– some of those technical financial terms explained!
Uncrystallised is how all pensions start before drawdown. Simply put, it is “money in a pension from which no tax-free cash has been taken”. You are usually able to draw up to 25% tax-free with the remaining 75% subject to tax.
Crystallised is how money is classed after any tax-free cash has been taken from your fund. Simply put, it is “the taxable money left in your pension after having drawn your tax-free cash” – in other words the remaining 75% that is taxable!
Flexible drawdown is the strategy of drawing your pension through a series of withdrawals (either lump sums or income) rather than using the whole lump sum at outset to buy an annuity or guaranteed income for life.
Cappped drawdown has not been available to new plans since 6/4/2015 so no new plans can be entered into. Existing plans can be maintained until converted to a flexible drawdown plan. The amount of income you may draw is linked to something called the “GAD rate” therefore you have limits on how much you can draw.
GAD Rates are published by the Government Actuary Department and are used in the calculation of potential withdrawals in a Capped drawdown plan. They normally use FTSE 15 year gilt yields and members can then withdraw between 0 and 150% of the published GAD rate.
Annuity is where a client “gives away” their pension funds in return for a guaranteed income for life. If they die sooner the lump sum is lost, if they die later they will receive the income for life and possibly way more than the lump sum used.
Pension commencement lump sum (PCLS) is another word for tax-free cash. It will usually be no more than 25% of the uncrystallised pension pot. It can however be higher where someone has “protected tax-free cash”.
Enhanced tax-free cash is where a plan has been around for many years and a client is able to draw more than the standard 25% as a tax-free lump sum. This will have been calculated on 05/04/2006 so is only available with older plans. Upon subsequent transfer, the “enhanced” bit is lost and you become subject to the usual 25%.
Protected tax-free cash is where a member had more tax-free cash rights at 5/4/2006 in excess of £375,000. This is a form of lifetime allowance protection and will protect the sum from the additional tax charge when drawn.
Fixed protection of which there are many (2012, 2014, 2016 for example). When the lifetime allowance was reduced in previous budgets (was £1.8million to £1million), you were able to protect the value of pensions against the (previously higher) lifetime allowance if it was needed.
Stand alone lump sum is found in final salary schemes. Rather than generating tax-free cash using commutation factors (or reducing the income to generate a lump sum) some schemes had a stated and specific value instead. You effectively accrued a “income” and “lump sum” benefit separately during your membership in the scheme.
Defined Benefit is a pension scheme, run, paid for and sponsored by an employer. Instead of each member having their own “pot of money”, for each year you worked at the company, you accrued a future promise of income which was expressed as a % of your (as yet unknown) final salary when you ultimately leave. It is your ex-employers responsibility to pay your income for the rest of your life and is therefore considered very secure (you have no investment risk).
Final Salary is another name given to “defined benefit” pensions.
Defined contribution is a pension scheme where each member has their own “identifiable” pot of money. Usually the members (or their employers or 3rd parties) put money in and it is invested to provide growth. At retirement, the owner then draws the money out to provide income. It is your responsibility to arrange your income for the rest of your life, could run out if it spent too quickly, investments are poor or you live too long and is therefore considered very unsecure (you have the investment risk).
Money purchase is another name given to “defined contribution” pensions.
Gilts or “Gilt-edged Securities” are essentially loans made by the UK Government from investors. In return for borrowing the UK Government (via the Bank of England) money, the Government guarantees to repay the loan on a set date in the future (known as the “principle”) plus an income (known as the “coupon”) usually every 6 months until maturity. Gilts are regarded as “low risk” as the UK Government is seen as a secure borrower.
Conventional gilt are the most common type of debt issued. The loan itself (principal) is a specified amount to be repaid on a specific date whilst the coupon is also fixed. For example an investor may hold £1,000 nominal of 1% Treasury Gilt 2045. Meaning the investor will receive 1% per year (paid 6 monthly) and the capital sum back in 2045.
Index linked gilt first issued in 1981 and make up around 25% of UK debt. The loan itself (principal) is a specified amount to be repaid on a specific date whilst the coupon is also specified but revalued for inflation. For example, an investor may hold £1,000 nominal of 1% Index-linked Treasury Gilt 2045. Meaning the investor will receive 1% per year (paid 6 monthly) but revalued for inflation with RPI being used since start plus the capital sum back in 2045.
Undated gilt is a gilt but where the repayment of the principal was undated. These have now all been repaid as at 05/07/2015 so longer remain relevant.