UK personal pensions

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

Pensions are one of the most tax-effective ways of saving 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. Investors also need to be mindful of the potential for exceeding the annual allowance or the lifetime allowance. Excess tax charges once these allowances are exceeded 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 investors who hold them can direct investment decisions as required. The other main type of UK pension is a defined benefit pension, usually a workplace pension set up by an employer. In a defined benefit pension, all the investment and other financial decisions are taken by the pension trustees rather than by the individual.

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

Types of UK personal pension
The following personal pension types are available in the UK:
 * Stakeholder Pension
 * These have to adhere to strict government limits, mandating 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. Annual charges are generally modest, and they are a good choice for retirement savers with little or no interest in managing their investments themselves.
 * Self Invested Personal Pension (SIPP)
 * Most popularly offered by UK investment platforms, and behave as a simple wrapper around a vanilla-looking trading account capable of holding stocks, ETFs, funds or OEICs, and perhaps bonds directly. They range in price from economical to expensive. The more "boutique" varieties are pricey, but also support directly investing 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 benefit is generally that the employer will make contributions to the pension as part of their payroll, making life convenient for retirement savers. There is also an employer match (of varying generosity). Transfers of other plans in is usually permitted. Transfer out may be permitted while still at that employer, and is certainly allowed when no longer employed by the partner employer.

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

Personal pensions and stakeholder pensions
These pension types are typically offered by large life insurance companies such as Aviva and Aegon. Costs vary, but generally hover around the 0.3% to 0.5% level for everything (that is, the investment platform and the fund management). There may be additional charges for more specialist fund options.

The fund choices are likely to be limited, but are usually adequate. Often, the funds offered 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 would make a good holding for someone wanting a passive index tracker (in this case, one that is 50% UK stock and 50% ex-UK stock). BlackRock are a reputable index fund provider.

The pension provider will provide 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.

It is important in these schemes, when looking at the choice of funds, not to confuse limited with inadequate. Most will offer just a small selection of funds, but within those there is almost always a cheap index tracking subset that readily meets the needs of passive investors.

Self Invested Pension Plans (SIPPs)
A SIPP is the easiest type of pension to manage when it comes to holding index tracker funds. The "mass-market" SIPP is the place to look, for example Vanguard, Hargreaves Lansdown, Interactive Investor, AJ Bell, and iWeb. Costs are tolerably low, and the choice of investments will generally be OEICs and unit trusts, shares (including ETFs and investment trusts), and perhaps bonds or gilts directly.

Most mass-market SIPPs offer an extensive range of OEICs and full access to ETFs, meaning that it is easy to 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. The hardest part with many SIPPs is often trying to find the actual Vanguard or other tracker fund you want among perhaps thousands of funds on offer.

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 dividends are automatically reinvested in the fund in accumulation units, rather than paid out regularly to investors, the case with income units. As a general rule, using accumulation units in pensions is the most convenient way 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 is acceptable, 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 a flat-fee platform is usually preferable above these levels.

At the upper end of SIPPs are found expensive offerings that permit 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, normally with some level of employer match to employee contributions.

An employer GPP is usually run by a life insurance company, so will generally resemble a vanilla personal pension as outlined above. Employers usually negotiate a discount with the provider, so that the charges 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, into which new joiners are initially enrolled. This will generally be something relatively balanced, perhaps 60:40 stocks/bonds, and also likely passive. 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 suitable where there is a plan to buy an annuity to cover retirement, but probably unsuitable for direct drawdown, likely the more common case currently. In that case, switching out of it and into a non-lifestlyed selection of funds is probably sensible.

Salary sacrifice arrangements
An employer scheme may allow you to trade salary for increased 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. Only 'pensionable' salary and earnings may be paid into a pension -- PAYE and other earnings count, but investment income, rents received, capital gains and so on do not.

Up to three years of unused allowance from previous years can be carried forwards, but it can only be used once the current year's allowance is fully used, and there must be sufficient 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.

Non-earners or those earning less than £3,600 annual 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.

Annual pension contributions are also capped at 100% of annual earnings, so if earnings are below the annual allowance then it will not be possible to maximise its use. After age 75, pension contributions can be made but they will not qualify for tax relief.

Money Purchase Annual Allowance (MPAA)
Once taxable money has been drawn from any defined contribution pension, the annual allowance falls 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 first introduced in 2015, the MPAA was £10,000, but after just two years, in 2017 it was reduced 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 earnings are £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 earnings are £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 the '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 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. This often means that the only way to avoid breaching it is to restrict 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
Where the annual allowance is exceeded, the member must declare the overpayment on their annual tax return and then pay tax on it. This can be highly disadvantageous, because when the overpayment is taken 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 tax due on pension contributions above the member's annual allowance can be paid out of the pension scheme, rather than directly by the member. This mitigates some of the double-taxation problem, because it reduces the balance in the pension that is then later drawn as taxable income.

For example, suppose 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, they 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 them £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, they receive £15 tax-free and the other £45 taxed at 40%, leaving £42, for an effective 58% tax rate on the 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. A provider is only required to offer it where the standard £40,000 annual allowance has been breached, and where the tax charge exceeds £2,000. Notably, it is not required where a tapered annual allowance has been exceeded. A pension provider might offer it under circumstances other than exceeding the standard £40,000 annual allowance, but this is at their own discretion. Many currently do not.

For unfunded defined benefits pensions, using scheme pays may result in 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 the investor.

Pension lifetime allowance
As well as an annual limit on pension contributions, there is also a limit on the amount of money that retirement savers 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 aggregate of all pensions owned by the investor. (For defined benefit pensions, the amount tested against the lifetime allowance is 20 times the pension payable plus any tax free lump sum. )

When first introduced in 2006, the lifetime allowance was £1,500,000, indexed for inflation, and would have affected very few people. However, contrary to commitments made when it was introduced, it has been 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.

Beware that the lifetime allowance applies to the entire pension balance, not just contributions. This means that if retirement savings are invested well, they become ever more likely to breach the allowance.

Also contrary to government commitments made in 2016 when the lifetime allowance was reduced to £1,000,000, as of 2021 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 taken from the element of a pension that is above the lifetime allowance. The remaining 75% is then subject to income tax at 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 taken as a lump sum, amounts above the lifetime allowance are taxed at a flat 55%. This provides a ceiling on the worst case tax for breaching the allowance.

Lifetime allowance charges are payable whenever a pension is 'crystallised'; that is, moved into flexible drawdown or used to provide an annuity. These are generally under the control of the investor.

There is another forced lifetime allowance test on reaching age 75. Here, not only are uncrystallised funds in scope, 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 drawing down taxable income from the crystallised elements, even at 40% higher rate tax, since this will generally be lower than the 55% tax rate otherwise suffered from the 25% excess tax charge.

These rules also motivate crystallising a pension as early as possible where it has reached the lifetime allowance, and potentially can motivate retiring earlier than planned, since the tax penalties for continuing to work and pay into a pension now become very high.

There may be circumstances where it is worth paying into a pension even above the lifetime allowance. For example, where there is a valuable employer match that cannot be paid in any other way and so would otherwise be lost. However, savers above the lifetime allowance 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 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 growth and on future contributions.
 * Fixed protection
 * Used to keep the old pre-reduction lifetime allowance. This comes with a restriction that no further pension contributions at all may be made in future, either personal or employer. If any are made, the protection is lost. This can represent a significant trap.

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

Transfers between providers
Pensions can generally be transferred between providers at will. Timescales for transfers vary enormously, from a few days at the shortest to several months at the longest. If the sending and receiving schemes both support the same investments, holdings can usually be transferred 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 investment already held.

Some providers will 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 planning this, but even here there can be problems, since many sites offering to help with QROPS are unlicensed at best, and dodgy at worst. Also, advisers in other countries fall outside of UK protection schemes, creating added difficulties if anything goes wrong.

For QROPS to be available, both the sending and the receiving countries must accede. 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 QROPS transfers in.

Managing withdrawals
The earliest age you can get 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.

Withdrawals can be used in several ways:
 * An annuity is the safest way to ensure an enduring income from a pension, but annuity rates are poor and have been for some period (at the time of writing).
 * The popular alternative to annuities is 'flexi-access drawdown'. This involves 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 the pension so that 25% of each withdrawal is tax free and the rest subject to income tax. This is a useful way to extract a larger tax free element over time, but should not be used if the 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 should be a consideration 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 sit outside an investor's estate for inheritance tax purposes. This makes them a valuable shelter for people who intend to pass them on to heirs rather than to 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.

Pensions passed on before age 75 can be inherited tax free. After age 75, the payments from an inherited pension are taxable to the recipient as income.