A pension gives you a retirement income, paid for by investments built up during your working life. The State Pension is funded by your National Insurance contributions but only provides a basic income. You may need an additional pension to retire comfortably.

As a self-employed person, you cannot join an employer's pension scheme and do not qualify for the additional State Pension, also known as the State Second Pension, formerly SERPS. However, you can take out another type of private pension such as a personal pension or a stakeholder pension. The amount you get at retirement depends upon how much money has been paid in, how well it has been invested and the age you retire at.

It is important that you consider all your options before making a decision. This guide helps explain how pensions work and what you need to do to find one that suits your needs. 

Assessing your pension needs

Before you choose a pension scheme, try to work out how much money you'll need each year in your retirement. For most people, retirement comes at a time when they no longer have major outgoings such as a mortgage and therefore need less money to live on. However, as you get older, you need to consider the possibility that you will be faced with other expenses such as help around the home.

In order to have some idea of how much pension you'll need when you retire, you need to consider the following:

• The age you intend to retire. In general, because pensions are payable for life, the earlier that someone retires the lower the pension. It is important to have a good idea of when you would like to retire as this will determine how much you need to pay into your pension on a regular basis.
• How much basic State Pension you will get. 
• What your basic living expenses will be.
• Whether you are likely to have any dependent children.
• The lifestyle that you would like to have in retirement - for example, where you want to live, travel and hobbies.
• Other assets you may have such as savings, investments and property. 

If you've already got a pension, how much income will it give you at retirement?

You can ask your pension provider for a statement showing how much your existing pension is likely to pay at the age you intend to retire. This will help you decide whether or not you need to increase your pension payments in order to meet your retirement expectations.

However, it's hard to arrive at a reliable figure because the cost of living is likely to have changed by the time you retire. That is why it is important to review your pension arrangements regularly.

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 investments can go down as well as up.

Your contributions will attract tax reliefs. So 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 on 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, or have earnings that are less than £3,600 in any years 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, you can draw upon your 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 unless it is guaranteed to be paid for up to 10 years. 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.

The basic State Pension

You can get a basic State Pension by building up enough qualifying years before State Pension age.

A qualifying year for the State Pension is based on the National Insurance contributions (NICs) you have paid or have been credited with during a tax year. The tax year runs for the 12 months between 6 April and 5 April of the next year.

You normally get the full State Pension if you have paid NICs for most of your working life, 44 years for men, or women who have a State Pension age of 65, 39 if you have a State Pension age of 60. If you do not have sufficient qualifying years, your State Pension may be reduced. The full basic State Pension for 2005/06 is £82.05 per week.

How much basic State Pension will I get when I reach State Pension age?

To get an estimate of how much State Pension you will get when you reach State Pension age you can apply for a State Pension Forecast. Get a State Pension forecast on the Pension Service website.

State Pension age

Until now, the earliest age for drawing your State Pension has been 65 for men and 60 for women. However, changes are being brought in to make it 65 for both men and women by 2020.

Women born on or before 5 April 1950 will still be able to draw their State Pension at 60. Women born on or after 6 April 1955 will have to wait until they are 65. Women born between those dates will have a State Pension age between 60 and 65 based on their date of birth. The change to the State Pension age for women will be phased in from 6 April 2010, over a period of ten years. For more information, download a guide to State Pensions from The Pension Service website (PDF).

Stakeholder pension

A stakeholder pension is a low-charge, flexible and portable pension that must meet strict government standards. It may be worth considering a stakeholder pension if you:

• are a moderate earner
• have an irregular income or low earnings but can afford to save
• wish to top up other pensions

An independent financial adviser can help you identify the best pensions product for you.

Find out about stakeholder pensions at the Pensions Advisory Service website.

How do they work?

Stakeholder pensions operate in much the same way as personal pensions but must satisfy minimum standards:

• Capped charges - stakeholder pension providers cannot charge more than 1.5 per cent of the value of your pension fund a year to manage it for the first ten years, falling to 1 per cent thereafter. Charges for existing members remain at 1 per cent per year. However, pension providers are allowed to make certain charges outside the charge cap - for example, they will pass on stamp duty for buying and selling investments on your behalf.
• Extras are optional - any extra services and charges not provided for by law must be optional. They include advice on choosing a pension or life insurance cover. You must have agreed to these extra charges as a separate arrangement, and the charges for the services must be clearly defined.
• Low minimum payments - schemes will accept contributions of as little as £20, or even less. 
• Flexible contributions - you choose when and how often you pay into the scheme. If you stop paying your contributions for a time the stakeholder pension provider will not charge you extra.
• Penalty-free transfers - if you choose to transfer into or out of a stakeholder pension there will be no extra charges. 

How to choose a stakeholder pension

• What are the charges?
• Is advice provided as part of the deal? What must you pay extra for?
• Where your contributions will be invested and what input you have?
• Is there a cooling-off period in case you change your mind?

Compare pension schemes using the comparative tables on the Financial Services Authority (FSA) website. You can also search the register of stakeholder pension schemes at the Pensions Regulator website.

The difference between a stakeholder pension plan and a personal pension plan

Personal pensions are private pension schemes designed mainly for people who wish to top up their State Pension provision, and cannot or do not want to join an occupational pension scheme. They are typically run by financial organisations such as insurance companies, banks and building societies.

Personal pensions don't have specified minimum standards. For example, they might charge for:

• changing the amount of your usual payments or making lump sum payments
• skipping payments 
• transferring your pension to another provider

They may also charge a higher annual management fee than the 1.5 per cent to which stakeholder pensions are limited.

Personal pension plans can also be more flexible than stakeholder pensions. There are two main reasons to consider one:

• Investment choice - stakeholder schemes might offer a limited choice of funds in which to invest your contributions. Some schemes only offer 'tracker funds', that rise and fall in line with stock market indices. If you want more flexibility you should consider a personal pension plan.
• Extras - the personal pension provider may offer pensions advice and a choice of benefit options, such as life insurance, as part of the package. Those with complicated financial affairs or a lot of money to invest may want to get advice from a financial adviser.

Choosing a scheme

When choosing a personal pension plan, it is a good idea to consider:

• your current personal circumstances and plans for the future
• the reputation of the company
• past results - but take care, past performance is no guarantee of future success
• penalties and charges that may be made if, for example, you fall ill or take a career break
• how you pay into it - whether you have to pay a regular sum for a given number of years or are able to change this, and whether you will be charged for doing so
• whether you can control how your money is invested - some companies offer "ethical" or "green" scheme 

Make sure you compare schemes by shopping around to find one that suits your needs. Compare pension schemes using the comparative tables on the Financial Services Authority (FSA) website.

Other pension products

An insured personal pension is one where a fund manager makes investment decisions on your behalf. The investments should be unique to your particular fund and specific to your needs. A life insurance company manages the assets, and the fund managers must be authorised by the Financial Services Authority (FSA). This type of pension includes private managed funds.

Self-invested personal pensions (SIPPs) enable you to select pension fund investments yourself. You can invest in a wide range of assets, including stocks and shares, securities and commercial property.

The investments may be of a single type or a mix. Types of investment commonly chosen for SIPPs include:

• unit trusts - where you buy units in the mix of investments an investment company holds
• equities - where you buy shares in quoted companies usually through a stockbroker
• government securities - eg up to the tax free limit on a national savings account
• cash, usually in the form of long-term, high-interest accounts

Life annuity and capital protection

One way of investing the tax-free lump sum received on retirement through a pension scheme, is to buy what is known as a purchased life annuity. The regular annuity payments received are split into "capital" - representing repayment of the purchase price, which is tax free - and "income" elements. The income element is taxed, depending on the recipient's total level of income, at starting rate - 10 per cent, lower rate - 20 per cent or higher rate - 40 per cent, unless covered by allowances.

You can also take out a kind of insurance against your early death called capital protection, which is another type of annuity product. It ensures that if you suffer an early death, the difference between the gross income that is received and the original capital to buy the annuity is paid as a lump sum into your estate.

Other tax-efficient savings

You can save for their future in other ways, such as an ISA or property. However, saving into a pension is normally the best way to save for retirement giving an income for life. Relying on ISAs and property can be risky.

individual savings account

An individual savings account (ISA) is a tax-free investment allowance, covering investments such as stocks, shares or unit trusts. You don't pay tax on income from them or on capital gains if they increase in value. The maximum you can pay into an ISA in any tax year is £7,000. You can put it all in one fund, with a spread of investments, cash and life insurance - maxi ISA - or choose up to three different providers - mini ISA - as follows:

• up to £4,000 in a stocks and shares ISA
• up to £3,000 in a cash ISA
• up to £1,000 in a life insurance ISA

To find the best ISA for you, access the comparative tables at the Financial Services Authority (FSA) website.

The advantages of an ISA are that you get more control over your savings and that they are easy to track and understand. ISAs are flexible and unrestrictive in that you can change to another provider and access and invest into the fund at any time. You also do not have to pay income tax on any growth in the value of an ISA.

The disadvantages are that you will miss out on tax relief on initial contributions, plus they may not be a particularly reliable investment for long-term saving as they could be withdrawn in the future.

Property

The government proposals to simplify the taxation of pensions will allow savers to put residential property - including buy-to-let property - into their pension funds, as of 6 April 2006. This may prove especially attractive to those in the buy-to-let market, as the new regulations could cut tax bills. Currently, a Capital Gains Tax charge must be paid when such a property is sold. In addition, the income that is received is also taxable.

Transferring your pension

You may be thinking about transferring your pension, perhaps because some of the new pensions available are offering attractive benefits.

Before you do so, take a close look at the penalties of getting out of your existing scheme. Ask your pension provider for a transfer value to find out how much you stand to lose. You may decide that even with the penalties incurred, it is still worth transferring to the new scheme. Make sure you have compared the different products as closely as possible, particularly projections of final income. Note that there is no cooling off period if you transfer a pension, so it's vital to get it right. There is no charge for transferring a stakeholder pension.

Starting an additional pension scheme

If the transfer penalties are too heavy, you may be able to start up a new pension scheme in addition to your existing one. Check whether you can reduce payments to your existing pension and pay more into the new scheme instead. There may be charges for doing this.

The consequences of transferring your pension are significant, so you might like to get professional advice. The Pensions Advisory Service helpline can give you information and guidance on Tel 0845 601 2923.

Find out how to complain or resolve a dispute with a financial organisation at the Financial Ombudsman service website.

Keeping track of your pension

Don't forget about your pension. As your earnings change you may want to adjust contributions. And the nearer you get to retirement the more you can pay in.

Take stock

When you get your annual pension statement take some time in assessing your pension needs to see if your pension is still suitable. The statement will include an illustration of your pension income in today's prices. To work out the retirement value of your pension, use the online calculator at the Financial Services Authority and Association of British Insurers website.

Get forecasts

Some pension providers are already offering combined pension forecasts, which give you an estimate of what you can expect to receive from your company scheme and the State including the basic State Pension. See the page in this guide on the basic State Pension.

If it looks like the fund won't meet your needs, you could increase your contributions or consider an additional scheme.

If you have lost track of a pension

If you think you may have lost track of an old pension from a previous workplace, you may find it helpful to contact the Pension Tracing Service - trace an old pension on The Pension Service website or call 0845 6002 537.

Problems with your pension

If you have a problem with your pension that can't be sorted out by the provider, you can get help with pension problems at the Pensions Advisory Service website.

If you have a complaint about the way you have been sold a pension, you can contact the Financial Ombudsman Service (FOS). Find out how to complain or resolve a dispute with a financial organisation on the Financial Ombudsman website.

If your complaint relates to managing the fund once you have bought it, you can find out how to make a complaint on the Pensions Ombudsman website.

You can also take professional advice from an Independent Financial Adviser (IFA) or contact the Pensions Advisory Service Helpline on Tel 0845 601 2923.