Glossary of pension terms

A

Alternative annual allowance

This is the maximum benefit increase amount you have under a defined benefit pension and get tax relief. It only applies once the money purchase annual allowance has been triggered. The alternative annual allowance for most people is £50,000 but may be less than this if the tapered annual allowance also applies for the tax year concerned.

See also defined benefit pension and money purchase annual allowance.

Annual allowance

This is the maximum amount of pension savings an individual can make each year without a tax charge. For money purchase or defined contribution schemes , this is the total of their own contributions, any employer contributions and any contributions made on the individual’s behalf by someone else. Under cash balance and defined benefit schemes it’s the value of the increase in their benefits over the year. 

The annual allowance for most people is currently £60,000. The annual allowance applies across all an individual’s pension savings, not per plan. If they exceed the annual allowance, a tax charge is made which takes back any tax relief that was given at source.

The annual allowance is not the same as tax relief although they are interlinked. 

See also tax relief, tapered annual allowance and money purchase annual allowance.

Annual management charge

This is an ongoing fee paid to a pension provider for managing the funds an individual’s pension savings are invested in. It’s usually charged as a percentage of the value of the pension savings.

Annuity

This is a product that pays a regular income for life or a fixed term. You can buy an annuity using pension savings or, in some cases, non‑pension money (purchased life annuity). Options such as joint life, guarantee periods and inflation‑linking will change affect the amount of income it pays.

See also lifetime annuity, enhanced annuity, fixed-term annuity, investment-linked annuity and purchased life annuity.

B

Beneficiary

Someone who can receive benefits from a Will, a trust, a life insurance policy or death benefits from a pension or annuity.

Block transfer

A block transfer is where two or more people transfer their pension benefits from one scheme to the same new scheme. This type of transfer can protect low retirement ages and any tax-free cash lump sums that are higher than 25%.

A block transfer is defined as:

• A transfer of the pension rights relating to an individual and at least one other pension scheme member.
• The transfer is made as a single transaction.
• The transfer represents all the pension rights under the scheme for all the individuals transferring as part of that single transaction, and
• Before the transfer the individual has not been a member of the receiving scheme for more than 12 months. 

The rules around block transfers are different for people with a protected pension age of 55 and 56 in a pension plan and then transfer these benefits.  If you think this will affect you, you should speak to a financial adviser. 

C

Capped drawdown

This is a type of retirement income product that was only available before 6 April 2015. It was similar to a flexible retirement income product but there’s a cap on the maximum level of income that can be taken from the plan in a year. The limits are based on rates issued by the Government Actuaries Department.

If the amount of income taken is more than the capped drawdown limit, the money purchase annual allowance will be triggered restricting the amount of pension contributions made into a money purchase pension plan before incurring a tax charge.

See also pension drawdown and money purchase annual allowance.

Cash balance scheme 

A cash balance pension scheme is a type of workplace pension that sits between a defined benefit pension and a defined contribution pension. It provides either a specific lump sum at retirement or a guaranteed rate of growth on the amount saved. At retirement the value is used to provide tax-free cash and an income. 

Contracting out

This is where an individual or their employer opted out of the State Second Pension (State Earnings Related Pension Scheme). In exchange, the individual paid lower National Insurance contributions and received higher pension contributions.

It has not been possible to contract out of the State Pension since April 2016.

D

Defined benefit pension

Also known as a final salary or career average earnings scheme.

The scheme pays a retirement income based on their salary, or equivalent and how long they work for their employer. Generally they are 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, including group personal pensions. The individual’s contributions (and any employer contributions or contributions made on the individual’s behalf by someone else) are invested to build up pension savings. The individual can normally choose how and when they want to use their savings. The amount in their pension at retirement is based on how much has been paid in and how well the investments have performed.

Dependant

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

Dependant's pension annuity

Also known as a joint life annuity. In the event of the individual receiving an annuity dying, their surviving spouse, civil partner, dependant or named second life, will continue to get some or all of the income they were receiving. Because a joint life annuity pays an income to the chosen dependant if the individual receiving an annuity dies first, this option will cost more than an annuity that stops when the individual with the pension savings dies, so will reduce the income they receive during their lifetime.

Normally an individual must decide at the time they buy the joint life annuity who’ll receive the continuing annuity payments on their death. 

E

Enhanced annuity

An enhanced annuity takes health and lifestyle into account when working out the income an individual will 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 an individual can receive.

Escalation and inflation linking

This describes the way an annuity income can grow each year. The options are:

• No increase (level annuity) – the annuity income will stay the same each year. It will provide a higher starting income, but the effects of inflation over time will reduce the amount that can be bought with the income.
• To increase the annuity income each year at a fixed rate.
• To increase the annuity income each year in line with the change in a measure of inflation, such as the Consumer Prices Index (CPI).

F

Final salary scheme

Also known as a defined benefit pension.

Financial adviser

See 'Regulated financial adviser'.

Fixed protection

Fixed protection maintains a protected lump sum and lump sum and death benefit allowance at a certain level. There are three different versions.

• Fixed protection 2012 maintains a protected lump sum and and lump sum and death benefit allowance of £450,000 and £1.8 million.
• Fixed protection 2014 maintains a protected lump sum and and lump sum and death benefit allowance £375,000 and £1.5 million.
• Fixed protection 2016 maintains a protected lump sum and and lump sum and death benefit allowance of £312,500 and £1.25 million.

Fixed protection applied for after 15 March 2023 can be lost by:

• Starting a new arrangement other than to accept a transfer of existing pension rights.
• Making further contributions (money purchase).
• Having further benefit accrual (defined benefit).
• Breaking the transfer restrictions. 

For most people it’s no longer possible to apply for fixed protection. In very specific circumstances some members of Public Sector pension schemes have until 6 April 2027 to apply for fixed protection 2016.

See also lump sum allowance, lump sum death benefit allowance, money purchase annual allowance and individual protection.

Fixed term annuity

An income product that guarantees a regular income for a fixed number of years and it may pay out a lump sum at the end.

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

G

Guaranteed annuity rate (GAR)

When somebody buys an annuity, the amount of income is based on the amount of pension savings and the annuity rate. Some older plans may have had a GAR. A GAR is an annuity rate that was set in the terms and condition of the pension plan when it was taken out. The GARs that apply to older pension plans are usually significantly higher than annuity rates currently available. This means the level of annuity income is higher. Often there are restrictions on the way the annuity can be taken.

A GAR is normally lost if the pension savings are transferred to a new plan.

Guarantee period

When buying an annuity there may be an option to ensure the income payments are paid for a set period of time. If the individual dies during the annuity’s guarantee period, payments will continue to be paid to the dependant(s) for the remainder of the guarantee period.

I

Impaired annuity

See ‘Enhanced annuity’.

Income drawdown

See ‘Pension drawdown’.

Income Tax rates

Income Tax is a tax paid on your income.  There are a number of allowances that mean you do not pay tax on income which falls within those allowances. The most common allowance is the Personal Allowance. This is the amount of income a person can get before they pay income tax.

Income above the various allowances is then taxed. There are different rates of Income Tax, which apply to bands of earnings.  If a person’s income falls over one or more bands, only the income that falls within that band is taxed at the rate for that band.

Different rates of Income Tax apply in Scotland to those that apply in England, Northern Ireland and Wales. You can see the latest rates of Income Tax on the government website (England, Northern Ireland and Wales) or Income Tax In Scotland: Current rates.

Individual protection

Individual protection maintains a protected lump sum and death benefit allowance at a certain level depending on what type the individual has. There are two different versions.

• Individual protection 2014 gives individuals a protected lump sum and death benefit allowance equal to the value of their pension savings on 5 April 2014, subject to an overall maximum of £1.5 million.
• Individual protection 2016 gives individuals a protected lump sum and death benefit allowance equal to the value of their pension savings on 5 April 2016, subject to an overall maximum of £1.25 million. 

Under both versions the lump sum allowance is 25% of the protected lump sum and death benefit allowance.

Pension contributions can continue to be paid. The value of any pension savings above the protected lump sum and death benefit allowance will be liable to an income tax charge.

For most people it’ is no longer possible to apply for individual protection. In very specific circumstances some members of Public Sector pension schemes have until 6 April 2027 to apply for individual protection 2016.

See also lump sum allowance and lump sum and death benefit allowance and fixed protection.

Inflation

The increase in the general level of prices of goods and services. This results in a fall in the amount of good and services you can buy with the same amount of money. 

Investment linked annuity

An 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

See ‘Dependant's pension annuity’

L

Lifetime allowance

Lifetime allowance was a limit of pension benefits that could be built up without a lifetime allowance charge applying for benefits taken before 6 April 2024.

The lifetime allowance was £1,073,100 and was abolished on 6 April 2024. 

Lifetime annuity

An income product that guarantees to pay a regular income for the rest of somebody’s life.

An individual may be able to choose to add features to their annuity, such as providing an income for their spouse or partner if they die before them or protecting their income against the effects of inflation. An individual needs to decide how important these features are to them as the choices they make will affect the amount of income they receive during their lifetime.

Loyalty bonus

Some older pension schemes reward customers with a loyalty bonus after a set number of years. This could be paid by giving back some of their annual management charge (AMC) or as a lump sum when they come to take their pension savings, depending on the scheme. Normally if an individual chooses to leave a pension scheme before reaching their retirement date they’ll lose out on the loyalty bonus.

Lump sum allowance

The lump sum allowance limits the amount of tax-free lump sums an individual can take from their pension plan. Normally 25% of the benefits can be paid tax-free, with an overall maximum limit of £268,275. Payments above this are subject to tax at the individual’s marginal rate of income tax. An individual may have protection that allows them to take more than this.

Lump sum and death benefit allowance

The lump sum and death benefit allowance limits the total amount of tax-free lump sums that can be paid from an individual’s pension after they die. Any tax-free lump sums paid to the individual before they die also count toward this allowance. For most individual’s this is set at £1,073,100. Any lump sums above this are subject to tax at the individual’s marginal rate of income tax. An individual may have protection that allows them to take more than this.

M

Money purchase annual allowance (MPAA)

The money purchase annual allowance limits the amount of money that can be paid into a money purchase or defined contributions scheme. The MPAA is currently £10,000. Where the MPAA has been triggered contributions above that amount would be subject to tax at the individual’s marginal rate of income tax.

It does apply to defined benefit or cash balance schemes, though the alternative annual allowance would apply to those schemes.

The main reason the MPAA is triggered are:

• if pension savings are taken as an uncrystallised fund lump sum or as ad-hoc lump sums
• if pension savings are put into a flexi-access drawdown scheme and start to take an income
• if an investment-linked or flexible annuity is bought where the income could decrease
• if somebody with a capped drawdown plan takes payments that exceed their maximum income cap 

Also see annual allowance. and alternative annual allowance.

Money purchase pension

A money purchase or defined contribution plan is a type of pension savings plan. They come in a variety of different types including personal pensions, stakeholder pensions, self-invested personal pensions and group pension plans.

The individual and/or employer or somebody else on behalf of the individual make contributions to the plan. A plan is set up for the individual and the contributions are usually invested in unit linked or with profits funds.

The benefits payable on death or retirement are based on the value of the individual’s plan. 

O

Open market option

The open market option allows someone approaching retirement to ‘shop around’ annuity providers. This can help them get the best annuity rate when they convert their pension savings into an income (annuity). Rather than simply taking the default rate offered by their pension provider.

It's important to note that an open market option only applies to buying annuities. If a pension plan doesn’t offer income drawdown, it’s not possible to use an open market option to move the pension savings to a plan that does.

See also enhanced annuity, lifetime annuity, investment linked annuity and joint life annuity.

Overseas transfer allowance

The overseas transfer allowance is a limit set by HM Revenue & Customs on the value of pension benefits that can be transferred overseas to a qualifying recognised overseas pension scheme (QROPS). Where the total of an individual’s transfers from UK registered pension schemes to a QROPS exceeds their overseas transfer allowance, the excess will be subject to a 25% overseas transfer charge. For most people, their overseas transfer allowance is £1,073,100.  

An individual may have protection that gives then a higher overseas transfer allowance. 

P

Pension age

Age 55 (increasing to age 57 from 6 April 2028) is the earliest you can normally take your pension savings.​

Some individuals may still be able to take their benefits before age 55 after the pension age increases to 57. Before 6 April 2006 there were several occupations where an individual could take their benefits from a personal pension or retirement annuity contracts before the age of 50. Fifty was the normal minimum pension age at that time for these types of plans.​

Details of these occupations can be found in HM Revenue & Customs pension tax manual. There are still occupational pension schemes that have a normal retirement age below age 55, these schemes relate to the Armed Forces, Police and Fire Brigade. Certain conditions do apply. They are not affected by the increase in pension age.​

When the new normal minimum pension age comes into force in April 2028 individuals may qualify for a protected pension age of 55 or 56, depending on their pension scheme rules.

If a plan that has a protected retirement age is transferred to another pension plan, the entitlement to the lower retirement age will be lost unless it is a block transfer. 

If you are transferring a plan with an Individual Protected Pension Age to Royal London, on or after 6 April 2028, and you want to retain that entitlement, then you will need to contact our transfer team as a separate plan will need to be set up. By proceeding with the transfer via the transfer hub or mobile app the transfer payment will be applied to your existing pension plan and any protected pension age entitlement will no longer apply.​

Individuals taking their benefits due to ill health, severe ill-health and serious ill-health can do this before they reach age 55 or 57 from 6 April 2028, but there are conditions for doing so.​

Pension commencement lump sum

This is also called a tax-free lump sum or tax-free cash. Normally an individual can take up to 25% of their pension savings as a tax-free lump sum, this is called a pension commencement lump sum (PCLS).  Also see Protected tax-free cash.

Pension drawdown

Also known as ‘income drawdown’ or ‘a flexible retirement income product’. Using pension drawdown allows somebody to use their pension savings to provide a retirement income. The level of income isn’t guaranteed, but they have the flexibility to make changes to how much they take. An individual can use their remaining pension savings to provide a guaranteed retirement income by buying an annuity product. 

The income is paid directly from the plan, which will reduce the plan’s value. Any investment growth on the remaining pension savings may not be enough to maintain the level of income payments an individual needs for the rest of their life. 

Protected tax-free cash

Tax-free cash (pension commencement lump sum) is the money somebody can take as a tax-free lump sum when they begin to take their pension savings. It’s usually 25% of the fund value.

Some individuals in older workplace (occupational) pension schemes may have a right to more than 25% tax-free cash.  This higher amount may be lost if the individual transfers their pension savings to another pension plan, unless it is part of a block transfer.  A block transfer is where two or more people transfer their benefits from one scheme to the same new scheme. 

See block transfer.

Purchased life annuity 

A purchased life annuity is an annuity you buy with your own after-tax money (for example savings, investments, inheritance, or proceeds from selling a property), not with pension funds. It provides a guaranteed regular income, usually for life, although it can also be paid for a specific period of time. 

R

Regulated financial adviser

A regulated financial adviser is a qualified professional who is authorised and regulated by the Financial Conduct Authority (FCA) and must follow their rules when giving financial advice. They will recommend financial products only after taking account of an individual’s overall financial and personal circumstances. If the advice they give turns out to be unsuitable an individual can make a complaint and if necessary, take their 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.

Individuals should always check what an adviser is authorised to do on the FCA’s Firm Checker.

S

State Pension age

The age a person has to reach to be able to take their State Pension. You can check what your state pension age is by using the government's State Pension age tool.

T

Tapered annual allowance

The annual allowance of £60,000 is reduced or ‘tapered’ if an individual’s total income is over £200,000.

This is complicated, so if total annual taxable income, salary and investment returns, is around or above £200,000 an individual should speak to their financial adviser to find out whether tapered annual allowance applies to them.  If it does, the annual allowance that applies could be reduced to as low as £10,000.

Similar tapering applies to the alternative annual allowance if you’re in a defined benefit pension.

Tax-free cash

See ‘Pension commencement lump sum’ and Protected tax-free cash.

Tax relief

When an individual pays into a pension from their pay or make a one-off contribution, they get a boost from the government in the form of tax relief. 

How tax relief is given depends on what type of pension plan they are saving into.  

For personal pensions, group pension schemes and stakeholder pension schemes, contributions are paid after income tax has been deducted. Most providers will automatically add basic rate relief of 20% to the contributions. If the individual is a higher or additional rate taxpayer they need to complete a self-assessment tax return before they get their additional tax relief. 

For cash balance and defined benefit pension schemes pension contributions are deducted before income tax is paid. This means they get the full tax relief immediately and do not have to complete a self-assessment tax return if they are a higher or additional rate taxpayers. 

U

Uncrystallised pension fund

Pension savings that have not paid out any tax-free cash or retirement income. 

Uncrystallised funds pension lump sum (UFPLS)

An UFPLS is one of the options available to individuals with a money purchase (defined contribution) pension savings. 

This option allow pension savings to be taken as a one-off lump sum, or possibly as a series of lump sums when needed. For each amount taken the first 25% (a quarter) will usually be paid tax-free and the rest will be taxed at the individual’s highest rate of income tax. 

V

Value protection

Value protection is an option somebody can choose when they buy an annuity.

On death, the total amount of gross annuity payments made up to the date of death is deducted from the amount paid to buy the annuity. The difference is paid as a lump sum.

If somebody dies before age 75, the lump sum is paid tax free, otherwise it’s taxed at the beneficiary’s highest rate of income tax.