Learn to Speak Pension – Part 2
First published 19 January 2016 • Updated 25 July 2017
If you’ve found part 1 of our glossary, you should be well on the way to telling your money purchase from your defined contribution pension (wait – aren’t they the same thing?). Looks like it’s high time for part 2 of the fun guide to pension terminology.
Welcome to the only pension glossary you’ll actually enjoy reading (we hope). If you see any words in bold that aren’t explained here, then you should find them defined in part 1. (Now that’s what we call a defined benefit…)
What it actually means: In place since April 2015, this is a set of reforms enabling people with defined contribution pensions to access their pension pots from the age of 55 onwards in many more ways than were previously allowed. It is prudent to seek advice on the best way to use pension freedom, as there are still many factors to take into account (such as tax on withdrawals and the inherent risks of certain options such as drawdown). This guide provides a simple introduction to pension freedom.
What it sounds like: A washable alternative to the pension tattoo.
What it actually means: If you have a defined benefit pension, then you can’t access it flexibly as you can with a defined contribution pension – you will just be paid an annual income (and possibly a one-off lump sum). If you want the kind of flexible access available under pension freedom, you will need to transfer your current pension into a defined contribution pension. However, this option is usually not recommended, as you are unlikely to obtain the same level of value. For this reason it is a legal requirement to seek financial advice if your pension has a transfer value of £30,000 or over (and highly recommended in all cases).
What it sounds like: The start of a large DRINK.
What it actually means: A self-invested personal pension. This defined contribution arrangement lets you decide how your pension contributions are invested, choosing from a range of investments including stocks and shares, investment trusts, commercial properties and national savings products. A SIPP is generally higher risk, but has the potential to generate greater growth. Ask your financial adviser about whether a SIPP is the best choice for you.
What it sounds like: Income received by Van Helsing after he gave up chasing Dracula.
What it actually means: A kind of personal pension arrangement, a defined contribution arrangement simpler than a SIPP and with lower management costs. Management charges cannot be more than 1.5 per cent of the fund’s value for the first 10 years, and 1 per cent after that. Stakeholder pensions are a popular choice for people who don’t have access to a workplace pension scheme (e.g. the self-employed or those not in work).
What it sounds like: The government will look after me.
What it actually means: The state pension is a small guaranteed pension provided by the government. Though it can be useful to top up the income from your private pension, it’s unlikely to be enough to live on. From April 2016 there will be a new flat rate state pension of £155 per week, but the additional state pension (which is earnings-related) will be abolished. This will mean a lower overall state pension for many people.
What it sounds like: Phew! I’ve finished my self-assessment.
What it actually means: When you pay into a pension, the government pays back the money you would have paid on it in income tax. This means that if you pay income tax at 20 per cent, a contribution of £80 into your pension will turn instantly into £100, because that 20 per cent tax has been added back on. Higher and additional-rate taxpayers are currently able to claim 40 per cent and 45 per cent tax relief – however, many advisers believe that the government will slash these figures in the near future, so now is the time to take advantage of the more generous rates.
Tax relief remains the most attractive benefit of saving into a pension, setting pensions apart from all other types of investment.
What it sounds like: Bad news!
What it actually means: Good news! An unfunded scheme is a type of defined benefit pension provided for public sector workers and funded directly by the taxpayer (unlike a funded scheme, which depends on a central fund). This kind of pension is often the most generous of all. The only (arguable) downside is that you can’t do a pension transfer out of an unfunded scheme, as you can with a funded scheme. However, with the guaranteed benefits of a defined benefit pension, most people shouldn’t want to leave it.
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 pensions will take a look at your current level of pension savings and 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.
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