Pensions terminology
Nothing mystical, it is just the name given to a policy which is designed to help you buy an income when you retire. There are lots of rules, some of which keep changing, relating to how much you can put in, where you can invest and how and when you can draw the benefits. Since April 2006 (known as A Day) there are now two main types of scheme. Although different they do share some common features, such as:
The Government will give you tax relief, at the highest rate of income tax that you pay, on every £ you pay in, subject to certain limits (see below). Therefore if you are a basic rate tax payer then a £100 gross contribution will only cost you £80 as the government adds in the extra £20. If you pay income tax at 40% then it works slightly differently, you still receive Basic rate relief so a £100 contribution will only cost you £80 but instead of the additional 20% of relief being added to your pension it is used to reduce the amount of income that you pay 40% tax on.
Even if you do not have any annual earnings you can still pay into a pension and receive basic rate tax relief. Strange but true! The maximum you can contribute is £3,600 which with basic rate tax relief will only cost you £2,880.
This is the maximum value your pension pot is allowed to hold. For the current tax year this is set at £1,800,000. This falls to £1,500,000 in April 2012.
This is the maximum amount you are allowed to pay into a pension and still receive tax relief in any one year. For the current tax year it is set as the lower of either of 100% of your earnings or £50,000. The two different types:
As the name suggests with this type of pension there are limits on what you can pay into your pension. The idea is that you build up a sum of money and then when you retire you use that sum to provide yourself with an income. Also you may take up to 25% of the value of the pot as a Tax free lump sum. Examples of this type of scheme are:
With this type of plan the Government limits the annual charge that a provider may take. With the most common type of Stakeholder plan the maximum annual charge is currently set at 1% of the pot’s value. There can be no initial product charge. Due to the low cost nature these plans tend to be a “no thrills” approach to saving for your retirement.
Similar to a Stakeholder Pension, but without the Government capping the maximum charges. These tend to offer more “whistles and bells”. There are two common variants:
This gives you the option to choose where your pension invests, subject to certain restrictions. For instance if you are a bit of whizz on the Stockmarket then you could use your pension pot to buy shares in individual companies, also you can use your pot to buy commercial property either outright or with the use of a mortgage.
As the name suggests this is just a group of personal pensions that are administered by a single provider. Commonly used by employer’s for their employee’s. The employee owns the pension pot as if it was their own personal pension.
Also known as. With this type of scheme the retirement benefits that you receive are known at outset, hence the term defined benefit.
The most well known example of this type is a Final Salary Scheme where you receive a pension that is expressed as a fraction of your final salary for each year you work for your employer. Typically you will receive 1/60th of your final salary for every year worked. These schemes are the “Blue Riband” of pension schemes. They are very expensive for employers to maintain and as such are now the preserve of large corporations or Governments.
The other type of scheme, now less common since A Day is known as a Money Purchase Scheme. With this type of scheme your income in retirement is based upon a set of rules issued by the Inland Revenue.
This is where you use the money you have saved in your pension pot to buy a guaranteed income for life. You can choose to take a tax free lump sum from your potThere are different types of Annuity available depending on what you are trying to achieve. The income you receive is set at outset therefore it is important that you look at all of the options open to you. The Annuity dies with you. You can however choose to add in income benefits for a surviving spouse should you die before them. You do not have to buy an Annuity with the company you have built up your pension pot with.
This is when you draw an income direct from the pension pot instead of buying an Annuity. You can take out up to 25% of the pension post as a tax free lump sum. You set the level of income that you wish to receive, between limits set by the Inland Revenue, although ultimately the level of income that you will receive will depend upon the underlying performance of the investments held by your pension pot. Therefore unlike an Annuity the income is not guaranteed. Unlike an Annuity the underlying fund is not lost when you die and therefore it can be used to benefit your surviving spouse, again this option is subject to a number of rules.
If you die whilst drawing benefit then any unused money can be paid to your estate as a lumpsum, less a 55% tax charge.