Pension Glossary – learn the lingo (part one)
65% of us Brits have a pension, but do you know your SIPP from your DB? As it’s Pension Awareness Week, we’ve written a Pension Glossary – learn the lingo guide to help you understand some of the terms used when referring to your retirement savings.
> Link to Pension Glossary part two
Accrual rate
An accrual rate is the percentage interest rate applied to a financial obligation, such as bonds, mortgages, credit cards and pensions. Accrual rates vary based on what type of financial obligation they are applied to.
If you have a Defined Benefit Pension (DB), the accrual rate is the proportion of your earnings you’ll get as a pension for each year in the scheme. This is commonly 1/60th or 1/80th. So, if you are in a pension scheme for 20 years at a 1/80th accrual rate, your pension will pay you 20/80ths (a quarter) of your final salary.
Annuity
An annuity pays a regular retirement income either for life or for a set period. It used to be the standard option for the majority of people at retirement. Annuity is an insurance product that you buy with some or all of your pension pot, so make sure you shop around to get the best value product for you.
Compound interest
Compound interest is the interest earned on your interest! For example, as you earn interest on your invested pension pot it makes it a larger investment, on which you then earn more interest. This highlights the importance of starting a pension as soon as possible, as compounding interest over time can make a huge difference to the invested sum.
Decumulation
Once you start making withdrawals from your pension pot (drawdown), it will get smaller. Decumulation is the term financial advisers use to describe this process and of course, is the opposite of accumulation.
Default fund
If you have a workplace pension, the company you work for will have selected where your funds are invested – this is the Default Fund. Your pension will stay there until the company moves it or you ask for it to be changed. Often the Default Fund is a compromise covering all scheme members’ needs and may not suit your personal requirements. If you have concerns, do speak to your Financial Adviser about your switching options.
Defined benefit pension (DB)
A Defined Benefit scheme is a workplace pension which is often called a Final Salary pension (although it may be based on your average salary). It pays a guaranteed income for life based on the years you worked at the company, your pensionable earnings there and the scheme’s accrual rate. Usually you will be paid an annual income from your DB pension and possibly, a one-off lump sum.
A DB pension is excluded from ‘Pension Freedom’, introduced by the Government in 2015, meaning that it is less flexible than a Defined Contribution pension.
Defined contribution pension (DC)
With a Defined Contribution pension you build up a pot of money that can be used to provide yourself with an income in retirement. You ‘define’ how much you want to contribute (pay in), choose your range of funds to invest in and your contributions receive tax relief at your marginal rate (20% for basic rate taxpayers).
If it is a workplace DC pension scheme, your employer will usually choose the funds. They will take your contributions from your salary and pay them in, plus any contribution they may be adding to it.
While you are working, the fund is usually invested in stocks and shares and other investments, with the aim of growing it over the years before you retire.
When you retire, under ‘Pension Freedom’ you can access and use your DC pension pot in any way you wish from age 55. For example, you could take it all out as a lump sum or a number of lump sums when you need them. You can use the rest to provide a regular taxable income. Or you can convert some or all of the rest into a taxable retirement income (known as an Annuity). Speak to a financial adviser about the tax implications of any money you may wish to access. Remember that the value of investments can go up or down.
Drawdown
Drawdown enables you to receive an income from your pension in retirement. Often people choose to take up to 25% (a quarter) of their pot as a tax-free lump sum, then re-invest the remainder into one or more lower risk funds.
Or the remainder can be used to purchase an Annuity. As there are many options and variables with a drawdown scheme, do speak with your Financial Adviser to determine the best plan for your unique requirements.
Pension freedom
In April 2015 the Government enabled people over the age of 55 with Defined Contribution pensions to access their pension pots more flexibly. The changes did not affect Defined Benefit pensions. The Pension Freedom reforms gave control back to the pension owner to decide how and when to access their money, but the responsibility is on them to ensure their pot lasts the length of their life.
> Link to Pension Glossary part two
Pension Glossary – learn the lingo – Contact us on tel: 01244 347583 or email: info@innesreid.co.uk for bespoke and independent financial advice on your pension options and retirement plans.
