Busting The Jargon Around UK Pension Advice
Pensions can be a complicated subject. Hence the need for professional pension advisers! So it’s understandable many people feel bewildered by the different types of schemes, investment opportunities and technical language banded around by pension advisers and the media.
To help our users, we’ve put together this handy list of terms explaining some of the 17 most important jargon used in UK pension advice circles. We hope you find it helpful.
#1 Auto Enrolment
Abbreviated from “automatic enrolment,” auto enrolment is an initiative by the Government which requires UK employers to enrol their workers onto a workplace pension scheme. This change is being phased in, but all companies are expected to be complying by February 2018. Presently, “eligible workers” for auto enrolment count as employees aged at least 22 years old, who earn over £10,000 per year, and who work in the UK.
#2 Workplace Pension
This is a broad term to describe any pension scheme set up by an employer for their employees. They are sometimes called company pensions, or occupational pensions. There are different types of WP pensions which are covered in more detail below, including defined benefit pensions and defined contribution schemes.
#3 State Pension
The state pension is an income provided to you by the UK government in retirement, funded by national insurance contributions. It is not affected by how much you earn across your lifetime, or your marital status. Rather, it hinges on your own record of NI contributions. Presently, the law states you need to have been paying NI for 35 years to qualify for the full state pension.
#4 Annual Allowance
This is the amount of money you can put into a defined contribution pension each year, whilst also receiving tax relief. Currently, this annual allowance stands at £40,000 and applies across all of your pension schemes.
#5 Lifetime allowance
At present, there is a legal limit (“lifetime allowance”) of £1m on your pension fund’s value before it loses its tax-free status. This limit applies to your defined contribution pension schemes, as well as final salary plans. If you are set to earn an annual income of £50,000 in retirement, you face being charged 55% on any income above the cap.
#6 Defined Benefit /Final Salary Pension
Under a defined benefit scheme, an employer offers you a guaranteed retirement income. This can be based upon your salary at retirement (sometimes called “final salary” scheme), or upon your average salary over the course of your career.
#7 Defined Contribution Pension
Under a DC plan, you put a proportion of your salary into a pension pot every month. Your employer also makes contributions into the pot. Sometimes employers match their employees’ contributions up to a percentage limit. Other employers might offer a flat rate regardless of your contributions (e.g. 3% of your salary). There are many choices available to you when you have a defined contribution pot, so getting UK pension advice from a reputable independent financial advisor can be a good idea.
#8 Stakeholder Pension
A type of defined contribution pension, a stakeholder pension (SHP) must meet a minimum set of conditions set out by the UK Government. For instance, they are designed to be highly accessible to lots of different people (e.g. those on low/middle incomes), portable if you change jobs, have lower minimum contributions, and have a cap on charges
#9 Personal / Private Pension
This is a kind of defined contribution pension, where you choose the pension provider and then make regular contributions to build up a pot. The provider will usually invest the pot on your behalf, and the value of your pot at your retirement will depend on the fund’s investment performance, inflation, your circumstances and your contributions. You can set one up even if you currently have a workplace pension. When you retire, you might want to use the pot to buy an annuity, or engage in income drawdown. These are explained in more detail below.
A Self-Invested Personal Pension (SIPP) is a form of personal/private pension, where you are allowed to invest in a wider range of assets. This gives more freedom and flexibility to people who want to manage their own funds. On the flip-side, the charges can be higher than they are for personal pensions and stakeholder pensions.
A type of company pension, a Small Self Administered Scheme (SSAS) is usually available to a small number of senior staff and directors at a company. It often allows an employer much greater access to a wider range of investment opportunities for the scheme’s assets (e.g. purchasing the company’s premises and leasing them back to the business).
At the point of retirement, you might want to use your pension pot to buy an annuity from an insurance company. This is a once-in-a-lifetime transaction, which buys you a guaranteed income for the rest of your life. The income you get will depend upon a range of factors, an important one being your provider’s rate (which might be higher if you have poor health). There are different types of annuity, including “single-life” annuities and “enhanced” annuities. Speak to a qualified UK financial advisor in order to get professional pension advice in this complex are.
#13 Income Drawdown
When you retire, you are usually allowed to withdraw up to 25% from your pension pot as a tax-free lump sum. The rest, you might choose to invest and also take money from in order to provide a retirement income. This is called “income drawdown”, and is an option if you are aged 55 or over with a defined contribution pension. There are different kinds of income drawdown, including “capped drawdown” and “flexible” drawdown. The risks are also typically higher than buying an annuity, since your money is usually invested in the stock market. Again, these factors make it a good idea to consider getting UK pension advice from a specialist financial adviser if you are looking at income protection as a serious option.
This is the term used by the Government to describe all of your possessions, property and money. It is a particularly important aspect of UK pension advice at the point of your passing, as the value of your estate will affect your exposure to inheritance tax (explained below).
#15 Inheritance Tax (IHT)
When you die, the Government imposes a tax upon your estate (defined above). At the moment, this is usually 40% on the value of your estate above £325,000. However, there are many factors which determine how much inheritance ta (IHT) you will have to pay. It’s therefore important that you consider getting pension advice from a qualified, experienced UK financial adviser who can help you sort through the issues and identify your tax liability.
#16 Nil Rate Band
This refers to the cut-off point after which the value of your estate is subject to IHT. This cut-off point is currently £325,000 (as mentioned in the section above), and applies to each individual (meaning each partner in a marriage / civil partnership has their own NRB). As of April 6th 2017, however, an additional “residence nil rate band” has come into effect. This is described below.
#17 Residence Nil Rate Band
Sometimes called the “additional threshold”, the residence nil rate band is an extra, available nil rate amount on top of the NRB described above. It applies to deaths after April 6th 2017, and comes into force when you leave your residence (or sales proceeds thereof) to your descendants after you die. This area of IHT can get incredibly complicated, especially when downsizing comes into the picture. It can therefore be a good idea to receive expert pension advice from a UK financial adviser. PensionAdvice.org can refer you to someone local, regulated and experienced advisor here.