Pensions and retirement jargon buster

Alternative annual allowance

The maximum amount of defined benefit pension savings that qualify for tax relief once you trigger the Money purchase annual allowance. The alternative annual allowance is £30,000 (plus any carry forward allowance from the previous three tax years). If you have defined benefit pension savings and exceed the alternative allowance (where it applies to you) a tax charge is made which claws back any tax relief that was given on the excess pension savings.

See also Annual allowance, Money purchase annual allowance and Tapered annual allowance.

Annual allowance

The maximum savings into pensions that you can have in a year that qualify for tax relief – based on your own contributions, any employer contributions and any contributions made on your behalf by someone else. In the tax year 2016-17, the Annual allowance is £40,000.

The annual allowance applies across all your pension savings, not per scheme. If you exceed the annual allowance a tax charge (‘the annual allowance charge’) is made which claws back any tax relief that was given at source. See also Money purchase annual allowance.

If your taxable earnings in the year are below the Annual Allowance then tax relief on pension contributions from all sources is limited to 100% of your earnings (or to £3,600 if you have no earnings). From 2016-17 the Annual allowance will reduce for those on higher incomes – see Tapered annual allowance below.

Annuity

A type of retirement income that provides you with a regular payment, usually for life.

Cash balance pension

A pension arrangement where your employer promises you a pension pot of a specified amount, when you reach retirement age. Typically, the amount is calculated as a proportion of your salary for each year of service. You know how much your pot will be, but there is no promise as to the amount of pension you will be able to buy (or take) from it.

Cash lump sum

See tax-free lump sum.

Defined benefit pension

Pays a retirement income based on your salary and how long you have worked for your employer. Defined benefit pensions include ‘Final Salary’ or ‘Career Average’ pension scheme. Generally only available from public sector or older workplace pension schemes.

Defined contribution pension

Builds up a pot to pay you a retirement income based on contributions from you and/or your employer and investment returns. Includes workplace and personal pensions, including stakeholder pensions. Might be run through an insurance company or master trust provider, or through a bespoke scheme set up by your employer.

Drawdown

See Income drawdown.

Final salary pension

See Defined benefit pension.

Flexi-access drawdown

Allows you to use your pension pot to provide a regular retirement income by reinvesting it in funds specifically designed and managed for this purpose.

Replaced flexible drawdown and capped drawdown from April 2015, though existing users of capped drawdown can continue in that plan.

Guaranteed annuity rate (GAR)

A competitive guaranteed income offered by some pension schemes if you take a lifetime annuity out with them – often hard to match if shopping around.

Guaranteed Drawdown

A ‘hybrid’ product that combines a guaranteed income for life with the flexibility of drawdown.

Highest tax rate

Also referred to as ‘marginal tax rate’

Income Tax is split into bands and you pay different rates: 20%, 40% and 45% based on these bands. The practical effect is seen in the table below.

Your pension income is added to your other earnings and then taxed according to which tax band it falls inside. If it pushes your overall income into a new tax band you may pay tax on it at two rates

Income Tax rates 2015-2016

Income between these amounts Income Tax rate for most people
£0 to £11,000 0%
£11,001 - £43,000 20%
£43,001 - £150,000 40%
Over £150,000 45%
  • The personal allowance is the amount of income you can have before you have to start paying Income Tax. When your income is over £100,000, your personal allowance reduces by £1 for every £2 above the limit.

‘Hybrid’ products

Products that combine features of annuities and income drawdown to provide a retirement income.

Income drawdown

Referred to as flexi-access drawdown under new rules from April 2015.

See also Flexi-access drawdown.

Income Tax rates

Income Tax is split into bands and you pay different rates: 20%, 40% and 45% based on these bands. Your pension income is added to your other earnings and then taxed according to which tax band it falls inside. If it pushes your overall income into a new tax band you may pay tax on it at two rates.

Inflation

Increase in the general level of prices of goods and services.

Lifetime Allowance

The maximum value of pension savings that you can build up without incurring a tax charge at the time you draw out your savings as cash or pensions (and without leaving a tax charge for your beneficiaries if you die before age 75).

For the tax year 2016-17 the Lifetime Allowance is £1 million. From 6 April 2018, the standard Lifetime Allowance will be indexed annually in line with the Consumer Prices Index (CPI).

If you exceed the allowance you pay tax on the excess amount at 55% if taking the pension as a lump sum or at 25% if you take it as income. The same savings aren’t assessed twice – so if you put £2m into drawdown this will have been tested and the excess taxed at that time and no further Lifetime Allowance charge is due.

If you die leaving untouched pension savings that exceed the Lifetime Allowance - and they have not already been assessed against it – then your nominated beneficiary will be liable for the extra tax charges on the amount that exceeds the lifetime allowance.

Marginal rate of tax

See Highest tax rate

Market value reduction

A reduction to your pension pot that could apply if you want to cash in your with-profits policy before or after its maturity date or other date(s) specified in the policy.

Money purchase pension

See Defined contribution pension

Money Purchase Annual Allowance (MPAA)

A reduced annual allowance for tax relief on defined contribution pension savings that applies if you have taken money out of any pension pot as cash, either entirely or as small cash sums (see Uncrystallised pension fund lump sum), or once you have started taking income from flexi-access drawdown or a flexible annuity (the income from which could rise or fall).

The MPAA is also triggered for payments from a pre-April 2015 capped drawdown plan that exceeds the cap and in certain other limited circumstances.

In the tax year 2016-17 the MPAA is £10,000 compared with the full Annual allowance of £40,000. If you exceed the MPAA a tax charge is made which claws back any tax relief that was given at source.

If your taxable earnings in the year are below the MPAA then tax relief on defined contribution pension savings is limited to 100% of your earnings (or to £3,600 if you have no earnings).

The MPAA limit does not apply to other pension savings. For example, if you use up your £10,000 MPPA you are still entitled to tax relief on up to £30,000 (Alternative annual allowance) on any defined benefit savings in 2016-17.

Also see Annual allowance and Alternative annual allowance.

State Pension

A regular payment from government that you qualify for when you reach State Pension age. The State Pension age for men and women is increasing and will reach 66 by 2020. It’s due to rise further to 67 by 2028. The amount you get depends on your National Insurance record.

Tax-free lump sum

An amount of cash set by law that you can take at retirement free of tax. It’s usually up to a quarter of your pension. Sometimes simply referred to as ‘tax-free cash’ or ‘cash lump sum’.

Tapered annual allowance

From April 2016, the Annual allowance will be reduced or ‘tapered’ if your ‘adjusted income’ (your annual income before tax plus the value of your own and any employer pension contributions) is over £150,000. In this case the Annual allowance will reduce by £1 for every £2 that your income exceeds £150,000, up to a maximum reduction of £30,000. In practice this reduces the Annual allowance to £10,000 once adjusted income reaches £210,000. If your annual income after tax and excluding pension contributions is below £110,000 the tapered reduction will not normally apply.

Similar tapering will apply from April 2016 to the Alternative annual allowance if you are in a defined benefit pension. See Alternative annual allowance above.

Uncrystallised Pension Fund

A pension pot that has not been accessed for retirement income.

Uncrystallised Funds Pension Lump Sum (UFPLS)

A cash sum taken from a pension pot that has not paid out any retirement income. For each withdrawal the first 25% (quarter) will be tax-free and the rest will be taxed at your appropriate tax rate. Introduced from April 2015 as part of the cash option for withdrawing your pension.

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