CMC Invest’s jargon busting guide for pensions

Important: This article is for general guidance purposes only and should not be considered investment advice. If you are unsure about the suitability of an investment, please seek out independent financial advice. When you invest, your capital is at risk. Tax treatment will depend on your individual circumstances and could potentially change in the future.Pension rules apply. 

When it comes to pensions, the sheer volume of specialised terms can be intimidating for investors. 

If you’ve ever found yourself wondering what terms like “crystallisation” or “carry forward” mean, then read on. We’ve compiled some of the most frequent terms you’re likely to come across where pensions are concerned. 

Let’s get jargon busting… 

Annual allowance (AA)

Your annual allowance is the amount you can contribute across all your pension accounts in any given tax year while still receiving tax relief. Currently, this is either an amount equal to your taxed income or £60,000 – whichever is higher. The government sets this and it can change in the future. It’s also further reduced (to a minimum of £10,000) for high earners through a process known as tapering.

All contributions made to any of your pensions count towards this limit. If your employer matches your contributions to your workplace pension, for example, this will count towards your annual allowance. Any tax relief you receive will also count towards it. 

Once you start taking taxed payments from any pension, the annual allowance is replaced by the lower money purchase annual allowance, which we address in more detail below.

Carry forward

If you’ve maxed out your annual allowance in any one tax year, you can make use of any unused annual allowance from the past three tax years. This is called carry forward.

Certain conditions need to be met in order to use carry forward. These are outlined in our primer on pension allowance, which you can find here.

The Lifetime pension allowance (LTA)

The Lifetime pension allowance is the maximum amount you can contribute across your pension accounts during your lifetime before receiving a tax charge. This is set to be abolished on 6 April 2024, when the new tax year begins. 

Two new allowances will be introduced, the lump sum allowance and the lump sum and death benefits allowance which will limit the amount you can take out tax-free.

Tapering 

High earners are subjected to tapering on their annual allowance. In other words, after your annual taxed earnings exceed a certain amount, your annual allowance will be reduced. 

You can read more about how this is calculated here. 

Defined contribution pension

Defined contribution pensions are workplace or personal pensions that enable you to build-up your pension pot so you can rely on it for income in the future. 

These pensions don’t have any guarantee about how much income will be available to you in retirement. Instead, this will be determined by a number of factors including how much you (and/or your employer) contribute to your pension, how long you contribute for and the performance of investments in your portfolio. 

Defined benefit pension

Defined benefit pensions (sometimes referred to as a “final salary scheme”) are provided by employers. They provide participants with a guaranteed income later in life. This could be determined by your final salary or your average income over your career and how long you’ve been a member of the pension scheme. 

Safeguarded benefits

A safeguarded benefit pension is one which, although not a defined benefit scheme, includes some form of guarantee. An example might be conversion options or guaranteed annuity rates. Many people may have safeguarded benefits as part of their pension but might not be aware of this. 

Normal minimum pension age (NMPA)

Put simply, this is the earliest age at which you can start withdrawing money from your pension pot, as set by the government. 

Currently, you can begin withdrawing from your pension pot at 55. This is rising to 57 in 2028. You don’t have to start taking money from your pension at this age, but making a withdrawal before this will result in a tax penalty. There are some scenarios where you’d be able to withdraw money from your pot before this age – an example being if you had been diagnosed with a terminal illness. 

It’s important not to confuse the minimum pension age with your retirement age – that’s the age you cease working and, obviously, differs for everyone. It’s also not the same thing as the age at which, if eligible, you’ll start receiving your state pension. This is currently 66 for those born between 6 April 1954 and 5 April 1960. 

Crystallisation 

This is a term used to refer to an administrative step that’s taken when you make a tax-free withdrawal from your pension pot.

You are able to withdraw 25% of your pension pot as a tax-free lump sum. Many pension providers allow you to do this in stages, rather than taking the 25% in one go. 

For every £1 you withdraw tax-free as part of this process, £3 is “moved” into a drawdown account. This is a purely administrative step – you won’t have another pension account opened for you.

Before you withdraw any money, both the portion you’re planning on withdrawing and the sum being set aside is said to be crystallised.

Let’s look at this in practice. Let’s say your pension pot is £100,000. If you withdraw your 25% tax-free lump sum all in one go, then you’ve crystallised your whole pension pot.

If, however, you want to take £10,000 as a tax-free lump sum you’ll need to crystallise £40,000 of your pension pot to do this.

Uncrystallised fundspension commencement lump sum (UFPLS)

A rather cumbersome title for a withdrawal made from your pension pot that is partly taxed and partly tax-free. You can make as many withdrawals of this nature as you want from funds in your pension pot that have not already been crystallised. 

For more information on withdrawing money from your pension pot, please check out our more comprehensive guide here. 

Money purchase annual allowance (MPAA)

Once you have taken any taxable benefit from any of your defined contribution pension accounts, you can only pay in £10,000 annually across all your pensions while still receiving tax relief. This is called the money purchase annual allowance. Just like the annual allowance, the government sets this and it can change in the future. There’s no“carry forward”option once you are subject to the MPAA.

Once again, let’s look at this in practice. If you take 25% of your pot as a tax-free lump sum, leaving the remainder invested, you will still be able to contribute up to your annual allowance until you start withdrawing the remaining amount. Once you start to take money from the remainder, you’ll only be able to contribute £10,000 annually to your pot. 

Alternatively, let’s say you took an uncrystallised lump sum from your pension pot, which as we know is part taxed and part tax-free. As soon as you do this, your annual allowance will be reduced to the money purchase annual allowance since you’ve redeemed a taxable benefit from your pension.