Pensions glossary

Cut through the jargon around pensions with our handy glossary for pension terms. From Annual Allowance to Value protection, we've got easy-to-understand, plain language explanations to help you understand your pensions product.

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A

Adjusted income

Your annual income before tax plus the value of your own and any employer pension contributions.

Alternative annual allowance

The maximum amount you can save into a Defined Benefit pension and get tax relief on each tax year once you trigger the Money Purchase Annual Allowance. The Alternative Annual Allowance for most people is £36,000 but may be a lesser amount if the Tapered Annual Allowance applies for the tax year concerned.

If you have Defined Benefit pension savings and exceed the Alternative Annual Allowance (where it applies to you) a tax charge is made which claws back any tax relief that was given on the excess pension savings. If your ‘adjusted income’ is over £150,000 the Alternative Annual Allowance is reduced by £1 for every £2 that your income exceeds £150,000, up to a maximum reduction of £30,000.

See also Defined Benefit pension and Money Purchase Annual Allowance.

Annual Allowance

The maximum amount of pension savings you can get tax relief on each tax year – based on your own contributions, any employer contributions and any contributions made on your behalf by someone else. In the tax year 2019-20 the Annual Allowance is £40,000 for most people.

The Annual Allowance applies across all your pension savings, not per policy. If you exceed the Annual Allowance, a tax charge is made which takes back any tax relief that was given at source.

If your taxable earnings in the year are below the Annual Allowance then pension contributions from all sources on which you can get tax relief is limited to 100% of your earnings or £3,600, whichever is higher.

If your ‘adjusted income’ is above £150,000 the Annual Allowance is gradually reduced or ‘tapered’. See also Adjusted income and Tapered Annual Allowance.

See also Money Purchase Annual Allowance (MPAA).

Annuity

A type of retirement income product that is bought with the proceeds of a pension policy. It provides a regular income – either for life or for a set period. See also Lifetime annuity, Fixed-term annuity and Investment-linked annuity.

B

Beneficiary

Someone who benefits from a will, a trust, a life insurance policy or death benefits from a pension or annuity.

C

Contracting out

You or your employer had the option to opt out of the State Second Pension (State Earnings Related Pension Scheme). In exchange, you could make lower National Insurance contributions and higher pension contributions. Or you could get a rebate into your pension.

From 6th April 2012, this is only available in Defined Benefit (Final Salary) schemes.

D


Defined Benefit pension

Also known as a Final Salary or Career Average Earnings scheme.

Pays a retirement income based on your salary and how long you have worked for your employer. Generally now only available from public sector or older workplace pension schemes.

Defined Contribution Pension

Also known as a Money Purchase scheme. Includes most personal and stakeholder pensions, and those arranged through your employer.

Your contributions (and any employer contributions or contributions made on your behalf by someone else) are invested to build up a pot of money, and you choose how and when you want to use that pot. The amount in your pension pot at retirement is based on how much has been paid in and how well the investments have performed.

If you’re thinking of using your pension pot (also known as pension savings) to buy a retirement income product then you should shop around for the best deal before making your final decision.

You should check whether your pension has a Guaranteed Annuity Rate (GAR) or other form of guarantee. If you’re in any doubt ask your pension provider(s).

These guarantees will often provide you with an income for life much higher than you might normally get. If you decide to move your pension pot elsewhere or use it for something other than to take an income you may lose these guarantees.

Dependant

Someone who is financially dependent on you, usually a partner. Annuity providers often need proof of this - like a joint utility bill or mortgage/bank statement.

Dependant's pension annuity

Also known as a joint life annuity. In the event of you dying, a surviving spouse, civil partner, or dependant will continue to get some or all of the income you were receiving.

Because a joint life annuity pays an income to your chosen dependant if you die first, it will reduce the income you receive during your lifetime.

Drawdown pension

See ‘Flexible retirement income product’.

E


Enhanced annuity

An enhanced annuity takes your health and lifestyle into account when working out the income you’ll receive.

With most other financial products, such as life assurance, you get penalised for being in poor health. But with annuities a medical condition or lifestyle factors, such as being a smoker, having high cholesterol or being overweight, could actually boost the amount of income you receive.

You should check that your health and lifestyle information is being taken into account when obtaining quotes for an annuity. Your income will never go down as a result of the information you provide, but it could increase.

Escalation and inflation linking

This describes the way an annuity income can grow each year. You can choose:

  • No increase (level annuity) – your annuity income will stay the same each year.
  • Increase your annuity income each year at a fixed rate.
  • Increase your annuity income each year in line with the change in a measure of inflation, such as the Retail Prices Index (RPI).
  • A level annuity will provide you with a higher starting income, but the effects of inflation over time will reduce the amount you can buy.

F


Final salary scheme

Also known as a Defined Benefit scheme.

Pays a retirement income based on your salary and how long you have worked for your employer. Generally now only available from public sector or older workplace pension schemes.

Financial adviser

See 'Regulated Financial Adviser'.

Fixed term annuity

A retirement income product that guarantees a regular income for a fixed number of years, and pays out a ‘maturity value’ at the end.

At the end of the term you need to decide what to do with the rest of your pension pot. This could include taking a lump sum payment or buying a further income.

Flexible retirement income product

More commonly known as ‘income drawdown’ or ‘pension drawdown’ This allows you to use your pension pot to provide a regular retirement income. The income isn’t guaranteed for life but you have the flexibility to make changes to how much you take or to later switch your remaining pension pot to a more secure retirement income product.

G


Guarantee period

An option when taking out an annuity.

A Guarantee Period will ensure that your income payments are paid for a set period of time, regardless of whether you die earlier. If you die during the annuity’s Guarantee Period, payments will continue to be paid to your dependant(s) for the remainder of the Guarantee Period.

Guaranteed Annuity Rate (GAR)

A valuable guaranteed income offered by your own pension scheme or provider if you take a lifetime annuity with them. Likely to be hard to match by shopping around.

I


Impaired annuity

See ‘Enhanced annuity’.

Income drawdown

See ‘Flexible retirement income product’.

Income tax rates

Income Tax is split into bands and you pay different rates based on these bands. In 2019-20 the bands are 20%, 40% and 45% in England, Wales and Northern Ireland and 19%,20%, 21%, 41% and 46% in Scotland. Your pension income is added to your other earnings and then taxed according to which tax band (or bands) it falls inside.

Inflation

The increase in the general level of prices of goods and services.

Investment linked annuity

A retirement income product that guarantees to pay out for life but not a set amount – payments will rise and fall in line with the value of the underlying investments. A minimum monthly income may be guaranteed if performance is weak

J


Joint life annuity

Also called dependant's pension or annuity.

In the event of you dying, a surviving spouse, civil partner, or dependant will continue to get some or all of the income you were receiving.

Because a joint life annuity pays an income to your chosen dependant if you die first, it will reduce the income you receive during your lifetime.

L


Lifetime Allowance

The Lifetime Allowance is the highest value of pension savings you can draw without paying tax. The amount set by the Government is £1,055,000 for tax year 2019/20.

Whenever you draw benefits from a pension scheme, these are tested against the lifetime allowance. Your pension provider will tell you the percentage of the lifetime allowance you have used.

Lifetime annuity

A retirement income product that guarantees to pay you a regular income for the rest of your life.

You can choose to add features to your annuity, such as providing an income for your spouse or partner if you die before them, or protecting your income against the effects of inflation. You will need to decide how important these features are to you as the choices you make will affect the amount of income you receive during your lifetime.

M


Money Purchase Annual Allowance (MPAA)

If you start to take money from your defined contribution pension, this can trigger a lower Annual Allowance of £4,000 (2019/20) known as the Money Purchase Annual Allowance (MPAA). This means you’ll normally only receive tax relief on pension contributions of up to 100% of your taxable earnings or £4,000, whichever is lower.

As a basic guide, the main situations when you’ll trigger the MPAA are:

  • if you take your entire pot as a lump sum or start to take ad-hoc lump sums from your pension pot
  • if you put your pension pot money into a flexi-access drawdown scheme and start to take an income
  • if you buy an investment-linked or flexible annuity where your income could decrease
  • if you have a pre-April 2015 capped drawdown plan and start to take payments that exceed the cap.

The MPAA won’t normally be triggered if:

  • you take a tax-free cash lump sum and buy a lifetime annuity that provides a guaranteed income for life (that either stays level or increases)
  • you take a tax-free cash lump sum and put your pension pot into a flexi-access drawdown scheme but don’t take any income from it
  • you cash in one or more small pension pots valued at less than £10,000. (Maximum of 3).
    The MPAA of £4,000 only applies to contributions to defined contribution pensions and not defined benefit pension schemes.

Also see Annual Allowance.

Money Purchase Pension

Also known as a Defined Contribution pension.

Money Purchase schemes include most personal pensions and stakeholder pensions. This covers those arranged through your employer.

You or your employer can make contributions while you are a member of the scheme to build up a pension fund. The amounts you and your employer pay into your pension fund are set. But the value of the pension fund at the time you plan to retire is not fixed and may carry investment risk.

You should check whether your pension has a Guaranteed Annuity Rate (GAR) or other form of guarantee. If you’re in any doubt you should check with your pension provider(s).

These guarantees often provide you with an income for life much higher than you might otherwise get. You might lose these guarantees if you decide to move your pension pot elsewhere or use it other than to take an income.

O


Open Market Option

If you are considering taking an income from your pension pot, then you don’t have to take it from your pension provider. You can shop around and move your pension pot to another provider. This is known as the ‘Open Market Option’. By shopping around you could get a higher income than your pension provider can offer or a type of income that is more suitable for your needs.

P


Pension Commencement Lump Sum

You can take up to 25% of your pension fund as a lump sum, which is currently tax-free.

This is called a Pension Commencement Lump Sum (PCLS), but may also be known as as a tax-free lump sum or tax-free cash. The Pension Commencement Lump Sum is yours to do with as you see fit.

R


Regulated financial adviser

A qualified professional who is authorised and regulated by the Financial Conduct Authority (FCA) and must follow their rules when giving financial advice. Will recommend financial products only after taking account of your overall financial and personal circumstances. If the advice they give you turns out to be unsuitable you can make a complaint and if necessary take your case to the Financial Ombudsman Service.

‘Independent financial advisers’ look at all financial product types and all providers. Financial advisers offering ‘restricted advice’ specialise in certain product types and/or restrict how many providers’ products they look at.

S


State Pension age

The age you have to reach to be able to take your State Pension. You can check your state pension age by using the government's State Pension age tool.

T


Tapered Annual Allowance

The Annual Allowance of £40,000 (see earlier) is reduced or ‘tapered’ if your ‘adjusted income’ (your annual income before tax plus the value of your own and any employer pension contributions) is over £150,000. In this case the Annual Allowance will reduce by £1 for every £2 that your income exceeds £150,000, up to a maximum reduction of £30,000. In practice this reduces the Annual Allowance to £10,000 once adjusted income reaches £210,000. If your annual income after tax and excluding pension contributions is below £110,000 the tapered reduction will not normally apply.

Similar tapering applies to the Alternative Annual Allowance if you are in a defined benefit pension. See Alternative Annual Allowance.

Tax-free cash

You can usually take up to a quarter (25%) of your pension pension fund as a tax-free lump sum.

This is called a Pension Commencement Lump Sum (PCLS), but may also be known as a tax-free lump sum or tax-free cash. The Pension Commencement Lump Sum is yours to do with as you wish.

U


Uncrystallised pension fund

A pension pot that hasn't been accessed for retirement income.

Uncrystallised funds pension lump sum (UFPLS)

One of the options available to individuals with a money purchase (defined contribution) pension pot.

You can take your pension pot as a one-off lump sum, or as a series of lump sums as and when you need. For each withdrawal the first 25% (a quarter) will be tax-free and the rest will be taxed at your highest tax rate.

V


Value protection

Value protection is an option you can choose when you take out your annuity. It returns a lump sum to your beneficiaries if you die without receiving the full value of your pension savings. It is sometimes called annuity protection or capital protection.

You can protect up to 100% of your pension savings. When you die, your beneficiaries will receive the value of your protected pension savings. Your annuity provider will deduct the total gross income paid to you as an annuity income.

The lump sum will be paid tax-free if you die before age 75. If you die after age 75, the lump sum will be taxable your beneficiary’s marginal rate of tax.