to declare the overpayment on your annual tax return and then pay tax on it. This can be highly disadvantageous, because when you take the overpayment out later as a pension withdrawal it will again be taxable income. This leads directly to double-taxation.

Scheme pays
'Scheme pays' is a mechanism by which you can pay any tax due on pension contributions above your annual allowance out of the pension scheme, rather than directly by you. This mitigates some of the double-taxation problem, because it reduces the balance in the pension that you draw out later as taxable income.

For example, suppose you are a 40% taxpayer with £100 of over-contribution. The results are somewhat less awful if in the 20% tax bracket on withdrawals. Here the effective tax rates are 55% without scheme pays, and 49% with scheme pays.
 * Without scheme pays, you will pay £40 in tax on that £100 of contribution, and then later withdraw the £100 with £25 tax-free and the other £75 taxed at 40%, leaving you £70. Subtract the £40 tax paid on the contribution, leaves £30 and so an effective 70% tax rate on the over-contribution.
 * With scheme pays, the scheme pays their £40 in tax, leaving £60 in the pension. On withdrawing the £60, you receive £15 tax-free and the other £45 taxed at 40%, leaving £42, for an effective 58% tax rate on your over-contribution.

In nearly all cases, apart perhaps from uncommon edge cases such as an employer match that could otherwise be lost, making pension contributions above the annual allowance is worse than simply taking the money as ordinary salary instead.

Scheme pays has some significant limitations in practice. Pension providers are only required to offer it where you have breached the standard £40,000 annual allowance, and where your tax charge is more than £2,000. Notably, they do not have to offer it if you exceeded a tapered annual allowance. A pension provider might offer it where you do not meet these conditions, but only at their own discretion. Many currently do not.

For unfunded defined benefits pensions, if you use scheme pays you may end up with a long-running requirement to pay interest on the payment made by the scheme. When compounded, this interest payment can destroy any benefit that scheme pays might have offered you.

Pension lifetime allowance
As well as an annual limit on pension contributions, there is also a limit on the amount of money that you can build up inside a pension before an 'excess' tax charge becomes due. For tax years 2020-21 to 2025-26, the limit is £1,073,100. The limit applies to the total of all pensions you own. (For defined benefit pensions, the amount tested against the lifetime allowance is 20 times the pension payable plus any tax free lump sum. )

When the government first introduced the lifetime allowance in 2006, it was set at £1,500,000, indexed for inflation, and would have affected very few people. However, contrary to commitments made when it was introduced, the government has successively reduced over the years, and this combined with inflation and lack of the subsequently promised inflation uplifts means that it now affects many more retirement savers. To put this number into context, a £1,000,000 defined contributions pension could provide around £25,000 annually from an annuity.

Remember that the lifetime allowance applies to your entire pension balance, not just your pension contributions. This means that if you invest your retirement savings well, you become ever more likely to breach the allowance.

Also contrary to commitments made in 2016 when the government yet again reduced the lifetime allowance, as of 2023 it is currently not indexed for inflation, and will remain frozen until at least 2026.

Tax charges on breaching the lifetime allowance
There is a 25% excess tax charge on income you take from the element of a pension that is above the lifetime allowance. The remaining 75% is then subject to income tax at your usual marginal rates. There is no 25% tax-free lump sum above the lifetime allowance. The effect is that above the lifetime allowance, the tax rate for 20% basic rate taxpayers is 40% (that is, 25% plus 20% of 75%), and 55% for higher rate taxpayers (comprising 25% plus 40% of 75%).

If you take it as a lump sum, you pay tax on amounts above the lifetime allowance at a flat 55%. This provides a ceiling on the worst case tax for breaching the allowance.

You pay lifetime allowance charges whenever you 'crystallise' some or all of a pension; that is, you move it into flexible drawdown, or use it to buy an annuity. You control the timing of these events.

However, there is another forced lifetime allowance test on reaching age 75. Here, not only are uncrystallised funds covered, but there is also a test against any gains in crystallised (but as yet undrawn) balances. Any and all nominal growth in these balances is subject to a 25% excess tax charge at age 75. This strongly motivates you to draw down taxable income from any crystallised elements that would fail the lifetime allowance test, even at 40% higher rate tax, because this will generally be lower than the 55% tax rate you would otherwise suffer from the 25% excess tax charge.

These rules also motivate you to crystallise a pension as early as possible where it has reached the lifetime allowance. They also potentially motivate you to retire earlier than planned, because the tax penalties for continuing to work and pay into a pension now become very high.

There may be cases where it is worth you paying into a pension even above the lifetime allowance. For example, where there is a valuable employer match that cannot be paid to you in any other way and so would otherwise be lost. However, if you hold pensions that are above the lifetime allowance you should consider the details very carefully. No employer match, no matter how generous, can overcome a 100% tax rate.

Lifetime allowance protection regimes
Each time the government reduces the lifetime allowance, it creates new 'protection' regimes to try to mitigate the effectively retroactive effects of the reduction. These are usually only partially successful, and may come with significant restrictions on your future pension saving.

There are two main types of protection:
 * Individual protection
 * Used by people with pension balances above the reduced lifetime allowance at the time of reduction. It is based on the balance on date of reduction. They will not pay lifetime allowance charges on any pension value below that, but will on all future growth and future contributions.
 * Fixed protection
 * Used by people who want to keep the old pre-reduction lifetime allowance. This comes with the restriction that they can make no further pension contributions at all in future, either personal or employer, to a defined contribution pension. If they make any future defined benefit pension contributions, they lose their entire protection. This can represent a significant trap.

Other protections exist for people with pensions in payment or close to retirement when the government introduced the current pension saving regime in 2006.

Transfers between providers
You can transfer pensions between providers at will. Transfer timescales vary enormously, from a few days at the shortest to several months at the longest. If the sending and receiving schemes both offer the same investments, you can usually transfer your holdings intact (the industry phrase is 'in specie'). This removes any out-of-market risk, but is generally the slowest transfer option. Transferring as cash is usually the fastest option, and also the only one where the receiving scheme does not offer the investments you already hold.

Some pension providers may charge for transfers out, but not all. Some pension providers will not accept transfers in of 'crystallised' pensions (that is, ones that have been placed into 'flexi-access drawdown'; see below for more).

Qualifying Recognised Overseas Pension Scheme (QROPS) transfers
It may be possible to transfer a UK pension to a recognised pension scheme outside the UK. This is really only useful if you will be living permanently in the country to which you will transfer the pension.

The rules around QROPS transfers are complex, and penalty charges abound for any mistakes or rule breaches. It is best to consult a professional if you are planning this, but even here there can be problems, because many sites offering to help with QROPS are unlicensed at best, and dodgy at worst. Also, advisers in other countries are outside of UK protection schemes, and this creates additional difficulties if anything goes wrong.

For QROPS to be available, both the sending and the receiving countries must agree. It is currently not possible to transfer a UK pension to a US one. Although the UK is happy to allow QROPS transfers out to the US, the US does not permit general QROPS transfers in.

Managing withdrawals
The earliest age you can take withdrawals from a personal or stakeholder pension is usually 55, depending on your arrangements with the pension provider or pension trust. You do not have to be retired from work. In 2014 the government indicated that it intends to raise the earliest age for accessing a personal pension to 57 by 2028, and from then on to track at ten years before UK state pension age.

You can use withdrawals in several ways:
 * An annuity is the safest way to ensure a permanent income from a pension, but annuity rates are not great, and have been that way for some time now (at the time of writing).
 * The popular alternative to annuities is 'flexi-access drawdown'. This means crystallising a part of or all of a pension, taking the 25% tax free lump sum, and then drawing taxable income from the remaining 75% as and when needed.
 * An alternative method is to use 'Uncrystallised Funds Pension Lump Sum' (UFPLS). This slices your pension so that 25% of each withdrawal is tax free and you pay income tax on the rest. This is a useful way to extract a larger tax free element over time, but is a poor choice if your pension is above the lifetime allowance.

There is no general early access allowed to UK pensions before age 55. There are narrow exclusions for serious illness, and where a scheme entered into before 2006 specified a retirement age earlier than 55.

This lack of any feasible early pension access is something to consider for temporary foreign workers in the UK, who may be thinking about whether or not to join an employer pension scheme. Foreign nationals working temporarily in the UK should check to see if there is a tax treaty between the UK and their likely future country of residence, and if so, what type of protection that treaty provides for pensions, if any. They might also investigate using UK Individual Savings Accounts as an alternative to pensions, for the duration of their stay in the UK.

Inheritance tax issues
Pensions are outside of your estate for inheritance tax purposes. This makes them a valuable shelter if you plan to pass them on to your heirs rather than spend them in retirement.

Once crystallised, the 25% tax free lump sum element becomes in scope for inheritance tax. However, the remainder that is not yet drawn down taxably is still sheltered from inheritance tax.

Beneficiaries can inherit pensions passed on before age 75 tax free. After age 75, beneficiaries and recipients pay ordinary income tax on payments from an inherited pension.