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Thursday 18th April 2024

The most common pensions buzzwords you need to know

Helena Jones demystifies common pensions buzzwords with a guide to retirement pot phrases you need to know.

pensioner and daughter

For all the acronyms and jargon surrounding pensions, it’s no surprise many people are at a loss as to their choices, what type of scheme they are in and how this works.  

To help put you in the driving seat, we’ve broken down some of the most common pensions terms you’re likely to come across below.

Final Salary Scheme

A Final Salary Scheme is another term for a Defined Benefit (DB) scheme. People with this type of pension are guaranteed a certain level of income in retirement for the rest of their life by their employer, calculated based on things like salary and length of service.

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Being rather expensive for employers to run, the vast majority of DB schemes are sadly now closed to new members, with Defined Contribution (DC) schemes now the norm.

A DC pension plan – sometimes referred to as a ‘Money Purchase Scheme’ – puts the onus on the individual to pay in enough money each month to fund their retirement.

For tips on how to find out which type of scheme you are in and how to get the most out of it, click here.

Tax relief

Contributions into a workplace pension are paid before tax, which means saving for retirement is actually a smart way to reduce the amount of your salary going to HMRC.

This ‘tax relief’ is why you’ll often hear pensions experts saying not contributing into a pension is like turning down ‘free money’!

Basic-rate taxpayers (people earning up to £50,270) get 20% tax relief, while higher-rate and additional-rate payers get 40% and 45% respectively.

Tax relief is offered on pension contributions worth up to 100% of someone’s yearly salary, so anyone paying in more than their annual income will be charged tax based on whichever band they fall into.

Annual Allowance

Tying in with the above, the Annual Allowance is the amount you can save into a pension each year before that money is taxed. Or in other words, with tax relief applying.

You can put as much as you like into your pension each year, but if you exceed the annual allowance – which is currently £60,000 – there’ll be a tax charge on anything contributed above that amount, for the rest of the tax year.

Those lucky enough to earn more than £200,000 per year are also impacted by something called the ‘tapered annual allowance’. This essentially means that high-earners, who might choose to contribute larger sums of money acquired from bonuses etc., will have to pay a heftier tax charge.

Worth noting is that the annual allowance applies across a person’s total pension savings, not per scheme they might be paying into. This is so people can’t get around the Annual Allowance by spreading contributions across different schemes!

Annuity

An annuity is essentially a product you can buy to guarantee yourself a certain level of income in retirement. The idea is that someone approaching retirement exchanges the cash they’ve saved into their pension for a guaranteed monthly income, usually for the rest of their life.

In that sense, an annuity isn’t all that different from – say – a life insurance product.

Annuities used to be very common, but had fallen out of favour in the past 10 years when low interest rates had meant that the deals on offer weren’t great. However, with interest and inflation rates currently at record highs, and with some annuity products offering payments that rise (or fall) with inflation, these are now a more attractive option for many people.

Triple lock

The triple lock relates to the State Pension, and is a system which guarantees that retirees’ pension payments will increase by inflation, wage growth or 2.5% – whichever is higher at the time of an update the Chancellor of the Exchequer makes each year.

Introduced in 2010 under the coalition government, the triple lock has been the subject of much debate among policymakers. This is because of how expensive it is for the government to fund, particularly now when inflation and wage growth levels are soaring.

But for now at least, it seems the triple lock is here to stay. Chanceller Jeremy Hunt confirmed that retirees are in for another increase under the triple lock for 2024, with more details set to be released later this month.

The exact increase remains to be seen but, if pensions experts’ predictions are anything to go by, retirees could be in for a bumper increase of more than £900 per year based on current inflation data.

Photo Credits: Pexels

Helena MacPherson

Helena MacPherson writes about pensions and financial services. In her free time she can mostly be found chasing after her golden retriever, Cheddar.

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