Retirement Jargon Guide
There’s plenty of complicated terminology around retirement, and understanding the relevant terms can help you to make better decisions for later life.
Alternative Allowance
The maximum amount of defined benefit pension savings that qualify for tax relief once you trigger the Money purchase annual allowance.
The Alternative Annual Allowance is £36,000 or a lesser amount. It may be less than £36,000 when the tapered annual allowance (see Tapered Annual Allowance in this jargon buster) applies for the tax year concerned.
If you have defined benefit pension savings and exceed the Alternative Allowance (where it applies to you) a tax charge is made which claws back any tax relief that was given on the excess pension savings.
See also Annual Allowance, Money Purchase Annual Allowance and Tapered Annual Allowance.
Annual allowance
The maximum savings into pensions that you can have in a year that qualify for tax relief, based on:
- Your own contributions,
- Any employer contributions,
- Any contributions made on your behalf by someone else, and
- Your total income from all sources (see Tapered Annual Allowance)
In the tax year 2022-23, the Annual Allowance is £40,000.
The Annual Allowance applies across all your pension savings, not per scheme.
If you exceed the Annual Allowance a tax charge (‘the Annual Allowance charge’) is made which claws back any tax relief that was given at source.
If your taxable earnings in the year are below the Annual Allowance then tax relief on pension contributions from all sources is limited to 100% of your earnings (or to £3,600 if you have no earnings).
From 2019-20 the Annual allowance reduces for those on higher incomes – see Tapered Annual Allowance below.
Annuity
A type of retirement income product that provides you with a guaranteed regular payment, usually for life but can also be for a fixed term.
Cash balance pension
A pension arrangement where your employer promises you a pension pot of a specified amount, when you reach retirement age.
Typically, the amount is calculated as a proportion of your salary for each year of service.
You know how much your pot will be, but there is no promise as to the amount of pension you’ll be able to buy (or take) from it.
Cash lump sum
An amount of cash set by law that you can take at retirement free of tax.
It’s usually up to a quarter of your pension. Some older policies might allow a higher tax-free lump sum to be taken.
See tax-free lump sum.
Defined benefit pension
Pays a retirement income based on your salary and how long you have been a member of the pension scheme.
Defined benefit pensions include ‘Final Salary’ or ‘Career Average’ pension scheme.
Increasingly, only available from public sector or older workplace pension schemes.
Defined contribution pension
Builds up a pot of money to provide an income when you are no longer working; the amount depends on how much you (and your employer if you are employed) pay in, the investment returns your money receives and the charges you pay.
Includes workplace and personal pensions, including stakeholder pensions.
Might be run through an insurance company or master trust provider, or through a bespoke scheme set up by your employer.
Drawdown
Also known as income drawdown, pension drawdown, or flexible retirement income product.
Allows you to use your pension pot to provide a regular retirement income by reinvesting it in funds specifically designed and managed for this purpose.
Final salary pension
Pays a retirement income based on your salary and how long you have been a member of the pension scheme.
A Final Salary pension is a defined benefit pension, similar to a ‘Career Average’ pension scheme.
Increasingly, this product is only available from public sector or older workplace pension schemes.
See Defined benefit pension.
Flexible Retirement Income Product
Also known as income drawdown or pension drawdown.
Allows you to use your pension pot to provide a regular retirement income by reinvesting it in funds specifically designed and managed for this purpose.
Replaced flexible drawdown and capped drawdown from April 2015, though existing users of capped drawdown can continue in that plan.
The income provided is not guaranteed.
Guaranteed annuity rate (GAR)
Some older policies promised to pay out an income at a specific rate at the retirement date of the policyholder.
These guaranteed annuity rates were usually set at a level much higher than annuity rates offered today. Often hard to match if shopping around.
Guaranteed Drawdown
A ‘hybrid’ product that combines a guaranteed income for life with the flexibility of pension drawdown.
Highest tax rate
Also referred to as ‘marginal tax rate’
It is the highest band of tax you can be asked to pay. Your total income might straddle several bands and you therefore might pay tax at several different tax rates.
Income Tax is split into bands and you pay different rates based on these bands: 20%, 40% and 45% (in England, Wales and Northern Ireland) and 19%, 20%, 21%, 41% 46% (in Scotland).
Your pension income is added to any other earnings you might have and taxed according to which tax band it falls inside.
‘Hybrid’ products
Products that combine features of guaranteed income products (annuities) and flexible income products (pension drawdown).
Income drawdown
Also known as pension drawdown or a flexible retirement income product.
Allows you to use your pension pot to provide a regular retirement income by reinvesting it in funds specifically designed and managed for this purpose.
Replaced flexible drawdown and capped drawdown from April 2015, though existing users of capped drawdown can continue in that plan.
The income provided is not guaranteed.
See Flexible Retirement Income Products.
Income Tax rates
Income Tax is split into bands and you pay different rates based on these bands: 20%, 40% and 45% (in England, Wales and Northern Ireland) and 19%, 20%, 21%, 41%, 46% (in Scotland) based on these bands.
Your pension income is added to any other earnings you might have and taxed according to which tax band it falls inside.
Your total income might straddle several bands and you therefore might pay tax at several different tax rates.
Inflation
Increase in the general level of prices of goods and services.
Lifetime Allowance
The maximum value of pension savings that you can build up without incurring a tax charge at the time you draw out your savings as cash or pensions (and without leaving a tax charge for your beneficiaries if you die before age 75).
For the tax year 2022-23 the Lifetime Allowance is £1,073,100. From 6 April 2018, the standard Lifetime Allowance is indexed annually in line with the Consumer Prices Index (CPI).
If you exceed the allowance, you pay tax on the excess amount at 55% if taking the pension as a lump sum or at 25% if you take it as income.
The same savings aren’t assessed twice – so if you put £2m into drawdown this will have been tested and the excess taxed at that time and no further Lifetime Allowance charge is due.
If you die leaving untouched pension savings that exceed the Lifetime Allowance - and they haven’t already been assessed against it, your nominated beneficiary will be liable for the extra tax charges on the amount that exceeds the Lifetime Allowance.
Marginal rate of tax
Also referred to as ‘highest tax rate’
It is a band of tax you can be asked to pay. Your total income might straddle several bands and you therefore might pay tax at several different tax rates.
Income Tax is split into bands, and you pay different rates based on these bands: 20%, 40% and 45% (in England, Wales and Northern Ireland) and 19%, 20%, 21%, 41% 46% (in Scotland).
Your pension income is added to any other earnings you might have and taxed according to which tax band it falls inside.
Market value reduction
A reduction to your pension pot that could apply if you want to cash in your with-profits policy before or after its maturity date or other date(s) specified in the policy.
Money purchase pension
This is another name for a Defined Benefit Pension.
Builds up a pot of money to provide an income when you are no longer working; the amount depends on how much you (and your employer if you are employed) pay in, the investment returns your money receives and the charges you pay.
Includes workplace and personal pensions, including stakeholder pensions.
Might be run through an insurance company or master trust provider, or through a bespoke scheme set up by your employer.
Money Purchase Annual Allowance (MPAA)
The reduced amount that can be paid into a defined contribution pension scheme and still get tax relief if you have started to take money out of a defined contribution pension pot.
The main situations when the MPAA is triggered are:
- If you take your entire pension pot as a lump sum or start to take ad-hoc lump sums from your pension pot
- If you put your pension pot money into a flexi-access drawdown scheme and start to take an income
- If you buy an investment-linked or flexible annuity where your income could go down
- If you have a pre-April 2015 capped drawdown plan and start to take payments that exceed the cap
- If you exceed the MPAA a tax charge is made which claws back any tax relief that was given at source.
In 2022-23 the MPAA is £4,000.
If your taxable earnings in the year are below the MPAA then tax relief on defined contribution pension savings is limited to 100% of your earnings (or to £3,600 if you have no earnings).
The MPAA limit does not apply to other pension savings.
For example, if you use up your £4,000 MPAA you’re still entitled to tax relief on up to £36,000 (Alternative Annual Allowance) on any defined benefit savings in 2021-22.
State Pension
A regular payment from government that you qualify for when you reach State Pension age.
The amount you get depends on your National Insurance record.
Tapered Annual Allowance
From April 2016, the Annual Allowance is reduced to less than £40,000 per year (tapered) if your ‘adjusted income’ (your annual income before tax plus the value of your own and any employer pension contributions) is over £240,000.
In this case the Annual Allowance will reduce by £1 for every £2 that your income exceeds £240,000, up to a maximum reduction of £36,000.
In practice this reduces the Annual Allowance to £4,000 once adjusted income reaches £312,000.
If your annual income after tax and excluding pension contributions is below £110,000 the tapered reduction will not normally apply.
Similar tapering applies from April 2016 to the Alternative Annual Allowance if you are in a defined benefit pension.
Tax-free lump sum
An amount of cash set by law that you can take at retirement free of tax.
It’s usually up to a quarter of your pension. Some older policies might allow a higher tax-free lump sum to be taken. Sometimes simply referred to as ‘tax-free cash’ or ‘cash lump sum’.
Uncrystallised Pension Fund
A pension pot that has not been accessed for retirement income.
Uncrystallised Funds Pension Lump Sum (UFPLS)
A cash sum taken from a pension pot that has not paid out any retirement income.
For each withdrawal, usually the first 25% (quarter) will be tax-free and the rest will be taxed at your appropriate tax rate.
Introduced from April 2015 as part of the cash option for withdrawing your pension.