Understanding the main retirement planning terms with our jargon buster
Complicated jargon can make the financial world seem confusing or inaccessible. Understandably when it comes to retirement planning many people are baffled and confused with the array of acronyms and jargon.
The world of pensions is jam-packed with terms, some of which are easier to decode than others. But retirement planning needn’t be a complicated nightmare. So we’ve provided some of the most common retirement planning key terms and acronyms you may be confronted with.
Let’s start with the Annual Allowance which is a limit to the amount of pension savings you can make, before you face a tax charge. Currently this is £40,000 per year in the 2021/22 tax year. If you have not fully contributed towards your pension you may also be able to Carry Forward unused pension contributions from the last three years to increase your limit for the current year. Your Annual Allowance includes all the payments made into your pension by you, your employer, or any third-party.
At the point you look to take a pension income, if your opt for an Annuity it guarantees to provide you with a regular income for the rest of your life. This is in return for you paying over a lump sum from your pension fund. Annuity Rates are the factor used to calculate the amount of income that is payable, following the investment of a lump sum in an Annuity.
Over your working life if your have met the minimum National Insurance contribution requirements, the Basic State Pension is the flat rate state pension you receive. This changes each year on 6 April. To satisfy the minimum National Insurance contributions requirement you must have built up enough qualifying years. You will need 30 qualifying years for a full Basic State Pension.
Increasingly more employed people are members of a Company Pension Scheme or Occupational Pension Scheme. This is provided and contributed to by the employer for the employee. The scheme will either be a Defined Benefit Scheme, also called a Final Salary Scheme or a Defined Contribution Scheme, also called a Money Purchase Scheme.
A Defined Benefit Pension Scheme is where the pension the employee receives is linked to their length of scheme service and size of their salary as defined in the scheme rules. A Defined Contribution Scheme is where the contributions made by the employer and employee are set and the final pension the employee receives depends on a number of factors including the size of their fund on retirement.
This fund is then used to buy an Annuity or enter into Income Drawdown, also known as an Unsecured Pension. Income Drawdown enables the employee to draw or take an income and/or cash lump sums from their pension fund rather than buying an Annuity and to take income direct from their pension fund.
If the company pension scheme is a Final Salary Scheme employees receive a pension income linked to the size of their final salary and the number of years they have been a member of the scheme.
There is no limit on how big your pension fund can grow to, however you have a Lifetime Allowance in relation to the maximum amount of tax-relieved benefits you can build up over your lifetime. In the current 2021/22 tax year this amount is ££1,073,100.
The Pension Freedoms were introduced by the government on 6 April 2015. They let people aged 55 and over access their Defined Contribution or Money Purchase pension pot in whatever way they want. The biggest change is that people aged 55 and over can now withdraw their entire pension pot as one lump sum. 25% is tax-free, and the remaining amount becomes taxable.
An alternative to a Company Pension Scheme is a Personal Pension Scheme. The other main types of Personal Pension Schemes are a Group Personal Pensions (GPP). This is a collection of Personal Pension plans provided by employers for their employees. Each member receives their own plan, with both the employer and employee usually contributing. A Self-Invested Personal Pension (SIPP) is another type of Personal Pension Scheme. This allows you to choose how and where you want to invest your pension savings rather than relying on a pension company to do this on your behalf within the fund or funds that you have selected.
If you were a member of a Company Pension Scheme and you leave the company after less than two years’ service, you can take a refund of any personal contributions, less certain deductions. But if the you have been a member of the scheme for more than two years, the benefits become Preserved Benefits within the scheme or, if appropriate, can be transferred to another pension scheme, and will be paid at a future date.
The process by which the current value of a pension plan can be transferred from one registered pension scheme to another registered pension scheme is called a Pension Transfer or Pension Consolidation. The value is normally transferred direct from one employer or pension provider to another.
A tax-efficient method of increasing the money paid into a pension scheme is via a Salary Sacrifice. By giving up some of your existing salary or proposed salary increases, this amount is used as an additional company contribution into a pension scheme.
Depending on the amount you earn and the additional National Insurance contributions you have made, you may also be entitled to the extra State Second Pension (S2P). This benefit replaced the State Earnings Related Pension Scheme (SERPS) in April 2002. Self-employed people do not qualify for this. If you Contracted-Out (opted out of the scheme) of the S2P part of your National Insurance contribution can be paid into a Personal Pension or Company Pension.
To save for your retirement the UK government encourages you by giving you Tax Relief on your pension contributions. Basic rate tax payers can essentially contribute £100 to their pension for just £80. Similarly, if you pay tax at £40%, that £100 pension contribution will only cost you £60. If you pay income tax above the basic rate, you may be able to claim Additional Tax Relief from HM Revenue & Customs (HMRC) directly. The government limits these benefits via the Annual Allowance and the Lifetime Allowance.
Since the 6 April 2015, from age 55 you are now able to take all of a pension fund as a single or series of cash lump sums called Uncrystallised Funds Pensions Lump Sum (UFPLS). The first 25% is tax-free, with the remaining added to your income and is taxed accordingly.