Working out how much money you have for retirement is hard enough without having to navigate your way through a fog of baffling financial jargon.
To help demystify pensions and some of the rules that restrict how much you can save, here’s a handy guide to some of the most common terms:
This is your annual income before tax plus your own and any employer pension contributions. The calculation determines if you qualify for the tapered annual allowance.
This is the most money you can save in a year that qualifies for tax relief.
Savings can come from:
- Your own payments into a pension
- Payments from your employer
- Any contributions made for you by someone else – like a rich uncle
In the 2019-20 tax year 2019-20, the annual allowance is £40,000 for all pensions, not for each scheme.
If you manage to save more than the annual allowance, HM Revenue & Customs will claw back any tax top-up on your contributions..
If your taxable earnings in the year are less than the annual allowance, tax relief on money saved into your pension is limited to your total earnings or no more than £3,600 if you have no earnings.
Cash Equivalent Transfer Value (CETV)
In plain English, it’s the amount your pension is worth in cash. Financial advisers will call it the transfer value for short.
Defined or direct benefit pension (DB)
Pays a retirement income based on your salary and how long you have worked for your employer.
DB pensions are also called include ‘final salary’ or ‘career average’ schemes.
These pensions are going out of fashion due to the cost to employers and are mostly public sector or older workplace pensions.
Defined or direct contribution pension (DC)
Builds a pot of money to provide an income in retirement. How much you are paid depends on the value of your pension fund, which in turn depends on how much you and your employer paid in over the years.
If you have a personal pension, it’s likely to be a DC scheme. Most modern workplace pensions are based on this model, too.
A self-invested personal pension (SIPP) or qualifying recognised overseas pension scheme (QROPS) are likely to fall into this category.
See Flexible Retirement Income Products and Pension Drawdown.
Final salary pension
See Defined or direct benefit pension (DB)
Flexible Retirement Income Product
Also known as income drawdown or pension drawdown.
Funds that reinvest your pension to provide a regular retirement income. The income is not guaranteed.
Replaced flexible drawdown and capped drawdown from April 2015.
Guaranteed annuity rate (GAR)
One of the perks of older pensions that transferring from a defined or direct benefit pension (DB) cannot replace.
Typically, retiring workers buy an annuity with their pension fund to provide an income for life. The rate of return varies and most guaranteed annuity rates are double those currently available from providers.
This makes a guaranteed annuity rate valuable.
Lifetime Allowance (LTA)
The 2019-20 LTA is £1.055 million and the aggregate amount covers all pension savings except for the state pension.
The LTA will increase each year in line with inflation – alongside any rises in the consumer price index (CPI).
If the fund value exceeds the LTA cap, HMRC makes a tax charge against the excess of 55% if the amount is taken as a lump sum or 25% if the amount is taken as regular income.
If a saver dies leaving untouched pension savings of more than the lifetime allowance, any beneficiary must pay the tax charge on the amount that exceeds the lifetime allowance.
Money Purchase Annual Allowance (MPAA)
The MPAA takes the place of the annual allowance when someone aged 55 or over has already withdrawn some pension cash but wants to make further savings.
In effect, the MPAA is a reduced annual allowance of £4,000 for these savers:
- A saver taking their entire pension pot as a lump sum or takes ad-hoc lump sums from a pension pot
- A saver switching their pension cash into a flexi-access drawdown and takes an income
- Someone buying an investment-linked or flexible annuity that does not guarantee an income
- Savers with a pre-April 2015 capped drawdown plan and take payments that exceed the cap
Any tax relief on MPAA contributions is clawed back if you save more than the allowance.
A regular payment from government that you qualify for when you reach State Pension Age.
The amount depends on your National Insurance record, with the maximum of £168.60 paid a week.
Tapered annual allowance
The Annual Allowance is reduced or ‘tapered’ if your ‘adjusted income’ is over £150,000.
If you meet this condition, your annual allowance reduces by £1 for every £2 of income over £150,000, up to a maximum reduction of £30,000 – which is reached when you earn £210,000.
This cuts the annual allowance to as low as £10,000.
If your annual income after tax and excluding pension contributions is below £110,000 the tapered reduction will not normally apply – sometimes this is called the ‘threshold income’.
Tax-free lump sum
The cash set you can take from a pension on retirement that is free of tax.
The figure is 25% of the value of the fund.
Threshold income is when income after tax excluding pension contributions is £110,000 or less. The figure is part of the tapered annual allowance calculation.
Uncrystallised Pension Fund
A pension fund that remains unspent.
Uncrystallised Funds Pension Lump Sum (UFPLS)
Cash taken from a pension that has not previously paid out any retirement income.
For each withdrawal, usually the first 25% is tax-free and the rest taxed at your marginal rate – the highest rate you pay income tax (20%, 40% or 45%)