This month’s money jargon buster: the important terms you need to know about pensions
Finances can be confusing. There are so many different terms and acronyms, and so it can understandably become overwhelming trying to navigate all of them while simultaneously planning for your future.
That’s why we’ve created a new money jargon buster for you, where you can find straightforward definitions for the terms you might hear while planning the various parts of your finances.
This month, you’ll find some of the key terms that you might hear about when dealing with your pension.
If you’ve ever been stumped by the Money Purchase Annual Allowance, or wondered how tax relief actually works, find out what these terms mean and more with this month’s money jargon buster on pensions.
The pension Annual Allowance is the maximum amount you can save into your pension in a single tax year while still benefiting from tax relief.
As of the 2021/22 tax year, your Annual Allowance is either up to £40,000 or 100% of your pensionable earnings, whichever is lower.
An annuity is a type of insurance product you can buy using your pension that will provide a guaranteed income for the rest of your life or for a fixed number of years, depending on the product.
You can buy various different annuity products, for example an inflation-linked annuity where the amount you receive will increase each year in line with inflation.
Defined benefit pension
A defined benefit (DB) pension is a scheme where the amount you receive is calculated based on how many years you’ve worked for your employer and your earned salary while working there. You may also hear them referred to as “final salary” pensions.
DB pensions pay out a secure income for the rest of your life, with the amount increasing each year in line with inflation.
Defined contribution pension
A defined contribution (DC) pension is a scheme where the amount you receive depends on how much you put into your pot before you retire. This includes your contributions, employer contributions, tax relief, and any investment returns that your pension savings generate.
DC pensions are also sometimes called “money purchase” schemes.
Flexi-access drawdown is a type of pension product that allows you to access your pension savings flexibly (hence the name), while reinvesting the remaining funds so that they have a chance of generating returns that can support you in retirement.
You may have to pay Income Tax on the money you draw when using drawdown, depending on how much you take.
The Lifetime Allowance (LTA) is the maximum amount of money you can hold in your pension(s) tax-efficiently throughout your entire lifetime. The LTA currently stands at £1,073,100 as of the 2021/22 tax year, and it will be frozen here until 2026.
If you exceed the LTA with your pension savings, you’ll be subject to a tax charge, with the rate of tax dependent on whether you draw your pension as income or a lump sum.
Money Purchase Annual Allowance
The Money Purchase Annual Allowance (MPAA) can come into effect once you start withdrawing from a DC pension. It can reduce your Annual Allowance from £40,000 down to £4,000.
Certain activities can trigger the MPAA. For example, if you take your entire pot as a lump sum or move your pension holdings into flexi-access drawdown and start taking income, your Annual Allowance may be reduced.
The MPAA isn’t typically triggered by activities such as buying a lifetime annuity or putting your pot into flexi-access drawdown but not yet taking income. It has no effect on DB pensions.
Pension Freedoms is government legislation introduced in 2015 to give people more choice over how they access their retirement funds. The legislation only applies to DC pensions, not DB pensions.
Under these new rules, savers have a wider range of options for their pension pot, including purchasing retirement products such as annuities or using flexi-access drawdown.
Tapered Annual Allowance
The Tapered Annual Allowance is an additional rule to the pension Annual Allowance that affects high earners.
The taper comes into effect if your threshold income (i.e., your net income excluding pension contributions) is more than £200,000, and your adjusted income (i.e., your net income including pension contributions) is more than £240,000.
In this case, your Annual Allowance is reduced by £1 for every £2 that you exceed the adjusted income threshold, down to a minimum of £4,000.
Tax relief at source
If you’re contributing to your own personal pension, you’ll benefit from tax relief on your contributions. This means that, for non-taxpayers and basic-rate taxpayers, a £100 pension contribution only costs £80. A £100 contribution costs higher-rate taxpayers £60 and additional-rate taxpayers £55, with this additional relief claimed directly from HMRC through a self-assessment tax return.
Tax relief can be complicated, so please speak to us if you’re unsure how it will work for you.
Need more help?
If there’s anything else that you don’t understand about pensions or you’d like to discuss any other part of your finances, please get in touch with us at Britannic Place.
Email email@example.com or call 01905 419890 for more information.
A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits. The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation and regulation, which are subject to change in the future.
Workplace pensions are regulated by The Pension Regulator.