Pensions are one of the most popular ways to save for retirement.

Yet worryingly, according to research by Aviva, only 4 in 10 Brits think they “understand enough about their pensions”. That’s despite the fact that pensions represent the largest proportion of private wealth in the UK, totalling an impressive £6.4 trillion.

In fact, the complicated nature of these retirement pots led to pensions minister, Guy Opperman, describing pensions costs and charges as “impossible to comprehend”, calling for providers to “make it more accessible”.

At Cordiner Wealth, we always explain your pension to you in detail, so that you fully understand how we’re managing your retirement fund.

But, if you’d like a quick refresher or there are elements that you’re not quite sure on, here’s a rundown of some of the most important terms you need to know to help you understand your pension.

Tax relief at source

Tax relief may sound complicated, but it’s a surprisingly simple concept.

Tax relief removes the Income Tax you would have paid on your pension contributions and sees it added to your fund instead.

Essentially, this means that a £100 pension contribution “costs”:

  • £80 for non-taxpayers and basic-rate taxpayers
  • £60 for higher-rate taxpayers
  • £55 for additional-rate taxpayers.

Basic-rate tax relief is applied automatically, and you must claim higher- or additional-rate tax relief through your self-assessment tax return.

Tax relief can make a significant difference to the total amount in your fund, giving your contributions a healthy boost.

Annual Allowance

The pension Annual Allowance is the maximum amount you can contribute across all your pensions in a single tax year while still receiving tax relief.

In the 2021/22 and 2022/23 tax years, this amount is £40,000 or 100% of your earnings, whichever is lower.

Tapered Annual Allowance

If you’re a high earner, your Annual Allowance may be reduced. The taper comes into effect if both your:

  • Threshold income (i.e., excluding pension contributions) is more than £200,000
  • Adjusted income (i.e., including pension contributions) is more than £240,000.

This would see your Annual Allowance reduced by £1 for every £2 you exceed the adjusted income threshold, up to a maximum of £36,000.

That means, if your adjusted income is £312,000 or more, your Annual Allowance will be reduced to just £4,000.

Money Purchase Annual Allowance

The Money Purchase Annual Allowance (MPAA) may affect you if you’ve started to flexibly draw from your defined contribution (DC) pension. This doesn’t include your 25% lump sum.

The MPAA reduces your Annual Allowance to the lower of either £4,000 or 100% of your earnings.

It’s important to note that you won’t be affected by the MPAA if you have a defined benefit (DB) pension scheme. Read on to find out more about what this means.

Defined benefit (DB) vs defined contribution (DC)

A DC pension scheme means the amount you receive in retirement is based on how much you put in during your working life. This includes employer contributions, tax relief, and any investment returns your savings generate.

Meanwhile, a DB pension – also known as a “final salary” pension – is instead calculated based on your salary while working for your employer, and how many years you worked for them.

While DB pensions are less common these days, you may still have one from a previous job. However, most workplace schemes are now DC.

Lifetime Allowance

The Lifetime Allowance (LTA) is the maximum amount you can save across all your pensions in your lifetime without incurring a tax charge when you come to withdraw it.

The LTA currently stands at £1,073,100 where it will be frozen until at least 2026.

If your pensions exceed the LTA, you will face a tax charge of either:

  • 55% if you draw your pension as a lump sum
  • 25% if you draw your pension as income. This will be on top of your marginal rate of Income Tax.

There are options available for things you can do to reduce your tax bill if you think you’re going to exceed the LTA. Please speak to us if you’d like to find out more.

Need help?

At Cordiner Wealth, we manage your pension for you to make sure it will be suitable for your desired lifestyle.

If you’re confused about any element of your pension, please do get in touch with us.

Email or call 0113 262 1242 to find out more.

Please note

The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Levels, bases of and reliefs from taxation may be subject to change and their value depends on the individual circumstances of the investor.

Workplace pensions are regulated by The Pension Regulator.