Pension planning for the self-employed

How a personal pension works

You make regular payments into a fund, which is invested on your behalf. The more money you put in, the greater your retirement income should be, but remember that investments can go down as well as up.

Your contributions will attract tax reliefs. This means that if you pay tax at the basic rate of 22 per cent every £100 going into your pension costs you £78. For higher-rate taxpayers paying 40 per cent, every £100 going into their pension costs them £60. For both groups, tax relief is paid by HM Revenue & Customs into the individual's pension scheme for investment on their behalf - but only at a basic rate. Higher rate tax payers claim the difference between the basic and higher rates when they submit their tax returns.

The amount of pension contributions that qualify for tax relief depends upon your age and earnings during any particular tax year. If you are not working, you can continue to contribute up to £3,600 a year and still qualify for tax relief at the basic rate. When you are working you may be able to pay in more. Some schemes also enable you to carry back payments - if you contribute less than the maximum allowance one year, you can make up your contributions the next.

Some schemes enable you to invest lump sums providing that they are within the annual limits. You may find this particularly useful if you have irregular earnings.

When can I cash in my pension?
Currently, someone can draw upon his or her pension fund from age 50 increasing to 55 in 2010. You can currently take up to 25 per cent of the fund as a tax-free lump sum. The remainder must be used to either purchase an annuity, a form of investment that pays you an income for the rest of your life (a pension) or to draw payments under an interim arrangement known as "Income Drawdown".

When you die, the annuity stops. If you die before retiring, a life insurance element provides for your dependants. However, when you buy your annuity you can make provision for a survivor's pension to be paid to a partner in the event that you die before them.

Both a pension payable from an annuity and income taken under interim arrangement will be treated as earned income and subject to income tax.

Subjects covered in this guide

• Introduction
• Assessing your pension needs
• How a personal pension works
• The basic State Pension
• Stakeholder pension
• The difference between a stakeholder pension plan and a personal pension plan
• Other pension products
• Other tax-efficient savings
• Transferring your pension
• Keeping track of your pension

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