6th April 2006. This day saw huge changes to pension legislation in respect to when and how pensions can be accessed, as well as how pensions can be invested. Eight regimes were brought into one. It also introduced limits to tax relief on contributions (the Annual Allowance) and for the maximum pension pot size allowed before penalties are applied (the Lifetime Allowance). The aim of the new legislation was to make pensions simpler and more appealing to savers.
Investment companies holding personal pensions may take an upfront charge on the pension contribution or underlying funds using an allocation rate. For example, a 98% allocation rate means if £100,000 was contributed, £98,000 would be available for investment.
The Annual Allowance for the tax year 2020/21 is £40,000. This is the maximum that can be contributed to a pension and qualify for tax relief. For defined contribution schemes, it includes all gross contributions paid by an individual and employer. For defined benefit schemes, ‘contribution’ is defined as the increase in the value of benefits during the tax year. The annual allowance is across all registered pension schemes, not per scheme.
If the total contributions add up to more than the Annual Allowance, the excess contributions are subject to the Annual Allowance tax charge.
In April 2016, a reduced Annual Allowance was introduced for high earners, known as the Tapered Annual Allowance.
A type of retirement income that provides a regular payment for life but can also be for a fixed term. The annuity is purchased with a pension fund. There are many variants and options, but generally if the annuitant dies earlier than the average life expectancy, the annuity will be poor value for money. It is possible to add in extra features, such as inflation linking or a spouse’s pension, following death of the annuitant. Annuities work like insurance, as all the money is put into a pool and the insurer hopes that their customer does not live a long life.
Determines the level of income that an annuity will pay. The higher the annuity rate, the higher the income will be. The annuity rate is based on life expectancy, health, gilt yields, and interest rates. Those who are in poor health will receive a higher annuity rate if they have a reduced life expectancy, as the insurer will not have to pay the income for as long. Insurers will purchase government bonds (known as gilts), as they pay a fixed amount of interest. This ensures the insurer receive regular income to pay the income to the annuitants.
Additional voluntary contributions made to a pension scheme.
Individual or individuals who will benefit upon death of a pension member. Depending on the type of pension, the beneficiaries may receive an income or a lump sum. Usually the payment of death benefits is at the discretion of the Trustee.
A test that is carried out when benefits are taken from a registered pension scheme, to assess whether benefits exceed the member’s remaining Lifetime Allowance. There are several BCEs, the most common are taking benefits, death, reaching age 75 and transferring to a Qualifying Recognised Overseas Pension Scheme (QROPS).
This is a Department of Work & Pensions (DWP) form which is required to obtain a forecast of State Pension entitlement. The use of this form is limited now, as it is possible to request a statement online through the gov.uk site.
A way of drawing an income from a pension prior to the 2015 Pension Freedoms. The pension fund can remain invested. There is a limit on how much income can be drawn as per the maximum Government Actuary’s Department (GAD) limit. Income cannot exceed the limit, but the level of income can be varied each year. If the maximum is not taken in one year, it cannot be carried forward to the next year. After April 2015 it was not possible to commence a new Capped Drawdown arrangement, due to the introduction of Flexi-Access Drawdown.
A member of a defined benefit scheme can usually request a CETV free of charge annually. This is the cash value placed on their pension benefits, or to put it another way, the lump sum that the defined benefit scheme is offering in exchange for giving up rights in the defined benefit scheme. The CETV would be transferred to another registered pension scheme or a Qualifying Recognised Overseas Pension Scheme.
A commutation factor is used to convert the annual pension to a one-off lump sum. This will result in a lower annual pension income.
From 2006, a principle allowing savers to pay into more than one pension scheme at the same time.
This is the rate of return required by the chosen investments to provide and maintain an income at least equal to the income provided by an annuity, or from a defined benefit scheme. When assessing CETVs, the critical yield is the return needed on the investments to provide the same level of income expected from the defined benefit scheme.
Pension benefits which have already been accessed (retirement benefits started) and tested against the Lifetime Allowance. For example, a defined benefit pension in payment, or a defined contribution pension which is in drawdown.
An annuity which commences at a future date.
Benefit awarded to a defined benefit pension scheme member whose employment is terminated before retirement. Or a pension payable from a scheme closed to future accrual.
Delaying retirement until after the normal retirement age of the scheme.
A workplace pension scheme where benefits are defined at outset i.e.: 1/60th of salary for each year of service.
A pension scheme whereby retirement benefits are dependent on the value of the fund.
An individual who is financially dependent on the member. Often a spouse or child who is still in full time education.
The income paid to a dependant following the death of the member
Taking benefits before normal retirement date. Perhaps for early retirement or in the event of ill-health.
Allows the courts on divorce to make an order which requires all, or part of the member’s pension benefits to be paid to their ex-spouse when the member draws an income.
Allowed pension benefits built up before 06/04/2006 to be fully protected from a Lifetime Allowance Tax Charge. No further contributions to a pension fund were allowed.
Pensions in payment or deferred benefits increase by a fixed percentage, or in line with inflation.
Pension linked to an individual’s final salary- i.e.: 1/60th of final salary for each year of service.
A financial specialist who can help an individual make decisions about their own finances. The Financial Adviser will undergo a review of the individual’s current circumstances and their goals for the future, and prepare a financial plan to help reach those future goals.
Some advisers can only advise on one company’s products, others can advise on products from many companies. Those who can advise on products from many companies are known as Independent Financial Advisers.
Maintains the Lifetime Allowance at a certain level, depending on which version of the protection the member has. Protections at £1.8m, £1.5m and £1.25m have been available. It is still possible to apply for Fixed Protection 2016, which protects the Lifetime Allowance at £1.25m. For Fixed Protection 2016, benefit accrual must cease from 5 April 2016.
Introduced in 2015, flexi-access drawdown allows a pension fund member to withdraw their pension in a flexible manner, whilst leaving the remaining fund invested. For example, draw an income of £20,000 one year, and £10,000 the following year, subject to fund value.
Introduced in 2011, flexible drawdown allows a pension fund member with a secured pension income in excess of £20,000 p.a, to withdraw from their pension in a flexible manner. This has been replaced by Flexi-Access Drawdown.
Pension benefits that are deferred, and may increase in line with inflation, but without any further benefit accrual.
The value of the defined benefit scheme’s assets in comparison to the liabilities (pensions due to be paid in the future). Often expressed as a percentage. For example, a funding position of 80% would be a deficit, and 110% a surplus.
The GAD rate is a way of calculating what level of income can be taken from a pension in Capped Drawdown. The GAD rate allows pensioners to take 150% of the income a healthy saver of the same age could get from investing their fund in a lifetime annuity. The GAD maximum amounts allowed under HMRC rules often change.
Payments normally part of an annuity or defined benefit pension which are guaranteed to be paid for a set period, should the member die.
The hurdle rate is the annual performance required from the defined contribution pension, to match the starting pension of the former defined benefit scheme. It assumes no inflationary increases, no spouse’s pension, and no guarantee period.
A term used when a pension scheme member is drawing an income from their defined contribution pension.
Increase in prices and standard of living which can reduce the purchasing power of money. For example, if a loaf of bread cost £1 a year ago and now it costs £1.03, the price has risen by 3%.
An investment strategy which automatically switches investments to reduce risk as retirement approaches. A lifestyling strategy may start 10 years before retirement.
Limit on the total amount of pension benefit than can be drawn before an additional tax charge applies. In the 2020/21 tax year the Lifetime Allowance is £1,073,100 and is set to increase in line with inflation each year.
This is a reduced amount that can be paid into a defined contribution and still receive tax relief, if the pension scheme member has taken advantage of the 2015 Pension Freedoms and accessed their pension in a flexible manner. In the 2020/21 tax year the MPAA is £4,000.
See defined contribution.
Allows a pension scheme member to shop around and source the best annuity rate available from different annuity providers.
A new tax introduced on 9th March 2017 applying to transfers of UK pensions to Qualifying Recognised Overseas Pension Schemes unless a specified condition applies.
This is the amount of money available to the member ‘tax-free’ when their pension commences and is commonly known as ‘tax-free cash’. Since the introduction of Pension Freedoms in 2015, it is no longer necessary to take all the PCLS in one go. Up to 25% of the pension fund can be taken as PCLS, presuming there is sufficient Lifetime Allowance remaining.
A protection scheme for members of defined benefit schemes in which the employer has become insolvent. The PPF pays compensation to members, which in most cases is less than the pension from the former scheme.
A formal agreement which divides pensions upon divorce.
A type of ‘defined contribution’ or ‘money purchase’ pension. Usually set up by an individual but could also be set up and funded by an employer.
Protected Rights refer to the money built up with rebate payments from the Government when a person has contracted out of the State Second Pension. From 6 April 2012 the Government stopped the ability to contract out for defined contribution schemes, and the restrictions on how Protected Rights can be used have been removed. Sometimes pension companies refer to these benefits as ‘former protected rights.’ Contracting out ended for defined benefit schemes in April 2016.
An overseas pension scheme which is recognised by HMRC as eligible to receive transfers from UK registered pension schemes. A QROPS is a defined contribution scheme.
An arrangement where an employee gives up some of their salary in exchange for other benefits, such as pension contributions or private healthcare.
A SIPP is a type of personal pension that works in a similar way to a standard personal pension. SIPPs offer much wider investment choices than standard personal pensions and offer the most flexibility at retirement.
A retirement option introduced to help members with smaller pensions, get better value from their savings.
Pension scheme usually set up by the directors of a business to gain more control over how their pensions are invested. A SSAS generally has no more than 11 members all of whom are directors or senior employees. It is possible for the Trustees to invest into assets which are not generally available for other types of pensions.
Low cost personal pension that meets certain criteria, such as a cap on charges and a default investment fund.
Regular payment from the Government that most people can claim once they reach State Pension Age.
From April 2016, the Annual Allowance is reduced for high earners to a minimum of £10,000. From April 2020, the Annual Allowance reduced to £4,000 when income is more than £312,000.
Under triviality rules it may be possible for members of defined benefit schemes to take all their benefits as a one-off lump sum. The total value of the member’s pension benefits (not just from this pension) must be less than £30,000.
Pension benefits which have not yet been accessed.
Is a way of taking benefits from a defined contribution scheme. 25% of the withdrawal will be free of income tax, and the remaining 75% will be taxable. UFPLS was introduced so pension providers who did not want to take on the complexities of handling Flexi-Access Drawdown could still make lump sum payments to pension members.
When a pension scheme closes, and transfers its assets to an insurance company, personal pension or into the Pension Protection Fund.
A type of pension investment designed to protect the pension value and smooth out investment returns.