Learn to Speak Pension – Part 1

We’re going to be talking a lot about pensions in the weeks and months ahead. We don’t want useful information to get lost in a mass of technical terms, so we thought about a glossary. But most glossaries are so dull, aren’t they? Well, here’s a fun one for a change…

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The language of pensions is rich and varied, so we won’t be tackling it all in one go, thank goodness. Here’s part 1 of our guide to the key words and phrases you’ll need to know as you plan for retirement.

 

Accrual rate

What it sounds like: The speed at which a Disney villainess acquires Dalmatians.

What it actually means: If you have a defined benefit pension, the accrual rate is the proportion of your salary you receive as pension for each year of service. For example, if this rate is 1/80, and you spend 20 years in the scheme, then your pension will pay you 20/80 (i.e. a quarter) of your final salary.

 

Annuity

What it sounds like: ‘Good night’ in Esperanto.

What it actually means: An insurance product that pays you a guaranteed income for a set period of time (usually the rest of your life, unless you arrange otherwise). Traditionally the standard pension option for the majority of people at retirement. It’s vital to shop around to get the best value annuity, so don’t just take the first one offered by your existing pension provider.

 

Compound interest

What it sounds like: The hobby of a chemistry professor.

What it actually means: Interest on investments (e.g. in a pension pot) that goes on to earn interest itself. All right, you knew that – but it’s one of the best reasons to start a pension as early as you can, as the effects of compound interest on your money can be astonishing over time.

 

Defined benefit

What it sounds like: An attractive former colleague you still see occasionally when you’re bored.

What it actually means: A workplace pension that pays you a guaranteed income for life (similar to an annuity) at a level based on your pensionable service, pensionable earnings and the scheme’s accrual rate. Often called a final salary pension, though may be based on your average salary over the course of your employment. Mostly found in public sector jobs, rare in the private sector. This kind of pension is excluded from pension freedom unless you undertake a pension transfer.

 

Defined contribution

What it sounds like: The minimum you can pay for a poppy and walk away with dignity.

What it actually means: The most common kind of pension scheme. You choose (‘define’) how much you want to contribute to the scheme, and so build up a pot of money during your membership. Your contributions receive tax relief at your marginal rate (20 per cent for basic rate taxpayers) and (if it is a workplace pension) your employer’s contributions will be boosted in the same way. The pot is invested for long-term growth and benefits from compound interest. You can access the money from the age of 55 onwards under the rules of pension freedom.

 

Drawdown

What it sounds like: A showdown between two rival graphic artists.

What it actually means: A way to draw an income in retirement. The money from your pension pot is invested to generate income, so you can draw out as much as you need/want each year. This is a more flexible option than an annuity, but comes with much higher risk. If the stock market performs badly then the growth alone may not meet your income needs, forcing you to draw more on the original sum of money. As this sum gets smaller, the growth will shrink too, in what can become a vicious circle. This is why it’s vital to seek financial advice if you’re considering a drawdown scheme.

 

Final salary

What it sounds like: The leftovers in the salad bowl.

What it actually means: See defined benefit (above). Note that the term may be misleading: some ‘final salary’ pensions are actually based on your average salary over your pensionable service.

 

Money purchase

What it sounds like: I have forgotten my credit card

What it actually means: See defined contribution. The term ‘money purchase’ reflects the fact that you will eventually ‘purchase’ pension benefits using the money built up in your pot.

 

Pensionable earnings

What it sounds like: Making some extra cash in retirement by gardening or similar.

What it actually means: If you have a defined benefit pension, this is one of the factors used to calculate how much you will receive. Depending on the scheme, your pensionable earnings are either your salary at retirement, or your average salary over the period of your membership.

 

Pensionable service

What it sounds like: Being in the Home Guard under Captain Mainwaring.

What it actually means: Another factor in working out your defined benefit pension. This is simply how long you’ve been a member of the scheme (which may or may not be the same as the length of your employment with that employer).

 

Free pension health check

What it sounds like: A free pension health check.

What it actually means: An FCA-regulated financial adviser who specialises in pensioFree pension checkns will take a look at your current level of pension savings. They’ll then give you an objective estimate of the level of income you can expect in retirement. If you then choose to proceed to formal advice from this adviser, then you’ll also receive £50 off their fee.

Just click the button to search for a participating adviser.

 

Any words in bold not explained here will be covered in part 2!

Find a pensions specialist you can trust at unbiased.co.uk.