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Below are some of the more common financial terms that you might become exposed to:

Additional Voluntary Contribution Schemes (AVCs) - AVCs allow you to make additional contributions to your existing occupational pension scheme to boost the size of your fund, or to a separate freestanding AVC scheme.

Annual allowance - The maximum you may invest into your pension funds in a given tax year and get tax relief. The annual allowance is currently £40,000 from 2014/15. The lifetime allowance is now £1.25m for 2015-2016 going down to £1m from April 2016.

Annuity (or Lifetime Annuity) - An annuity is a contract to pay you an income for your life time. When you retire, you may choose to buy an annuity with your pension fund to secure a guaranteed regular income throughout your retirement.  The amount payable depends on a number of factors and options that you choose. See the section on annuities for more details.

Auto enrolment - Auto enrolment is a term used to describe employees automatically being enrolled into their company pension scheme; it is a recent Government initiative being rolled out from 2012 to 2018. Participation will be initiated without the employee having to take any active steps on their part.

Bonds - A form of investment. When you buy a bond, you are lending money to companies (corporate bonds), governments (gilts) or other organisations for a period of time at an agreed rate of interest. Typically, bonds are regarded as safer forms of investment than investments in shares, particularly when the market is volatile.

Commutation - The term used to describe the process by which people reduce their pension in order to increase their tax-free lump sum when taking their pension.

Defined Benefit Pension Scheme (or Final Salary Scheme) – a defined benefit pension scheme is a type of pension plan in which an employer promises a specified monthly benefit on retirement that is determined by a formula based on the employee's earnings history and length of employment.

Defined contribution (or Money Purchase) Pension Scheme - These include personal pensions, stakeholder pensions and occupational pensions. Money purchase involves making regular contributions to a pension fund, which is invested for you, for example in the stock market. The returns on the investment (which may be positive or negative) are credited to the individual's account. On retirement, the member's account is used to provide retirement benefits, usually through the purchase of an annuity, or one of the annuity variants, which then provides a regular income. The income you receive in retirement will depend on how much and how long you have contributed, and how well the underlying investments have performed. As from April 2015 additional options became available  including full withdrawal of pension funds (at marginal rates), an annuity or drawdown and potentially other products created by providers.

Enhanced or Impaired Life Annuity - An annuity that pays a higher rate because of a lower life expectancy due to lifestyle or medical conditions.

Income Drawdown (Unsecured pension)

Your pension fund can be converted into an unsecured pension. After optionally taking a tax free lump sum it is invested in an appropriate portfolio in accordance with your agreed risk profile and income requirements. You withdraw an income from the fund each year and this is generally taxed as earned income, with Income Tax deducted at source. The Unsecured Pension option enables the policy holder to buy an annuity at a time that is best suited to them and hopefully when annuity rates are more favourable.

While conventional annuities are highly secure but inflexible, Income drawdown is at the opposite end of the spectrum and is highly flexible but much riskier.

Individual Savings Account (ISA) - An ISA is a savings plan in cash, or in stocks and shares. While ISAs offer tax advantages, there are limits to what and how much you can invest.

Lifetime allowance - The maximum you can accumulate across all your pension funds throughout your lifetime while still benefiting from tax relief. The lifetime allowance is now £1.25m from 2014/15 going down to £1m from April 2016.

Open Market Option - You do not have to purchase an annuity from your pension provider. Most pension providers allow you to transfer the pension pot you have accumulated to purchase an annuity with another company, which ensures that you get the best possible rates available on the open market. This is known as the Open market option and is an extremely important option in ensuring you maximise your retirement income, which far too many people still don’t take advantage of.

Personal Pension - Personal pension plans (PPPs) and stakeholder pension schemes (SHPs) are defined contribution arrangements but not through an employer (see Defined Contribution explanation above). They are investment policies that provide an income in retirement. They are available to any UK resident and can be bought from insurance companies, high street banks, investment organisations and some retailers (i.e. supermarkets and high street shops).

Phased Retirement

Most personal pensions can be arranged not as a single plan, but as a cluster of many separate policies, sometimes called ‘segments’. The segments can be crystallised at various times to provide income by way of either an Annuity or Unsecured Pension as explained in those sections.

Purchased Lifetime Annuity  - Anyone that is typically aged 55 or over, has a large lump sum (from a non-pension source) and wants a guaranteed income for the rest of their life can benefit from purchased life annuities. The lump sum is used to purchase a lifetime annuity. The annuity taxation of a purchased life annuity is very favourable compared to pension annuities because some of the income is deemed to be a return of capital and therefore ‘tax free’ and it will often provide a higher income net of tax. This means that individuals on retirement that want to maximise their pension income could consider commuting the maximum tax free lump sum and using this for a purchased life annuity.

Short Term Annuity

A short term annuity will use part of your pension fund to purchase an annuity which provides a guaranteed income for a fixed period of no more than 5 years. The payments must cease before your 75th birthday.

By using a short-term annuity, the decision on buying a lifetime annuity can be deferred but not beyond age 75. Only part of your fund would be used in this way. The balance would be applied to an income withdrawal arrangement Unsecured Pension.

SIPP - If you want to have control over your investments, you should invest in a Self-Invested Personal Pension (SIPP). A SIPP is the name given to the type of UK-government-approved personal pension scheme, which allows individuals to make their own investment decisions from the full range of investments approved by HM Revenue & Customs (HMRC). These currently include such things as: Stocks and Shares, Investment Trusts, Units/Shares in Collective Investment Schemes, UK Real Estate Investment Trusts (REITs), Venture Capital Trusts (VCTS), certain National Savings and Investments products, Commercial Property, Warrants, Futures, Options and a number of others.

State Second Pension (S2P) - Also known as the additional state pension, the S2P provides additional benefits for those in employment by way of a top-up pension to the basic state pension based on the average earnings during an individual's working life.

Savings bonds - Typically, a safe and risk-free way to save money. They offer different options for how to invest your money with different payment options to choose from, depending on the provider. Savings bonds providers may also offer you the option of reinvesting the interest.

State Earnings Related Pension Scheme (SERPS) - The additional state pension scheme replaced by S2P in 2002, linking the amount of additional pension you received to the amount that you earned.

Term or bond account - A savings account that invests in bonds for you. You make a single payment and then earn interest on top of that amount, which you will receive back after the fixed term of the investment expires.

Third Way options - Against a background of increased volatility in stock markets, perceived poor rates being offered for Lifetime Annuities, concerns regarding future inflation and the fact that people are now living longer, the retirement market has been in need of a new type of product. These new plans are commonly known as ‘Third Way’ products and they are already very popular in the US and Japan. Essentially they fit in between a Lifetime Annuity and an Income Drawdown Pension plan as they offer the chance to still participate in stock market growth but with guarantees attached to either income, capital or both.

Unit trusts - Unit trusts are collective funds that allow individual investors to pool their money in a single fund. The advantages are that it allows them to spread their risk across a range of investments, have the benefit of a professional fund manager, and reducing the dealing costs. Unit trusts are open-ended in contrast to investment trusts, which are closed funds.

Unsecured Pensions (also known as Income Drawdown)

See Income Drawdown above




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