This jargon buster is designed to help you understand your pension and some of the options available to you.
With a defined benefit scheme, also known as a final salary scheme, each year a percentage of the employee’s salary is notionally put aside. This percentage is known as the accrual rate.
AVC schemes typically sit alongside but separate from a traditional pension. They give a saver the opportunity to make extra contributions into their pension savings. This gives savers some flexibility to increase the amount they contribute while still benefiting from tax advantages.
An annual allowance is the total amount that a saver can contribute tax-free to their pension each year. Since 6 April 2014 the annual allowance has been £40,000.
A financial product designed to be purchased with funds typically from an individual’s defined contribution pension fund that provides a regular stable income for life. The rate of return from the annuity is typically fixed at outset and is dependent on a range of factors such as prevailing interest rates, age and health of annuitant at outset and payment escalation or guarantees requested. A level 6% annuity rate on a pension pot of £100,000, for example, will pay out £6,000 per year.
For those who are aged 55 plus and those already in a form of a pension drawdown, money can be taken from a defined contribution pension fund. However, the amount available each year is limited. How much can be withdrawn is calculated by the Government Actuary’s Department (GAD), which uses variables such as the retiree’s age and the current yields on 15 year gilts. Capped Drawdown gives the option to take a 25% tax-free lump sum.
Defined benefit pensions – sometimes known as final salary pensions - are pensions that promise to pay a set amount of income to retirees based on how much they earned. The amount is normally guaranteed and could increase with inflation. Some ‘unfunded’ schemes, like with the Armed forces, are met purely by general taxation, whereas ‘funded’ schemes have additional reserves and assets that help pay for the entitlements.
Defined contribution schemes - sometimes known as money purchase schemes - are where the employer, employee or both, make regular contributions to a pension scheme. These contributions are then usually invested in a low-risk fund by the pension provider. Upon retirement there are various options such as converting the amount in the fund into an annuity or drawing it down.
Drawdown, also referred to as pension drawdown, income drawdown and pension fund withdrawal, typically allows an initial 25% tax free lump sum withdrawal. The remaining 75% is left invested with the aim of providing the investor with an income in retirement. The benefits offer more flexibility to manage any retirement income and the potential for further tax efficient growth on the remaining funds. Drawdown, however, is not as secure as an annuity because unlike annuities where any income is guaranteed, your investment could be subject to market turbulence.
For those looking to understand investment risk in more detail, Lloyds Bank is also able to provide some explanation.
The FSCS is a compensation fund of last resort for customers of authorised financial services firms. If a firm is unable to pay claims against it, if it has stopped trading or does not have enough assets to pay claims, the FSCS operates different levels of compensation according to the type of financial product involved and can include some types of pensions. The rules on eligibility are complex and in particular don't cover occupational pension schemes. For further information see the FSCS website.
FSAVCs operate like AVCs but are completely unconnected to a saver’s existing pension. FSAVCs are generally defined contribution, which means that the funds are invested and grow to provide a lump sum on retirement.
The life-time allowance is the maximum pay-out from a pension scheme – whether as lump sums or as retirement income – that can be received before extra tax-charges are triggered. Presently this is £1m.
Subject to pension scheme rules, most people with a defined contributions pension can withdraw up to 25% of their pension pot as a tax free lump sum. This has been the case for some time but the Government have now made this option, again subject to pension scheme rules, available to those in defined benefit schemes. This is applicable to those who transfer to a direct contribution scheme in full or to those who are accessing the pension under a terminal illness claim.
Before April 2015 these were restrictions placed on the maximum amount that could be withdrawn from a pension pot. As of April 2015, those restrictions were removed allowing those who are age 55 plus with defined contribution pensions and those already in a form of pension drawdown to withdraw their entire pension fund as a lump sum subject to income tax at their highest marginal rate.
NEST is a defined contribution pension scheme in the UK. This low cost scheme is backed by the Government and is designed to help businesses fulfil their obligations for auto-enrolment pensions.
Lloyds Bank Private Banking has produced a video which explains what NISAs are.
Under this scheme, whether on a defined benefit or defined contribution basis, an employee is not required to make personal contributions to their occupational pension, although their employer will pay-in. These schemes are generally rare although the Armed Forces are an example of an organisation that provides such schemes for members.
PLA’s can be acquired with any monies held by an investor, as opposed to pension annuities which are only purchased with funds held in an authorised pension plan. PLAs are taxed differently to pension annuities as part of the ‘income’ is in fact a return of the investor’s capital. As a result they are not liable to income tax and the purchase price is also removed from the investor’s estate. Subject to an investor’s individual circumstances, these may be worth considering in inheritance tax planning arrangements.
Traditional pension providers restrict where your pension can be invested. The choice is usually limited to a small number of funds run by the plan provider. A SIPP gives savers flexibility to invest their pension funds how and where they like and so give them more control over their retirement planning. Additionally business owners are able to borrow against the pension funds’ assets for business property purchases or fund for growth of the business subject to specific HMRC guidelines.
For those looking to plan future finances, Lloyds Bank may be able to help.
A SSAS is similar to a SIPP but is usually set up to include a small group of savers in the scheme rather than a single individual. Typically a SSAS will have fewer than 12 members and so they are popular with small businesses. Unlike a SIPP, a SSAS can make a loan back to a sponsoring business thus giving it some flexibility.
When a pension scheme is described as uncrystallised it means that no funds, either as a lump sum or as income, have been withdrawn from the pension pot. Previously with an uncrystallised fund, there was a six month time limit for a saver to decide how to use the remainder of their pot once the fund has been crystallised and the 25% tax free allowance has been taken. However, in April 2015 these time restrictions were removed, giving holders of defined contributions pension plans more flexibility.
Whether long- or short-term, establishing investment goals can help nurture your wealth. Find out more about how Lloyds Bank may be able to help with this and other financial matters including retirement planning.
And for those looking for more specific investment information, Lloyds Bank has also put together an investment jargon buster.
This article has been provided to Lloyds Bank plc by external/third party contributors and contains their views as at September 2016 and is not intended to provide legal, tax or financial advice. The information may not be accurate after this date.
Past performance is not a guide to future performance. Investors may not receive back the full amount originally invested and the value of investments and the income from them may fall as well as rise.
Tax treatment depends on individual circumstances and may be subject to change in the future.
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