Wonder what some of the terms you see used to describe pensions mean? When I first started researching retirement I found some of the words used confusing, so I thought it would be helpful to compile a glossary of pension terms with simple explanations. I hope you find it helpful!
Annual allowance
The annual allowance is the maximum amount of money you can save into your private or workplace pensions each year, tax-free. It applies across all your pension savings – including money you save if you are self-employed or from your limited company – not just for each pension scheme.
The current annual allowance is £60,000 a year. If you pay more than this amount into your pension you will be charged an annual allowance tax.
Read more about paying into your pension from a limited company.
Annual management charge
Your annual management charge is the annual amount your pension provider charges to manage your savings. This may be taken either as a flat fee or as a percentage of the value of your pension pot.
Annuity
A pension annuity is a way of receiving your pension (the other alternative is a pension drawdown… see below for details on this). An annuity pays you a guaranteed income for either a fixed period of time you choose, or for the rest of your life. Once you are ready to retire, you can buy an annuity from an insurance company. The amount you receive will depend on variables like your age, health and where you live.
Auto-enrolment
If you are employed in the UK full or part-time, by law your employer must offer you a workplace pension and contribute towards it. As long as you don’t choose to opt-out, you’ll need to pay at least 5% of your gross qualifying earnings into your workplace pension, and your employer must pay at least 3%.
To qualify for auto-enrolment you must:
- Be at least 22 years old
- Have not yet reached State Pension age
- Earn more than £10,000 a year
If you earn between £6,240 and £10,000, your employer doesn’t need to automatically enrol you in their scheme. However, if you ask to join, they cannot refuse and must make contributions on your behalf.
Carry forward rule
If you haven’t used your full annual allowance in the previous three years, you can ‘carry forward’ any unused allowance. This means you can pay over your annual allowance of £60,000 and still benefit from tax relief. If you are making personal contributions, you can only carry forward unused allowance up to the value of your annual earnings. You can read more about the carry forward rule here.
Crystallised pension
Once you start taking money from your pension – either by cashing it in, drawing down or buying an annuity – it becomes ‘crystallised’. You can crystallise your pension once you reach the age of 55 (rising to 57 in 2028).
Defined benefit pension
A defined benefit pension is sometimes known as a final salary pension. With a defined benefit pension, you receive a set amount of money each month for life (increased for inflation). The amount you receive is usually based on your salary and how long you have been in the pension scheme. Defined benefit pensions are more common in the public sector.
Read more about defined benefit pensions.
Defined contribution pension
With a defined contribution pension, the amount of money you receive will depend on how much you and your employer invest, and how your investments perform. When you are ready to retire with a defined contribution pension you can choose between an annuity or pension drawdown (see the definitions on this page for each option).
Read more about defined contribution pensions.
Earmarked pension
If you get divorced, your settlement may include part of your ex’s pension. An ‘earmarked’ pension is the percentage of their pension that is owed to you once they start withdrawing. An alternative to earmarking a pension is a Pension Sharing Order (we cover this later on).
Nominated beneficiary
When you die, your pension is not included as part of your will. Instead you will need to nominate someone to receive your pension savings when you die. This is known as a ‘nominated beneficiary’ and is done directly with your pension provider. Remember to update this if your life circumstances change, for example if you marry or get divorced.
Pension drawdown
Once you reach 55 (rising to 57 in 2028), you can start to take money from your personal or workplace pension if you wish. One option is pension drawdown (the other option is to buy an annuity – see above). With pension drawdown, your money stays invested and you decide how much you want to take and when. Your pension pot can increase or decrease, depending on how your investments perform. Many people follow the 4% pension drawdown rule to help their money last as long as possible.
Read more about pension drawdown.
Pension Sharing Order
If you get divorced, the court may order your ex to split their pension with you as part of a Pension Sharing Order (PSO). You can take your share of their pension immediately and either join their pension scheme or move it into another of your choice. Not all pension providers will acted a PSO transfer. A PSO is an alternative to pension earmarking (see above).
Personal pension
If you set up your own retirement savings plan, this is known as a personal pension or a private pension. This is not the same as a workplace pension, which is set up by your employer (see below for details on this). You can usually access your personal pension from age 55 (rising to 57 by 2028).
Salary sacrifice
With pension salary sacrifice you agree to give up part of your salary before tax, and this money is paid directly into your pension scheme by your employer. This can have several benefits – it can save you money on income tax and National Insurance, while boosting your pension pot faster.
Self-Invested Personal Pension
A Self-Invested Personal Pension (SIPP) is a defined contribution personal pension in which you decide how your savings are invested. You can either manage your investments yourself, or ask a fund manager to look after them for you.
State Pension
If you qualify, you will receive the State Pension once you reach State Pension age (currently this is 66, however it will rise to 67 in 2028). The amount of State Pension you will receive is based on your National Insurance Contributions record.
Uncrystallised funds pension lump sum
The first 25% of your personal pension is tax free. You can choose to take this as a lump sum, or over time. One way to take your money is as an uncrystallised funds pension lump sum (UFPLS). This is where you take money from your pension without moving it into drawdown or buying an annuity. 25% of each payment is tax-free and the remaining 75% is taxable. Your remaining funds stay invested, with the potential to keep growing.
Workplace pension
A workplace pension is a pension that is set up for you by your employer. If you are eligible (and don’t choose to opt out), you will usually be required to pay in at least 5% of your qualifying earnings into your pension, and your employer must pay in at least 3%. The earliest you can access your workplace pension is age 55 (rising to 57 from 2028). See auto-enrolment above for more details.
