The world of finance can be jargon heavy and difficult to understand. This is especially true with pensions, thanks to the strict regulations and tax rules surrounding them.
As a result, getting to grips with correspondence from your pension provider can be tricky, and all too often frustrating. It’s not all bad news though, as help is on hand with our ‘jargon buster’, which will help you to demystify the world of pension expressions.
Read on to discover what 12 important and commonly used pension terms mean, using clear and easy language.
1. Defined Benefit (DB)
This is a workplace pension that’s, broadly speaking, calculated on the number of years you work at the company and your salary. Your employer is responsible for ensuring that there is enough money in the pension plan to provide your retirement income. These are also known as ‘final salary’ or ‘career average’ schemes.
2. Defined Contribution (DC)
This type of pension can be a workplace or private pension plan and can also be known as ‘money purchase’ schemes. The amount of retirement income a DC scheme generates depends on:
- the amount of money you contribute into it
- the performance of the investments and assets held within it.
The amount of income these pensions generate cannot be guaranteed, as they’re essentially a long-term investment plan.
3. Annuities
You can use the value of your pension pot to buy an annuity, which provides a guaranteed income for an agreed period or the rest of your life. While an annuity offers financial security in retirement, they don’t offer flexibility as the amount you receive cannot be changed if your circumstances do.
4. Pension drawdown
If you don’t want to buy an annuity, you can place your pension into a drawdown scheme instead. This allows you to leave your pension fund invested while taking ad-hoc or regular amounts from it. While drawdown does offer flexibility, as you can alter the amount you take from your pension, it also carries risk.
For example, you may inadvertently take too much from it and deplete your retirement fund earlier than expected, impacting your future retirement living standards.
5. Salary sacrifice
If your employer agrees, you can arrange for them to reduce your salary and put the difference into your workplace pension. This could boost the value of your pension later on, so that you can enjoy a higher standard of living in retirement and make your current salary more tax-efficient. That said, salary sacrifice can reduce your Death in Service benefit and may make it more difficult for you to secure loans.
6. Uncrystallised funds pension lump sum (UFPLS)
This allows you to take slices from your pension fund while leaving the remaining amount invested. Each slice contains a 25% tax-free element, which can be used with your Personal Allowance to potentially create a retirement salary that’s free of Income Tax.
Your Personal Allowance is the amount you can earn before Income Tax is due, and in 2023/24 is £12,570.
7. Self-invested personal pension (SIPP)
Typically, the investments held within a pension scheme is overseen by a fund manager, who decides how your money should be used in order to maximise growth potential. With a self-invested personal pension (SIPP), you decide where and how the money within your pension fund is invested. Another difference with certain types of SIPP, is that you can place your money into alternative investments, such as art.
While SIPPs may be beneficial for business owners or experienced investors, care should always be taken with them as they can be a higher risk option.
8. Auto-enrolment
If you’re aged between 22 and 65 and pay Income Tax, your employer is obliged to include you into an auto-enrolment pension scheme if it doesn’t have a workplace pension plan. While you can choose to opt out, you’ll be re-enrolled automatically every three years or any time you change jobs.
9. Expression of wishes
This is a form that allows you to state who your pension’s Death in Service benefit should go to if the worst happens to you. Your selection will then be considered by the trustees that run the pension scheme. You can name anyone you like, including your:
- spouse or civil partner
- children
- relatives or close friends
- a good cause or charity.
There is no limit to the number of beneficiaries that you can name.
10. Annual allowance
While you can place any amount you want to into your pension, the amount that receives tax relief is limited to your Annual Allowance. In 2023/24, the allowance is either £60,000 or the amount you earn, whichever is the lower. If you’re a high earner or are taking an income from a Defined Contribution pension, it may reduce to £10,000.
11. Pension commencement lump sum (PCLS)
Otherwise known as ‘tax-free lump sum’, this is the amount of money you’re allowed to take from your pension pot when you first access it. While the PCLS is usually 25% of the value of your pension plan, with certain schemes it might be more.
12. Guaranteed rate of annuity (GAR)
In some cases, older pension schemes offer a ‘guaranteed rate of annuity (GAR)’. This means that subject to certain stipulations, the annuity you receive is calculated at a guaranteed rate that may be much higher than the annuity rates being offered at the time. As such, you could receive significantly more as an income in retirement.
Get in touch
Please remember that this article does not constitute financial advice, and this is not an exhaustive list of pension related terms. If you’re confused by your pensions, or are struggling to understand correspondence about your scheme, please contact us.
Our success has been built on explaining the world of pensions in a clear and jargon free way, so that our clients are better placed to make the right choices. A financial adviser can offer explanation and guidance around your retirement planning, taking into account your personal circumstances.
We can be contacted on 01527 577775 or please feel free to speak to one of our advisers, as we’d be happy to help.
Thursday 15 February 2024