Personal pension schemes (PPS), also known as personal pension plans, are U.K. tax-privileged individual investment vehicles. The main purpose of these plans is to save for retirement, but some plans also provide death benefits to the deceased person's designated beneficiaries.

What Is a Personal Pension Scheme and How Does It Work?

A PPS is a private defined contribution plan that is managed for the investor by an insurance company or investment firm. The investor who sets up the plan chooses the provider, and that provider invests the money paid in, providing an accumulated sum of money at the time of the investor's retirement.

At the time of retirement, the investor can use this money to purchase an annuity or simply deposit the money in a bank and begin drawing down the money to survive on until death. Any person who is self-employed can start a PPS. Also, any employee who works for a company but who cannot join an employer-sponsored plan is allowed to start a PPS. In some cases, an employee in a company-sponsored plan who also earns income elsewhere may be able to start a PPS.

An individual with a PPS may contribute the lower amount of 100% of his or her yearly earnings or the current allowance. As of 2020, the annual allowance is 40,000 pounds. Thus, if an individual earns 60,000 pounds, for example, then they are allowed to invest 40,000 pounds into a PPS.

On the other hand, if the individual only earns 30,000 pounds, they can invest the full 30,000 pounds into a PPS. The annual allowance amount changes each year, so it is advisable to confirm the amount with a U.K.-based tax professional in order to determine what is legal.

The ending lump-sum amount payment from the PPS depends on how much is contributed each year, how long the plan is in place, security selection, asset allocation, and market performance. While the account should increase in value each year, there is no guarantee that this will occur.

Personal Pension Scheme Investment Choices

Employer-based pension plans do not offer the individual a choice of what to invest in. This is not true with a PPS. An individual investing in a PPS has some flexibility of choice for investing contributions.

The plans typically offer cash-based funds, corporate bond funds, equity funds, and international investments. While there usually is a default investment choice, PPS investors have more control over their asset allocation and can adjust their PPS portfolio based on their risk tolerance and time horizon, which is important in overall retirement planning.

Other Benefits of a Personal Pension Scheme

Besides the primary benefit of enabling individuals to plan for retirement in ways that they wouldn't be able to otherwise and allowing flexibility of investment choices, PPSs have a few other important and useful benefits, such as the ability to take a tax-free sum from the plan at retirement.

Although the majority of the plan will be taxed at the individual's income rate, an investor in a PPS has the option to take up to 25% of his or her savings as a tax-free sum. While this will reduce the amount of the individual's retirement income to 75% of his or her PPS savings, the rest can be used to eliminate debt, such as a mortgage. An investor should work directly with a financial advisor to determine the most beneficial proportion of taxable and non-taxable PPS lump sums.

Another major benefit of a PPS is a death benefit. If the owner of the PPS dies before retirement, a lump-sum payment of the balance can be made to a spouse or other designated beneficiary. In this sense, a PPS is similar to a self-funded life insurance policy.