Pensions jargon explained

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 2021-22 the Annual Allowance is £40,000 for most people, but be warned, it can be as little as £4,000 if either your earnings are very high (Tapered Annual Allowance) or you’ve taken pension benefits flexibly (Money Purchase Annual Allowance).

The Annual Allowance applies across all your pension savings, not per policy. This includes the deemed increase (rather than what was actually paid) to any defined benefit pension. If you exceed the Annual Allowance, a tax charge is made – any excess is added to your income and taxed at your marginal rate of income tax, even if the contributions were solely paid by your employer!

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.

Annuity / Secure Income

A type of retirement income product that is bought with the proceeds of a pension policy from an insurer. It provides a regular income – normally for life but it can also be for a set period. The income could stay the same (a level annuity) or increase (escalating annuity) and it is also possible to include other options like a spouse’s pension, payable upon your death. The more options such as these you build into the contract, the lower the starting income.

Beneficiary

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

Contracting Out

It used to be possible for you or your employer 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 has only been available in Defined Benefit Pensions.

Uncrystallised Pension (Unvested) & Crystallised (Vested)

An uncrystallised or unvested pension is simply a pension that hasn’t been accessed for retirement income. In contrast a crystallised or vested pension is a pot that has been accessed for retirement income.

Because you don’t always have to take all your pension benefits in a scheme in one go, it is possible to have both an uncrystallised and crystallised pot of money in the same scheme. Crystallising or vesting is the stage at which those pension benefits are measured against the Lifetime Allowance for the first time, as well as the point at which you can elect to draw a pension commencement lump sum / tax free cash.

Defined Benefit Pension / Final Salary / Career Average

This type of pension benefit pays a retirement income based on your salary and how long you have worked for your employer. Generally these are only now available within the public sector or via older workplace pension schemes. In the past such schemes were extremely common and therefore many people may have defined benefit pensions related to previous employment. I you are no longer working for the employer but have not yet retired, you would be known as a ‘deferred’ members.

Dependant

Someone who is financially dependent on you, usually a partner or child.

Drawdown Pension / Flexi Access Drawdown / Capped Drawdown / Income Drawdown

These are 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. The big risks of this route compared to an annuity is that your pension pot will potentially be subject to investment risk and, if you take withdrawals, you could exhaust the pension entirely before you die.

Escalation

This describes the way either an annuity income or the income from a defined benefit pension grows each year.
• No increase to pension each year (level)
• Pension increasing each year at a fixed rate – i.e. 3% p.a. 5% p.a.
• Pension increasing each year in line with the change in a measure of inflation, such as the Retail Prices Index (RPI) or Consumer Price Index (CPI)

Guaranteed Annuity Rates (GARs)

A valuable guaranteed income offered by your own pension scheme or provider if you take a lifetime annuity with them. You’ll likely be hard pressed to match this by shopping around.

Guaranteed Minimum Pension (GMP)

Guaranteed minimum pension (GMP) is a defined benefit. This means it is a specific amount of pension and is payable at age 60 for females and 65 for males. The amount payable is calculated by HM Revenue & Customs (HMRC) and does not depend on investment return. You may have GMP in your pension if you were contracted out of the State Earnings Related Pension Scheme (SERPS) between 06/04/1978 and 05/04/1997 via a Defined Benefit Pension.

Lifetime Allowance (LTA)

The Lifetime Allowance is the highest value of pension savings you can draw without paying a Lifetime Allowance Tax Charge tax. The amount set by the Government is £1,073,100 for tax year 2021/22. This was being increased each year in line with the Consumer Price Index, however it has ben announced that it will be frozen at the existing level until April 2026.

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

It is possible to hold protection against the Lifetime Allowance and, if you do so, it is vitally important to comply with any of the restrictions these entail to maintain your protection.

Open Market Option

If you are considering buying an annuity 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’.

Pension Commencement Lump Sum / Tax Free Cash

You can normally 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 is more commonly known as a tax-free lump sum or tax-free cash. You don’t normally have to take this in one go.

Pension Sharing, Pension Sharing Order (PSO), Pension Offsetting

A pension sharing order is a court order used to separate two people’s pension assets, primarily in the context of divorce, but also when a civil partnership is dissolved. Whilst technically a court order, it is often necessary even for amicable divorces. This is because unlike with some assets (such as the family home) you and your spouse cannot simply make an agreement between the two of you to split a pension. Pension schemes require a court order to make the necessary changes – this is a percentage share of a one or more of a spouses pensions. If you have a pension sharing order in your favour this results either in your transferring these benefits into a pension in your own name or you sometimes have the option to join your ex-partners pension scheme. The options available depend upon which method that particular scheme allows.

Pension offsetting is an alternative method of accounting for pension assets between spouses upon divorce. Using this method the value of any pensions is offset against other assets.

For example, you might get a bigger share of the family home in return for your ex-partner keeping their pension.

Self invested Personal Pension (SIPP)

A self-invested personal pension (SIPP) is a type of defined contribution pension. It works in a similar way to a standard personal pension, albeit with a wider choice of investments to select. Not all SIPPs are the same, and some offer a much wider range of investments than others.

Small Self Administered Scheme (SSAS)

A Small Self Administered Scheme (SSAS) is a defined contribution pension scheme set up by a limited company. Private and family run businesses can set up a SSAS for the benefit of the owners, company directors and family members if they are employees.

The members are appointed as trustees to have control and flexibility over the scheme’s assets and pension investment choices. SSASs have the ability to invest in a wide range of assets, including Commercial Property & Loan Backs to the Company.

Trust

An arrangement whereby a person (a trustee) holds property (assets) as its nominal owner for the good of one or more beneficiaries. In the world of pensions, trusts are very commonly used by providers as a structure to hold pension assets for the benefit of clients, as it creates a clear separation (and distinct ownership) between the assets of the provider and those of its clients.

Trustee

A trustee is a person or firm that holds and administers property or assets for the benefit of a third party. Trustees are appointed for a variety of reasons, such as in the case of bankruptcy, for a charity, for a trust fund, or for certain types of pensions. In the pension’s world most SIPPs and SSASs are set up under Trust, and there will usually be a professional trustee (set up or appointed by the provider) and sometimes you as a client will also be appointed as a member trustee.

Uncrystallised Funds Pension Lump Sum (UFPLS)

One of the options available to individuals with a defined contribution pensions. 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.

With Profits / Market Value Adjustment (MVA) / Market Value Reduction (MVR) / Bonus Rate / Terminal Bonus

With-profits policies are medium- to long-term investment funds offered by insurance companies. These aim to provide a return linked to the stock market but with fewer ups and downs than investing directly in shares.

The costs of running the insurance company’s business are deducted from the fund and what is left over (the profit) is available to be paid to the with-profits investors. You get your share of profits in the form of annual bonuses added to your policy.

The company usually tries to avoid big changes in the size of the bonuses from one year to the next. It does this by holding back some of the profits from good years to boost the profits in bad years – this process is called ‘smoothing’.

Usually, once added, bonuses can’t be taken away. But if you surrender early, the insurance company may limit some or all of the bonuses paid by applying a Market Value Reduction (MVR) – or Market Value Adjustment (MVA) – to your policy. This is most likely in times of adverse investment conditions like a stock market crash.

You might also get a ‘terminal bonus’ when your policy matures.

This method can make the returns harder to understand and as such they are now a less popular form of investing.