Pension glossary: 78 simple definitions to help you understand

March 5, 2015

Pensions can be pretty confusing. And a big part of that is simply down to all the jargon used to describe them. Since we’re going to find it pretty difficult to avoid some of these terms completely over the coming weeks as we take you through various aspects of pensions, we thought putting together a simple glossary of some of the most common terms would help. Brace yourself, it’s a long one!

A-E | F-J | K-O | P-T | U-Z

Absolute Returns

A fund that aims to give the same positive return, regardless of market conditions.

Accrual rate

The rate at which you build up pension benefits while a member of a defined benefit scheme. The rate is multiplied by your earnings to calculate how much money you will eventually be entitled to. It’s usually expressed as a fraction – the bigger the fraction, the more pension benefit you’ll get. For example, a scheme with an accrual rate of 1/60th will provide 1/60th of pensionable salary for each year of pensionable service.

Active member

Someone who is working for the employer and currently making contributions to their pension scheme.

Active management

A system for managing investment funds where fund managers actively buy and sell stocks and shares to try and achieve better growth than passive management.

Added years

Some defined benefit pensions let you pay extra each month. This is then counted as if you’d paid into the pension scheme for more years and boosts your guaranteed pension. Contributions are eligible for income tax relief.

Additional Voluntary Contributions (AVCs)

Extra payments made by a member of a company pension scheme to boost retirement savings. They form a separate defined contribution pension pot with your name on it. Contributions are eligible for income tax relief.

Annual allowance

The limit set by the government for how much money can be paid into your pension in one year without you suffering a tax charge on it. It includes all payments made by you or on your behalf, including your employer’s contributionsTransfer payments do not count towards the annual allowance.

The maximum you can put into a pension is currently £40,000 per year (2014/15). Payments over the annual allowance will be subject to tax, although unused allowances from the three previous tax years may be available. As well as being limited by the annual allowance, tax-relievable contributions made by you personally cannot exceed your relevant UK earnings for the tax year.

Annual management charge (AMC)

Charge taken by fund managers to cover set up and management costs, administration and day-to-day fund management. They are deducted from the fund every day before unit prices are calculated and can change over time.

Annuity

A means of converting a pension fund into an annual, fixed, regular income for life in retirement. You can use all or part of your pension fund to buy an annuity from an insurance company. You’ll receive the payment regardless of how long you live (which can make it great value if you live a long time, but poor value for those who die earlier – the annuity provider pockets any surplus funds!). If you’ve been diagnosed with an illness, or have other health problems that could reduce your life expectancy, you might be able to get a higher net income – this is sometimes called an ‘Enhanced Annuity’.  The income provided will depend on various factors including your age when you buy it, whether you’re a smoker and the annuity rate at the time of purchase. Once an annuity has been purchased, you’re not likely to be able to change the income options selected or transfer to another provider.

To give you an idea, at 65 and in normal health, £100,000 will currently buy you approximately £6,000 a year (assuming single life basis, no escalation (not index linked) and guaranteed for 5 years).

Annuity rate

The rate of return you get when you buy an annuity with your pension pot. The rate applied will convert your pot value at retirement into the yearly income you will be paid. Rates change all the time so you’ll need to shop around for the best deal.

Assets

Assets are what investment funds invest in to try and achieve growth. They can have a significant impact on the performance of your investment. There are four main types of assets:

1)      Equities or shares – a share in a company. You’ll participate in any financial success achieved by that company. They’re generally considered a good long-term investment, but they can go down as well as up.

2)      Fixed interest securities or bonds – a loan, usually to a company (corporate bond) or government (gilt), which attracts interest from the company or government, paid back on a set date in the future. Returns tend to be reliable, but often lower, than returns from equities.

3)      Commercial property – here you buy ownership in commercial buildings. You may benefit from rising property values and rent paid by tenants, but property value is based on opinion so values can go up or down.

4)      Cash – keeping some money in cash can add flexibility to your asset mix, making your investment fund more stable. It’s low risk, but growth potential tends to be low.

Asset allocation

How you’ve decided to invest your pension contributions in the hope of making a good return. You can choose different types of investment (shares or bonds, for example), different markets (UK or overseas, for example) and sectors (technology or property, for example).

Auto-enrolment

The Government has introduced a new law to encourage more people to save for retirement. If you are aged between 22 and State Pension Age and earn enough to pay tax, your employer will automatically enrol you into a pension scheme (if you’re not already in one). You and your employer can both pay into the scheme. There are minimum employer and minimum total contribution levels – there is no regulatory minimum employee contribution, but the employee must make up any shortfall between employer contributions and the minimum total contribution required. This exact split will depend on your employer. You can choose to leave the scheme but, if you remain eligible, you will be automatically re-enrolled every three years or when you change jobs. Workers in other age groups/salary levels can choose to join, with some eligible for employer contributions and some not.

Beneficiary

Someone who may benefit from your pension fund if you die. When you first apply for a pension product, you’ll be asked to nominate a beneficiary. If you don’t make a nomination, any lump sum will be paid to your surviving spouse or civil partner (or your estate if you don’t leave a spouse or civil partner).

Benefit

Any payment made to you or a beneficiary from your pension plans, including tax-free lump sums, pension payments and death benefits.

Benefit Crystallisation Event (BCE)

A BCE occurs when you reach 75, or take benefits (such as an annuity purchase or income drawdown) before 75. When this happens, the total pension funds you take (or crystallise) will be measured against your remaining lifetime allowance. If your lifetime allowance is exceeded, a charge will be imposed. This is only likely to affect very high earners.

Cash Equivalent Transfer Value (CETV)

The amount offered to a member of a company pension scheme who wants to transfer to another pension scheme.

Carry forward

This is the facility to carry forward any unused pension contribution allowances from the previous three tax years to the current tax year. There are restrictions on who can use the facility and how much you can carry forward.

Closed scheme

A company pension scheme where membership is no longer open to new employees.

Company pension (or occupational pension)

A pension scheme set up by an employer for its employees. Usually, both the employer and the employee make regular contributions.

Consumer Price Index (CPI)

The government’s preferred measure for inflation. Basically, it measures a basket of goods and services (excluding certain costs like council tax, mortgage interest, building insurance and house depreciation that are included in the RPI) and uses this to calculate increases in some pension payments.

Contribution (or payment)

A payment into your pension plan made by you, your employer or any other person. Most people pay regular contributions each month, but you can also make one-off contributions before you take your benefits (known as a lump sum or single contribution). As long as contributions are within allowable limits, tax relief is given on the gross contributions.

Critical yield

When you go into income drawdown, you’ll receive an illustration of likely future income. A critical yield may tell you:

1)      the annual growth required on your fund to provide an income equal to an annuity you could have bought (if investment returns are less than this critical yield, you’re likely to end up with a lower income over time from your drawdown plan than if you’d bought an annuity)

2)      the growth needed to provide the income you specify (if investment performance is less than this critical yield, current income being paid is unsustainable and will need to be reduced or the investment selection will need to be changed).

Deferred pension

The benefit awarded to a defined benefit scheme member who has left service early.

Defined benefit scheme (or final salary scheme)

The so-called “gold-plated” pensions, where the amount you get at retirement is based on your earnings and the length of time you have been a member of the scheme (you pay into a defined benefit pension at work). When you reach pension age, they promise you a pension which is a percentage of your pay – in most cases it is your final salary but some pension schemes now use a career average salary instead. The pension is guaranteed by your employer who must pay in enough to make sure the promised pension can be paid.

While commonplace in the public sector, such pension schemes are now rare beasts elsewhere.

Defined contribution scheme (or money purchase scheme)

A pension plan where your retirement income is based on the amount of money paid in and the amount by which that money grows. All private pensions and most company pension schemes are defined contribution schemes. Your contributions, and any your employer makes, are saved up in a pension pot with your name on it. When you reach at least age 55 you can take the money out (although it’s usually more sensible to leave it put until you retire).

Drawdown pension (previously income drawdown)

If you don’t want to buy an annuity or spend all your savings, you can transfer your pension into in a drawdown scheme (subject to certain plans and limits). It allows you to leave your pension fund invested and take amounts out of your fund when you want but the fund remains yours – unlike an annuity where you give the whole lot to the insurance firm in return for your guaranteed lifetime income. There will be annual charges and it’s a good idea to regularly review your pensions and take on-going financial advice.

Early retirement

The Holy Grail, surely?! In relation to pensions, this is the payment of retirement benefits from your pension scheme before your normal retirement date. The earliest normal retirement date these days is 55 (unless you are suffering from ill-health) but some people have a lower protected pension age (often 50) or even lower for certain occupations (professional sportspeople for example).

Exit charge

Also known as a withdrawal charge, some companies charge a fee when you cash in your units.

Final salary scheme

See defined benefit pension scheme.

Financial adviser (also known as Independent Financial Adviser or IFA)

Folks like us who are authorised and regulated to provide advice and recommend financial products from providers in the UK. If you’re a bit overwhelmed by all the pensions options, it’s a good idea to seek professional advice before you do something you may regret.

Free-standing AVCs (FSAVCs)

Like an AVC, but the extra payment is made into a personal plan, unconnected to any company or occupational scheme.

Fund (or investment fund)

Payments made to your plan buy units in your chosen investment fund. Each fund invests in one or more types of asset. Money is pooled together from various sources and managed by a professional investment fund manager. This means that you can invest a fairly small amount while still enjoying the benefits of a larger investment fund.

Investment Fund

Payments made to your plan buy units in your chosen investment fund(s). Each investment fund invests in one or more asset types. When you choose an investment fund, you are deciding the assets in which you’d like to invest in.

Fund manager

A professional who manages an investment fund on behalf of investors. Each investment fund has aims and financial goals that the investment fund manager tries to meet.

Group personal pension

A type of personal pension scheme set up by an employer on behalf of its workers. Contributions are deducted through payroll. Although arranged by the employer, who can also make contributions, each pension contract is between the pension provider and the worker. Scheme charges may be lower than those of an equivalent straightforward personal pension because the company providing the scheme is able to offer a reduction for bulk business.

Guaranteed annuity rate

Some older pensions (normally begun before the mid 1990s) pay a guaranteed rate of annuity (GAR) when you reach the pension age specified in the scheme. Because annuity rates were much higher when these pensions were originally set up, an annuity bought with your fund could be nearly double the amount you would get on the market today. So always check for a GAR before deciding what to do with your fund. If you don’t ask, you might lose it.

Guaranteed Period

An annuity which continues to pay an income for five or ten years even if you die sooner.  If you die before the end of the guaranteed period, the pension provider will pay the annuity to your beneficiaries for the remainder of that period.

Guidance Guarantee

From April 2015 everyone aged at least 55 will be able to get free guidance and information about their money purchase pension choices. The guidance service is branded Pension Wise and will be provided by the Pensions Advisory Service on 0300 123 1047, face to face at some Citizen’s Advice offices, and online.

Individual Personal Pension (or private pension)

A private pension that you can take from job to job. Personal pensions can also be used by the self-employed or non-earners to save for a pension.

Inflation

The increase in prices over a period of time tracked by the Office for National Statistics UK. As prices rise, what you can buy with a fixed amount of money falls, so your money has progressively less buying power.

Inflation risk (or purchasing-power risk)

The risk that rising prices of goods and services over time, or, generally the cost of living, will decrease the value of the return on investments (e.g. increased prices of goods and services, a decreased value of cash).

Joint Life Annuity

A joint life annuity provides an ongoing income for a spouse or partner on death.

Lifetime allowance

Every individual has a level of benefits (set by the government) they can draw from their pension scheme in their lifetime without triggering certain tax charges – this is the lifetime allowance. The standard Lifetime Allowance for the tax year 2014/2015 is £1.25 million.

Certain circumstances may mean you have a different personal Lifetime Allowance because you have obtained protection for your pension fund from HMRC. You will have completed an HMRC form if this applies to you.  Depending on the protection you have, any contribution to a plan may mean you lose your protection.

Lifetime Allowance Charge

This is a tax charge levied on the excess pension benefits above the standard Lifetime Allowance.  The current charge is 55% if taken as a lump sum and 25% if taken as an income.

Market value reduction (MVR)

Penalty imposed on with-profits funds on those who try to withdraw their money (or transfer it to a different pension provider) before the end of the policy. It’s important to take advice on this before taking pension benefits.

Money purchase scheme

See defined contribution scheme.

National Employment Savings Trust (NEST)

NEST is a pension provider set up by the Government as part of its changes to workplace pensions and auto enrolment. Employers who have to enrol their eligible employees into a pension scheme as a part of auto enrolment can use NEST instead of a private pension scheme. NEST has an obligation to accept any employer wishing to use it regardless of number of employees.

Open-ended Investment Companies (OEICs)

Established companies that issue shares to investors. They pool investors’ money and can invest in funds in different market sectors. They are a form of collective investment scheme.

Open market option (OMO)

You don’t have to buy an annuity from your pension provider. You can shop around and compare rates offered by other insurance companies to find a better deal – this is the open market option.

Passive fund (or Index tracker funds)

These funds invest in most (or all) of the same shares as the index they are tracking (e.g. the FTSE 100 index) with the aim of producing a return in line with a particular market or sector.

Passive management

The opposite of active management. Funds are invested in passive funds rather than being actively managed by specialist investors.

Pension

Back to basics: in its most basic form, a pension is a tax-efficient savings plan where your money is locked away until you are at least 55. The actual term describes both the investment plan you save into and the income you receive from it in retirement. A pension can be provided by the state, your employer or a private company.

Pension Fund

The pot of money you have built up in a money purchase pension plan to provide your benefits at retirement.

Pension Transfers

This is when you move the benefits from one registered pension scheme to another.

Pension Protection Fund (PPF)

The PPF acts as a safety net for members of under-funded defined benefit pension schemes whose employer has become insolvent. It’s a bit like an insurance fund for pensions schemes. If your employer goes out of business or the firm is sold then your defined benefit pension will usually be taken over by the Pension Protection Fund. That guarantees you will get at least 90% of the promised pension up to a limit depending on your age. If you are already retired, the pension will be paid in full.

Personal pension plan (PPP)

A defined contribution pension, owned by you, into which you and/or your employer makes contributions. You can pay into a personal pension whether you work or not. They can also be used by self-employed people or those who have little or no pension at work.

Pensionable Earnings

Earnings on which benefits and contributions in a pension scheme are calculated.

Plan Value

The value of your plan on any day is the total of your investments in the plan. This is worked out by multiplying the number of units held for you by the unit price for those units on that day.

Preserved Benefits (or frozen benefits)

These are the benefits a company pension scheme member has already earned from the scheme when they stop making payments (or the scheme closes) before their normal retirement date.

The member will then receive these preserved benefits when they retire, either from the pension plan or through an individual policy.

Retirement Age/Date

The age/date at which a member of a pension scheme normally becomes entitled to receive their retirement benefits.

Retirement Annuity Contract (also called Section 226 pensions)

Retirement Annuity Contracts were not sold after June 1988, but if you bought one before then and are still paying into it, then it might be a very good deal. Check if it has a guaranteed annuity rate – many did.

Risk

When you invest in anything, including investment funds through your pension, it’s important to consider the risks. The value of investment funds (and so your pension pot) can go down as well as up. Funds have risk ratings. Higher risk investment funds offer the potential for higher returns but carry an increased risk of not getting back all the money you initially invested.

Retail Price Index (RPI)

A measure of inflation published each month by the Office for National Statistics. It measures the change in cost of a basket of retail goods and services, including housing costs. It is used by pension schemes to calculate pension increases.

Salary sacrifice

A tax-efficient way of increasing the money paid into your pension by giving up part of your salary so it can be used as an additional employer contribution into your pension.

For example, you give up, say, £1000 a year pay and your employer pays that into your pension instead of to you. That means you also save by not paying National Insurance contributions on that £1000, but you have to bear in mind that the lower salary is the one you will have to declare for things like your mortgage. As the employer also saves National Insurance, they sometimes include some or all of this saving as an additional pension contribution for you.

Self invested personal pension (SIPP)

Normally you trust a fund manager or someone else to decide how to invest the money in your personal pension fund. But Self-Invested Personal Pensions (SIPPs) allow you to decide how your pension fund is invested. SIPPs are good for those with big pension funds who are confident in making investment decisions. Charges should be checked though, as they can be high.

Stakeholder pension

A type of defined contribution personal pension scheme which has to meet some minimum standards, as set by the government. They have low and flexible minimum contributions and capped charges. Most have a more limited fund choice, including a default investment fund if you don’t want to choose.

State pension

The basic state pension is a regular payment from the Government that you get when you reach State Pension age. To get it you must have paid, or been credited with, National Insurance contributions. The state pension is undergoing some changes at the moment – read our recent blog post.

State Pension Age

The State Pension normally starts when you reach State Pension age. This age is set to steadily rise.

For many years, the state pension age for men was 65 and the state pension age for women was 60.

But from 2018 both men’s and women’s state pension age will be 65, from 2020, both men and women’s state pension age will be 66, increasing to 67 between 2026 and 2028, and then linked to life expectancy after that. The government will review the state pension age every five years.

State second pension (S2P)

The earnings related element of the state pension scheme. The amount you get depends on your earnings and National Insurance contributions paid during the whole of your working life. This replaced the State Earnings Related Pension Scheme (SERPS) to enhance the basic state pension.

Tax relief (see also salary sacrifice)

The Government encourages you to save for your retirement by giving you tax relief on payments into your pension. Basically, any contributions up to the annual allowance that you make into a pension are free of tax, i.e. some of the money that would have gone to the Government in the form of tax goes into your pension plan instead.

There’s no limit on how much you can contribute, however, there is a limit on how much tax relief you can get. Your contributions before basic rate tax relief is added are net contributions. Your contributions after basic rate tax relief is added are gross contributions.

For example, if you pay £80 a month as your net contribution, you get an extra £20, as the basic rate of tax is 20% (£80 divided by 0.8 = £100).

If you have no earnings, or earn up to £3,600 in a tax year, you can contribute up to £2,880 net across all your pension schemes and get tax relief of £720, giving you a gross contribution to your pension fund(s) of £3,600.

If you earn more than £3,600 in a tax year, you can get tax relief on 100% of the earnings you contribute up to the Annual Allowance, which is currently £40,000 gross. You may have to pay a tax charge for contributions paid by you, your employer, or a third-party that exceed the Annual Allowance.

If you’re a higher or additional rate taxpayer, you can reclaim any further tax relief through your yearly tax return.

Transfer

You can transfer the value of some pensions between providers. It’s a good idea to seek advice before you do this and request a transfer value analysis, so you can compare all the options available to you.

Transfer value

Don’t just look at the projected value of your pension plan, or even its investment value today. If you are worried about the performance of the plan, look at its transfer value. As the name suggests this is what you will be paid – when all charges and penalties have been deducted – if you were to move your funds elsewhere.

Uncrystallised Funds Pension Lump Sum (UFPLS)

From April 2015 you can leave your fund in a pension and take ‘slices’ out of it – regularly or as you please without having to move the funds into a drawdown plan first. Any amount from £1 to all the fund can potentially be taken as a UPFLS. Each slice has a quarter paid tax-free, the rest is added to your income and taxed.

Unit

A unit is a share of an investment fund. Each investment fund is split into units. The number of units you hold is your share of the investment fund.

Many annual pension statements will list how many capital and how many accumulation units you hold. As a rule of thumb, these different types of unit carry different charges (typically higher on capital units). Apart from the charges, there is no difference between the two units. Rather than pay monetary bonuses, pension providers will give away additional accumulation units at the end of each year, depending on how the fund has performed. Or it may reduce the period of time in which your money is investing in capital units.

Unit trust

A pool of individual investors’ money, which buys a range of investments. The trust is divided into units. The number of units you hold represents your share of the trust. Also known as a collective investment scheme and similar to an OEIC.

Unit-linked policies

Most personal pensions are now unit-linked plans, often investing in unit trusts, where the value of your pension is directly linked to the value of the investment fund. Your monthly contributions buy units in a fund, which is priced on a daily basis. If the fund increases in value the price of your units goes up, so you can cash them in at a profit at a later stage. The reverse is also true, and the value of your assets can fall.

With-profits pension

Few are sold now, but many people with older personal pensions, sold by insurance companies, will find they still have these plans. These funds invest in a broad range of assets and pay an annual bonus depending on the performance of the fund – plus a final bonus on retirement. The theory was that this smooths stock market returns. In reality returns have been patchy, bonuses have been withdrawn and hefty penalties sometimes applied to those who transfer funds or withdraw money early.

 

If there are any terms we’ve not covered that you’d like to know more about, feel free to contact us and we’ll add to this glossary over time.

This article is for general use only and is not intended to address your particular requirements. It should not be relied upon in its entirety and shall not be deemed to be or constitute advice.