OK, I’ll admit it, I’m a pensions geek. I can be a bit nerdy when it comes to tax too.
It’s not something I shout about at dinner parties or bring up at the pub (the invites might dry up) but I can’t deny the quiet satisfaction I get from getting my head around complicated concepts and making them easier to understand for people with better things to do.
But while the complexity of pensions – and the language the industry uses – might be keeping me in work, it’s not doing anyone else any favours.
A survey from advisers Drewberry last year found that more than 40% of employees are totally stumped by their workplace pension.
Putting it bluntly, pensions are complicated and the terminology is confusing. And the high level of jargon is doing absolutely nothing to encourage people to engage with their pension and take the action necessary to boost the income they’ll get when they retire (or as some pension providers might prefer to say, “improve their retirement outcomes”).
So, before Pension Awareness Week is wrapped up for another year, here’s my guide to the worst of the jargon. And maybe, just maybe, it might encourage someone out there to get a better understanding of their pension, make a positive decision or dodge a dud one.
1) Tax relief
This is, admittedly, not the worst of the nonsensical terminology out there, but despite being a huge incentive to save in a pension, it remains something numerous savers are oblivious to. And even for those who are aware of it, they often don’t understand how it works and underestimate the (huge) difference it can make to their pension savings.
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Tax relief on pension contributions, does at least sound like a good thing. There’s an aroma of a reduced tax bill or a hint that you might be spared some tax, but it doesn’t spell out what tax relief is.
What tax relief actually means is that you do not need to pay income tax on money you pay into a pension (subject to certain limits, of course). It does this either by paying the tax back to you or by taking your pension contributions out of your earnings before tax is deducted (meaning you only pay income tax on the remainder).
Whichever method your pension uses, the effect is the same. It means it only costs a basic-rate taxpayer (paying 20% tax) £80 to invest £100, while a higher-rate taxpayer (paying 40% tax) only needs to pay £60 to invest the same amount.
It might be more helpful just to call it a government top-up instead?
2) Money purchase annual allowance
The annual allowance is a perfectly sensible bit of terminology. I’m pretty sure most people can work out that it’s the amount that they can pay in each year.
But the “money purchase annual allowance” (MPAA) – a lower allowance for people who have made a taxed withdrawal from their pension – makes no sense at all.
If I wasn’t a financial journalist, all I could possibly guess at is that I could perhaps use my “money” to “purchase” a bigger annual allowance, but even that’s clutching at straws.
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All the addition of these two words does is suggest something has changed and that we’re no longer talking about the ordinary annual allowance. It turns something that is quite clear into something that is not.
The “money purchase” bit is just one way the industry refers to a pension that you and/or your employer contribute to each month, and which benefits from tax relief (see above). It’s also called defined contribution, or DC, because your retirement pot will depend on how much you have contributed and the performance of your investments.
But if you are wanting to take money out of your pension, but still want to carry on making a high level of contributions, it’s vital that you are aware of the MPAA, as it will reduce the amount you can contribute in the future.
This is particularly important if you’re expecting a windfall such as a bonus or inheritance that you would like to pay into your pension towards the end of your working life.
Currently the MPAA is £10,000, compared to 100% of your earnings up to a maximum of £60,000 with the annual allowance.
3) Pension commencement lump sum
Another incentive to save in a pension is that you will be able to take up to 25% of it tax-free. You might have heard this referred to as your “tax-free lump sum” or as your “tax-free cash”.
But it’s “proper” name is your pension commencement lump sum. OK, so there’s an inference that you get it when you start taking your pension, but the fact that it’s paid tax-free – a big perk – is completely lost in the terminology.
When you’re mulling over the best ways to take money out of your pension (which is now possible from the age of 55, rising to 57 in 2028), you might come across the terms crystallised and uncrystallised.
But these terms have nothing to do with alchemy or cheap jewellery. They are, in fact, a reference to the status of your pension savings. While you are building your pension and have made no withdrawals, it is considered to be uncrystallised. Once you have accessed it for a tax-free lump sum, to take income or buy an annuity, it is described as crystallised.
Confusingly you can take money out of your pension without crystallising it, which takes us nicely on to...
5) Uncrystallised fund pension lump sum
From the age of 55 (rising to 57 in 2028), you can take a lump sum of any size out of your pension, without needing to do anything with the rest of your pension savings, or “crystallising” it as your provider might say.
But while this might give you easy access to cash, an uncrystallised funds pension lump sum (UFPLS, pronounced ‘ufplus’), must not be confused with your tax-free cash (or pension commencement lump sum). That’s because only the first 25% of your withdrawal is paid tax free. The rest is taxed at your rate of income tax.
Getting these two mixed up can therefore land you with quite a tax bill.
6) Death benefit
Death and benefit aren’t two words you expect to go hand in hand. But death benefit isn’t an unexpected upside to dying, it’s just the return of any money left in your pension to your loved ones when you die.
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It’s important you complete an expression of wishes form to tell your pension provider who you would like to receive this money. Without this, your provider will have to decide who to pay the money to and will not be able to take your views into account.
You may also come across the terms accumulation and decumulation when discussing or reading about your pension.
Accumulation refers to the “pre-retirement” or “savings” stage, where you are paying into your pension and growing your pot before you call on it for money. Decumulation, meanwhile, is the “post-retirement” or “spending” stage, when you are using your pension to give you income or lump sums.
It’s important to understand the difference between these stages as you’re likely to need a different investment strategy for each. Once you retire and start spending your money, for example, you may not have the same focus on growth and want to consider investments that pay an income.
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