6 important pension terms you might want to know

If you’re planning for your eventual retirement, it’s important that you fully understand the options open to you. Your pensions are likely to form the backbone of your retirement income and so it is vital that you make the correct choices with them.

The pension industry can be complicated and full of jargon. So, you will likely need to have a firm grasp of the essential terminology to help you make informed choices.

According to research cited by FTAdviser, one-third of UK savers lack pension knowledge and don’t know where to go for relevant retirement information.

We believe it’s important to stay properly informed. So, read on to discover six essential pension-related terms we believe you should know to help you better understand your pension planning options.

1. Defined contribution pension

The most popular form of private or workplace pension in the UK, a defined contribution (DC) pension relies on contributions made by you, or on your behalf, to a pension pot.

Your pension provider will likely save and invest these funds potentially leading to further growth in the value of your pot over time.

Your contributions to your pension pot are likely to benefit from Income Tax relief.

Workplace pension schemes also benefit from auto-enrolment rules, which ensure your employer usually contributes the equivalent of at least 3% of your earnings to your pension pot each month.

Once you reach pension age – which is currently 55 but is set to rise to 57 on 6 April 2028 – you will be able to withdraw funds from your private or workplace DC pensions.

2. Defined benefit pension

Defined benefit (DB) pensions have largely been phased out in the UK and the majority are closed to new members. Yet, it is still possible you may have one, particularly if you work in the public sector.

A DB pension, also known as a “final salary” scheme, typically pays a retirement income based on your salary at the time of your retirement and how long you have worked for your employer rather than the amount you’ve contributed to a pot.

DB pensions normally guarantee employees a retirement income for life. While they can be less flexible than DC pensions, they do usually offer added security and stability.

3. Annual Allowance

Your Annual Allowance refers to the maximum amount of pension contributions you can make each tax year before additional tax charges are levied.

This amount includes your own contributions, tax relief, any employer contributions, and any contributions made by someone else on your behalf.

The Annual Allowance is £60,000 (as of the 2023/24 tax year). Although, you might be able to boost this amount by using the “carry forward” rule, which allows you to additionally use any unused allowances from the previous three tax years.

4. An annuity

An annuity is a type of retirement income product normally purchased with the proceeds from a pension scheme. An annuity can provide you with a regular, guaranteed income in retirement.

There are many kinds of annuity, but three of the most common are:

  • Lifetime annuity
  • Fixed-term annuity
  • Investment-linked annuity.

A lifetime annuity guarantees you a regular income for the rest of your life at a set rate. You can add additional features, such as:

  • Providing an income for your spouse or partner if you die before them
  • Protecting your income against the effects of inflation.

Meanwhile, a fixed-term annuity guarantees a regular income for a fixed number of years and can additionally pay out a lump sum at the end.

An investment-linked annuity differs by not paying out a set amount but rather linking payments to the value of underlying investments.

Read more: Stable retirement income – 7 things to consider before buying an annuity

5. The State Pension and the “triple lock”

In order to receive the full UK State Pension, you’ll likely need at least 35 qualifying years of National Insurance contributions (NICs).

Although, if you have gaps in your record, you could opt to make retrospective payments to try and gain full access before you reach State Pension Age (SPA). This is currently 66 but will rise to 67 by 2028.

Read more: National Insurance credits – why gaining more might help boost the value of your State Pension

The UK government’s “triple lock” helps protect the value of your State Pension year-on-year.

The triple lock works by raising the State Pension in line with the highest of these three measures:

  • 2.5%
  • Average wage growth between May and July against the same period the previous year
  • Inflation – measured by CPI in the year up to September.

Read more: What is the State Pension “triple lock” and how much is it worth to you?

6. The Lifetime Allowance (LTA)

The Lifetime Allowance (LTA) was previously defined as a lifetime cap on the amount of pension contributions that you could build up without any additional tax charges being applied.

However, the government’s spring Budget changed LTA rules.

As of 6 April 2023, the LTA charge for exceeding the lifetime cap (£1,073,100) has been removed.

This could be incredibly beneficial for your retirement plans. It might give you further opportunities to reduce your Income Tax liability through making additional pension contributions, which could also result in a significantly larger pension pot.

Although, the LTA could affect your pension rights in alternative ways, as certain lump sum benefits could be subject to Income Tax if they are in excess of the LTA.

As of 6 April 2024, the LTA is due to be abolished altogether.

Simplifying the jargon could improve your understanding, get in touch to learn more

There are plenty of terms you might also want to know – such as pension crystallisation, pension consolidation, or the Money Purchase Annual Allowance – that we haven’t touched upon in this article.

It is likely you’ll want to have a well-rounded pension vocabulary to help you make fully informed decisions regarding your pension plans.

Working with a financial planner can help you cut through the jargon and improve your understanding of your pension plans. To set up a meeting to discuss your options and help build on your existing knowledge, email helpme@aspirellp.co.uk or call 0117 9303510.

Please note

This article is no substitute for financial advice and should not be treated as such. To determine the best course of action for your individual circumstances, please contact us.

The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Levels, bases of and reliefs from taxation may be subject to change and their value depends on the individual circumstances of the investor.

Workplace pensions are regulated by The Pension Regulator.

This article is for information only. Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.

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