A guide to understanding some of the basic terms used
6 April 2006 – the day that the pension simplification rules came into effect changing the way we can save for retirement.
The maximum you may invest in your pension funds in a given tax year with tax relief.
An annuity is a type of insurance policy that provides a regular income in exchange for a lump sum.
Asset allocation ensures that an investment portfolio holds a balanced range of different investments such as equities, gilts, property and bonds to protect against any reduction in value of any one or more asset class. The asset allocation will be planned to match the investor’s investment outlook.
AVCs – Additional Voluntary Contributions
A pension top-up for an occupational pension. You pay contributions into an AVC scheme run by your employer to increase the size of your fund.
Basic state pension
This is the pension you will receive from the government as a result of paying national insurance (NI) contributions throughout your working life.
Capital gains tax (CGT)
Tax paid on any increase in the value of your assets that you benefit from. For example, selling shares for more than you paid for them will involve paying some capital gains tax. You receive an annual allowance for capital gains and you only pay CGT on any gain over this amount.
Child Trust Fund
The Child Trust Fund (CTF) is a long-term savings and investment account for children. The government has introduced the CTF to ensure a child has savings at the age of 18.
Bonds issued by companies when they need to borrow money. These often offer higher rates of interest than banks and building societies but with a varying amount of risk depending on how financially secure the company issuing the bond is.
Critical illness cover
Insurance that pays a lump sum if you’re diagnosed with a specified critical illness covered by your policy.
Pension schemes whose final value is defined by the amount of money you have put in to them, where the money was invested and how much growth was achieved plus the amount of time invested. Also referred to as money purchase schemes.
Pension schemes where the member receives a set amount on retirement also referred to as final salary schemes.
Investors generally should spread or diversify their investments over a range of different or unrelated investments as this results in less risk. If one type of investment falls in value, the remaining ones may not.
Payments made to shareholders by a company from profits.
For inheritance tax (IHT) purposes, an individual’s estate is their total assets less any liabilities. Estate/inheritance tax planning could save your family hundreds of thousands of pounds. IHT is essentially the tax charged on what you leave behind when you die, as a death duty. IHT will be due at 40 per cent of the value of all the assets you leave behind on death above the IHT threshold for that tax year.
Businesses or funds that aim to avoid companies that are involved in certain activities such as the manufacture of armaments, cigarettes, animal research or alcohol, or that are involved in trade with countries deemed to have infringed certain human rights can be considered as ethical investments.
A term to describe a company’s issued stocks and shares. If you own shares in a company you own some of the company’s equity.
Equity Release is when you use the value of your home to raise cash thereby releasing equity. There are two main types of Equity Release schemes available: Lifetime Mortgage or Equity Release Mortgages and Home Reversion Schemes.
Final salary scheme
Final salary pension schemes provide you with an income in your retirement based on how much you are earning when you retire – up to two-thirds of your final salary – depending on how long you have been part of the scheme and what you earn. Also referred to as defined benefit schemes.
Fixed interest security
Another name for bonds, where the amount of interest you will receive is stated at the time of purchase. Regarded as a lower risk investment than in stocks and shares.
The Financial Services Authority, the UK’s financial services regulator. The FSA has four statutory objectives which are to maintain confidence in the financial system, promote public understanding of the financial system, secure the appropriate degree of protection for consumers and reduce the extent to which it is possible for a business carried on by a regulated person to be used for a purpose connected with financial crime.
FSAVCs – Free-Standing Additional Voluntary Contributions
A pension top-up policy for an occupational pension scheme, but separate from your employer’s pension scheme and normally run by a pension company.
Also called gilt-edged or Treasury bonds, these are bonds issued by the UK government, and are regarded as very secure investments because it’s the government promising to pay you back.
Group Personal Pension
A group of personal pension plans often offered by employers to employees. They are set up on a money purchase basis like all personal pension plans.
These funds look to make large investment returns from complex investment strategies on the stock markets.
Income protection (or permanent health insurance)
Insurance that pays you a monthly income if you’re unable to work due to illness or injury, until you are able to return to work, or retirement, whichever is the sooner.
Individual Savings Account (ISA)
There are two types of ISA – cash and the stocks and shares. For each tax year you can put your money into both types up to limits or all of your yearly ISA allowance in a cash or stocks and shares ISA. They are not an investment in their own right but are a tax-free wrapper in which you can shelter investments.
Inheritance Tax (IHT)
IHT is charged upon an estate following a person’s death and is currently charged at 40 per cent on amounts above the IHT threshold which changes yearly. A person’s estate includes the total of everything owned. If this amount is less than the threshold, no inheritance tax will be due. However, some outright gifts are exempt.
Two or more people taking out life assurance which can be a useful way to set up a policy to protect a family in the event of either or both parents dying.
Key Features/Key Facts Information documents
Documents that all firms authorised and regulated by the FSA must give you to explain their services and details about any products or services you are interested in.
The maximum amount you can accumulate as pension savings throughout your lifetime that can be used to provide benefits when you die or retire while benefiting from tax relief.
A lifetime annuity will give you a regular income for the rest of your life. You buy an annuity with the cash sum you have built up in a pension fund to turn it into pension income. There are different types of annuities to suit your needs and circumstances.
Money purchase pension
Some occupational pensions and all personal, group personal, stakeholder, Free Standing Additional Voluntary Contributions (FSAVCs) and some Additional Voluntary Contributions (AVCs) are money purchase pensions. Your can choose where your contributions are invested. The size of your fund depends on your contributions, over what time period and how well your investments do.
National Insurance (NI) contributions are paid as a percentage of your income if you are aged over 16 but under the pension age (60 for women, 65 for men) and you earn more than the minimum threshold. They go towards providing for state pensions, as well as other state-provided benefits.
If you do not pay tax you can elect to receive gross interest (i.e. interest without tax deducted). Remember, the interest from investments that could turn you into a taxpayer. You can also reclaim any overpaid tax. Complete Tax Form R85.
Also known as a company pension scheme as they are only available through employers. There are two types of occupational pension schemes – final salary scheme or a money purchase scheme.
Open market option
You do not have to buy an annuity from your pension fund provider as you can shop around to compare rates and arrangements offered by other annuity providers if you find a better deal – this is called the open-market option.
Open-ended investment companies (OEICs)
An open ended collective investment fund that can invest in many types of different investments. The OEIC manager must create shares when money is invested and redeem shares as requested by shareholders.
A pension policy you take out through a pension company into which you pay contributions which are invested in funds which you can choose from to suit your investment outlook. A personal pension is set up on a money purchase/defined contribution basis. Your employer may offer a group personal pension plan.
Protected rights pension
The part of your pension fund which was used to contract out of the State Second Pension (SERPS or S2P) that must be used to buy a protected rights annuity.
Payment protection insurance (or accident, sickness and unemployment cover)
Pays out a regular pre-agreed amount for a stated time if you can’t work for health reasons. Sometimes these policies offer redundancy cover.
Private medical insurance
Insurance that pays for you to receive private medical treatment.
Everyone has a personal allowance, which is the amount of income you can have before you start paying tax.
Personal Equity Plans (PEPs)
From April 2008 PEPs automatically became stocks and shares ISAs.
Price to earnings ratio (P/E)
The performance of companies is measured by their P/E ratio. The Price is the current share price and the Earnings are the profit the company earns in one financial year for each single share.
Tax years in which National Insurance Contributions (NIC) have been made. A minimum number of qualifying years must be built up during your working life in order for you to qualify for the full basic state pension.
Some investments are riskier than others. For example investment in the stock market is riskier than savings accounts from banks because there is more chance of something going wrong and you losing money. Riskier investments tend to offer potentially higher returns as compensation.
Self-Invested Personal Pension Plans (SIPPs)
SIPPS are a personal pension where you or your appointed fund manager is responsible for choosing from a wider range of investments than other pension schemes allow. With a SIPP you can invest in the shares of any company listed on a stock exchange and more exotic investments. SIPPs may incur higher charges than normal personal pensions.
A type of personal pension that has to meet certain standards set by the government. You can take one out yourself or your employer may offer access to a stakeholder scheme.
Your basic State Pension is based on your National Insurance Contribution record. You may also qualify for the additional State Second Pension based on your earnings and National Insurance contributions.
State Second Pension
The State Second Pension is an additional State pension paid on top of your basic State Pension. This was called SERPS. Self-employed people are not entitled to a State Second Pension.
Investing in such a way as to minimise the amount of tax paid. This could mean targeting investment opportunities that are tax-efficient such as ISAs.
The length of your mortgage, policy or investment.
Life assurance protecting you for a specific amount of time for a pre-agreed amount.
A way of taking an income from your pension fund up to age 75, while leaving the rest of your fund invested, but this involves some risk to the value of your pension fund. There are two types of unsecured pension – short-term annuity and income withdrawal.
Open-ended investments where the underlying value of the assets is directly calculated by the total number of units issued multiplied by the unit price less the transaction or management fee charged and any other associated costs. There are many different unit trusts available investing in many different assets.
Whole-of-life insurance, as opposed to term insurance, lasts throughout your life so your dependants are guaranteed a payout.
A general term for the rate of income from an investment expressed as an annualised percentage and based on its current capital value, i.e. the relationship between income generated and the value of the capital.