Pension jargon made simple

Additional voluntary contribution (AVC)

Most company pension schemes encourage a certain level of monthly contributions from the employer and employees (usually 3% and 5%, respectively).

If you choose to pay in extra contributions on top of this minimum amount, these are known as additional voluntary contributions.

Annual Allowance

The Annual Allowance, which is currently capped at ￡40,000, is the amount that can be put into your pension every year (and still receive tax relief).

It’s worth flagging that the Annual Allowance applies across all pension schemes that you are part of.

You should avoid exceeding your annual allowance as you won’t receive tax relief on any contributions over ￡40,000 and you could receive a tax charge.

Alternatively, you may be able to bring forward unused previous annual allowances to reduce any charges.

Annuity

When you retire, you can use an annuity to get a fixed income for life or for a specific amount of time.

Automatic enrolment

You’ll be automatically enrolled into a workplace pension scheme if you’re aged between 22 and State Pension age, earn at least ￡10,000 a year and work in the UK.

Defined benefit pension 

Members of a defined benefit scheme are promised a guaranteed pension for life, which is usually based on their final salary and how long they’ve worked for their employer.

These are the ‘gold standard’ of company pension schemes and are expensive to fund, which is why you’re unlikely to be offered one with your current employer unless you work in the public sector.

Defined contribution scheme

With a defined contribution scheme, both you and your employer pay into a pension.

As the pension is usually invested in the stock market, the size of the final pot and the income that it will generate are uncertain, as this will depend on the amount paid in and performance of underlying investments

Guaranteed annuity rate (GAR)

You may be able to get a guaranteed annuity rate from your pension provider, which is likely to offer you a higher level of income compared to elsewhere.

It’s worth making sure you understand the conditions under which the GAR is offered and that it meets your personal needs.

Income drawdown

If you’re not interested in an annuity, you can use income drawdown to keep your pension invested and also dip into it for a regular income.

Of course, there are advantages and disadvantages to using income drawdown, so make sure you do your research beforehand.

Your income is also not guaranteed.

Investment fund

When you pay money into your pension, this is invested into one or more investment funds, which can include different assets such as shares or bonds.

Investment funds may have different levels of risk so it’s best to check before you invest.

Get impartial advice with PCC Wealth Management

Lifetime Allowance

It’s vital that you don’t put over ￡1,073,100 (the Lifetime Allowance) into your pension as you can get hit with a tax charge when you withdraw your savings.

If you exceed your Lifetime Allowance, you’ll be hit with a huge tax bill of either 25% or 55% of the amount over the limit, depending on if you take the pension as a lump sum or income.

Unfortunately, tax will still have to be paid if you die and leave an untouched pension that exceeds the Lifetime Allowance as your nominated beneficiary will have to foot the bill.

Loyalty bonus

Some pension providers offer a loyalty bonus for customers who stick around, which is usually a saving offered against any charges.

Marginal tax rate

This refers to the marginal Income Tax bands in England, Wales and Northern Ireland – the basic rate (20%), higher rate (40%) and additional rate (45%).

It’s worth noting that income from your pension is added to any other earnings you might have and is taxed depending on which tax band it falls into.

Money Purchase Annual Allowance (MPAA)

If you take your entire pension pot as a lump sum or withdraw chunks of money, your MPAA is triggered, which can have a big impact on your pension.

At the time of writing, you can contribute up to ￡40,000 into your pension every year and receive tax relief, but once you’ve triggered the MPAA, this dramatically falls to ￡4,000.

Self-invested Personal Pension (SIPP)

A SIPP is a type of personal pension that holds investments until you retire, and you get the same tax relief as other pensions.

One of the advantages of a SIPP is the flexibility – you can pick and choose exactly what you want to invest in to suit your retirement needs.

Tapered Annual Allowance

Your Annual Allowance (mentioned above) could be tapered if your threshold income exceeds ￡200,000 or your adjusted income goes over ￡240,000.

For every ￡2 earned over ￡240,000, your Annual Allowance is reduced by ￡1 –and the maximum reduction is ￡36,000.

Tax-free lump sum

You can usually withdraw 25% of your pension pot tax-free, known as a ‘tax-free lump sum.’

After you do this, you’ll probably be stuck with a tax bill, which is why planning how to use your savings throughout retirement is vital.

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