Ever felt like you needed a degree in finance to understand your pension? We hear you! Pension freedoms may have given over 55s more control over their retirement cash, but the terms used to describe these options can be confusing as heck.
Let’s break down the jargon so you can feel confident about your retirement savings:
What is “Pension Freedom”?
Pension freedom is about giving you more control over your retirement money. In 2015, the rules changed, giving you greater power to spend, save, or invest your pension pot. No more needing to buy a boring annuity!
Here’s what changed:
- Annuity no longer compulsory: You don’t have to buy a guaranteed income for life (annuity) anymore.
- Investment options expanded: Invest-and-drawdown schemes previously only available to the rich are now open to everyone.
- No more “death tax”: The 55% tax on pension pots left untouched after death is gone!
What are “Defined Contribution” and “Defined Benefit” Pensions?
Defined Contribution (DC) pensions: These are the more common type these days. Your employer and you both contribute, and the money is invested for you. The amount you get at retirement depends on how much you saved and how well your investments performed.
Defined Benefit (DB) pensions: These are the “gold-plated” pensions – the ones that guarantee a regular income for life, often linked to inflation. They’re mostly found in the public sector now.
Pension freedom applies to DC pensions. If you have a DB pension, you can transfer to a DC scheme, but only if you get financial advice.
Understanding Annuity & Income Drawdown
Annuity: This is an insurance product that gives you a guaranteed income for life. They can be restrictive and offer poor value. However, with rising interest rates, they might be more appealing again.
Enhanced Annuity: This type pays a higher income if you have health problems.
Joint Life Annuity: This pays your partner an income after you die. Important: If you buy a single-life annuity, your partner gets nothing. Talk to your partner about this!
Income drawdown: This lets you take money from your pension pot while the rest remains invested. This is popular, but it involves investment risks.
Unravelling the Jargon – UFPLS, Decumulation, and More!
UFPLS: It’s a mouthful! This means uncrystallised funds pension lump sum – your retirement savings that haven’t been used to buy an annuity or invested in a drawdown scheme.
Decumulation: This is the opposite of saving. It’s when you start to spend your retirement savings.
Flexi-access drawdown: This means you can withdraw from your pension pot whenever you want, in any amount.
MPAA: This stands for Money Purchase Annual Allowance. Once you start withdrawing from your pension, your annual contribution limit drops to £10,000.
Taking Action – What to Do Now
Pension freedom offers a lot of choices, but it can be overwhelming. Here are some key tips:
- Don’t rush into anything: Especially if you’re still working or don’t need extra cash.
- Seek financial advice: Don’t try to do this alone, especially if your pension is worth £30,000 or more.
- Beware of jargon: Ask for clear explanations and don’t be afraid to say you don’t understand.
Remember, your retirement savings are important. Take your time, understand your options, and make informed decisions to secure your financial future.