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The world of pensions is jam-packed with jargon, some of which is easier to decode than others.
A major part of the problem is that firms often use different terms to describe the same thing, leaving many who have pensions from a string of previous employers completely in the dark.
To help you make sense of the pensions landscape, our jargon-buster explains ten of the most confusing terms used by providers.
In this article, Barclays is not providing tax or pensions advice. Every individual’s retirement circumstances are unique, with different degrees of pension planning needed, so if you need help preparing your finances for retirement, get in touch with an expert. The Financial Conduct Authority provides tips on how to find a qualified independent financial adviser.
The jargon: ‘defined contribution retirement fund’
The most common type of pension – you contribute a set percentage of salary each month, which is then usually matched or topped up by your employer which means a ‘defined’ amount is paid in each month. Contributions will be placed into a ‘default fund’ but you may be able to choose alternate investments in which to invest your cash. When you retire, you can withdraw this money to spend as you wish or swap it for an annuity (see below).
There’s no guarantee of how much your pension will be worth. Instead, what you get at retirement will depend on how well your investments have performed, how much you invested each month and charges. Also known as a ‘money-purchase’ pension.
The jargon: ‘a defined benefit pension’
A pension policy that guarantees to pay you a defined annual income when you retire. What you’ll receive depends on how long you worked for the company and what it’s prepared to pay for each year you were an employee. This is usually expressed as a fraction, so if the rate is 1/60th – a typical level – your pension payout would be 1/60th of your final (or average) salary for each year you worked for that firm.
So, taking the final salary example, if you left earning £40,000 after 15 years’ service, you'd get 15/60ths – a quarter, or £10,000 a year – in retirement. Many such schemes are now closed to new entrants, and tend to be held by older workers. When you reach 55 you may have the option to ‘ transfer out’ to an alternate plan but it’s a very complex decision that usually requires financial advice.
The jargon: ‘pension tax relief’
A tax payment to boost how much you put into your pension pot. A government incentive, it puts the tax you’d normally have paid on your income into a pension for you.
For example, a basic rate taxpayer paying 20% income tax who puts £80 monthly into a pension has it topped up by £20 – so £100 is saved into a scheme in total. For a higher earner whose income is taxed at 40%, additional tax relief (above 20%) needs to be reclaimed via self-assessment, unless the contribution is paid out of your gross salary by your employer.
The jargon: ‘diversification'
Putting your pension cash into a mix of investments - to spread the risk you’re taking with the money saved for retirement. For example, your money may be spread across a mix of shares, bonds and cash invested in the UK or internationally. Pension funds usually let you decide how much risk you want to take.
As a general guide, it’s usually wise to take fewer risks as you get older so you can protect what you’ve built up.
The jargon: ‘your pension beneficiary’
A person – typically your partner – you can name on your pension documents who would inherit your pension fund on death when you die. This could be a lump sum or on-going payments, depending on the type of pension policy.
The jargon: ‘your annual pension allowance’
It’s the most money you can put into or build up in benefits across all your pensions during a single tax year, without having to pay a tax charge – it’s set at £40,000 for the 2018/19 financial year (assuming you haven’t already started drawing an income from your pension – in which case it is £4,000 for 2018/19). However, this limit shrinks if you’re a high earner. For every £2 you earn over £150,000, this annual allowance is reduced by £1 – all the way down to a minimum of £10,000.
The jargon: ‘an annuity’
A guaranteed regular payment to you in exchange for cash in your pension pot – one usually made throughout your retirement until you die. How much you get is called the ‘annuity rate’ – for example, a 5% rate typically means you’d get £5,000 a year, usually paid monthly, from a £100,000 lump sum .Your age, health and life expectancy will play a part in how much you get.
The jargon: ‘a pension saver’s lifetime allowance’
How much you can save in a pension overall throughout your working life without facing a tax charge. In the current financial year 2018/19, it is £1,030,000. You face a charge of up to 55% on anything you hold over and above this limit.
The jargon: ‘take your 25% tax-free lump sum’
Once you reach retirement age, you have the choice of taking a cash lump sum (or series of lump sums) from a defined contribution pension and often from a defined benefit pension too – if you do, you can take up to a quarter of it tax-free. So retire with a £100,000 pension pot, and you can take £25,000 tax-free. The rest can stay invested, or be withdrawn and taxed.
The jargon: ‘Income drawdown plan’
Available to those with a defined contribution pension once they reach retirement age, it allows you to make withdrawals - and keep the rest of your pension invested . The value of your remaining cash will hopefully grow, but can fall too. Above and beyond the 25% tax-free lump sum (see above), you can make flexible withdrawals from what’s left but these will be taxed.
Jonathan Dean considers his future retirement and explains how simple tasks, like digging out your pension papers and updating your correct home address, can help. Remember – while listening to others and talking to your family, friends and peers can be a great help, you should seek professional advice when making important financial decisions to ensure consideration of your own personal circumstances.
Consider these thoughts about retirement. How do you want to spend your well-deserved rest? Remember – while listening to others and talking to your family, friends and peers can be a great help, you should seek professional advice when making important financial decisions to ensure consideration of your own personal circumstances.
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