Pension Jargon Buster
Understanding your pension can sometimes feel like deciphering a new language. To help you navigate this important aspect of your financial wellbeing, here are clear explanations of some common pension terms.
Annuities: An annuity is a financial product that you can buy with your pension pot. In return, it gives you a guaranteed income for the rest of your life or for a set number of years. Think of it as buying a steady paycheck for your retirement.
Auto-Enrolment: Auto-enrolment is a government initiative that requires employers to automatically enroll their eligible employees into a workplace pension scheme. This means that a portion of your salary is put into a pension plan, and your employer also contributes, helping you save for retirement.
Contributions : Contributions are the amounts of money that you, your employer, or both put into your pension pot. The more contributions made over time, the larger your pension pot will be when you retire.
Defined Benefit (DB): A Defined Benefit pension scheme, also known as a final salary or career average scheme, promises a specific income in retirement. This income is usually based on your salary and the number of years you’ve worked for your employer. It’s a bit like knowing exactly what you’ll get when you retire, regardless of how the investments perform.
Defined Contribution (DC): A Defined Contribution pension scheme is where you and your employer contribute money into a pension pot. The amount you get in retirement depends on how much was paid in and how well the investments have performed. It’s a bit like a savings account that grows over time, but with investments.
Income Drawdown: Income drawdown (flexi-access) is a way to take money out of your pension pot while keeping the rest invested. Instead of buying an annuity, you can draw a regular income directly from your pension pot. This allows your money to continue growing, but it also means your income isn’t guaranteed for life.
Marginal Tax Rate: Your marginal tax rate is the rate of tax you pay on your next pound of income. For example, if you are in the 20% tax bracket, your marginal tax rate is 20%. This is important when withdrawing money from your pension, as it affects how much tax you’ll pay on those withdrawals.
Tax-Free Lump Sum: When you retire, you can usually take up to 25% of your pension pot as a tax-free lump sum. This means you get a quarter of your savings without paying any tax on it.
Money Purchase Annual Allowance (MPAA): The MPAA is a limit on how much you can contribute to your pension once you’ve started drawing money from it. Currently, it’s £10,000 per year. If you go over this limit, you won’t get tax relief on the extra contributions.
Lifetime Allowance The Lifetime Allowance is the maximum amount of money you can have in your pension pot without paying extra tax. As of now (2024/25), it’s been abolished but this may change with new government policies.
By understanding these terms, you can make more informed decisions about your pension and ensure you’re on the right path to a comfortable retirement. If you have any questions or need further clarification, don’t hesitate to reach out to a financial advisor.
