The A-Z of pension terms

Pensions jargon is so full of
abbreviations and legalese that few can claim to understand it fully. Matt
offers a brief guide to the main terms

Accrual rate The rate at which
pension rights build up for each year of pensionable service completed in a
final salary scheme

Added years – The
allocation of extra benefits by increasing the number of qualifying years’
service for a member of a final salary scheme

Voluntary Contributions (AVCs)
Contributions made by a
member/employee in addition to the individual’s normal contributions to an
occupational scheme

Annuity – A
series of payments to an individual, made at regular intervals until a
particular event occurs, usually the death of the person receiving the annuity
or the end of a specified period

Approved – The
status given by the Pension Schemes Office (PSO) to pension arrangements so
they can benefit from tax advantages

Contract Out – To
opt out of the State Earnings Related Pension Scheme and instead participate in
a private pension arrangement

Deferred Member
A member of an occupational scheme who has left service but has left
benefits remaining in the scheme and has not yet reached normal retirement date

Defined Benefit
Scheme –
An occupational scheme that provides pension benefits based on a
salary at or close to retirement. Also referred to as final salary scheme

Contribution Scheme –
An occupational scheme where benefits are based on the
fund provided by the contributions paid into the scheme, the benefits of which
rely on investment growth made on these contributions. Also referred to as
money purchase scheme

Earnings Cap – The
maximum level of earnings on which a person can base their benefits and
contributions for occupational schemes. This is £97,200 for the tax year
2002/03, and usually rises annually in line with prices

Final Salary
Scheme –
See Defined Benefit Scheme

Free Standing
Contributions paid by members of occupational pension schemes
into separate arrangements to purchase additional benefits in retirement

Minimum Pension (GMP) –
The minimum pension that an occupational scheme may
provide in order to contract-out of SERPS for pre-6 April 1997 service

Group Personal
Pension Plan (GPPP) –
A scheme usually established by an employer
comprising a collection of individual personal pension plans

Income Drawdown
A method of deferring annuity purchase by withdrawal of income from a
SSAS personal pension or defined contribution scheme

Minimum Funding
Requirement (MFR) –
A method of valuing the assets and liabilities of final
salary schemes to ensure that the value of assets is on course to meet pension

Money Purchase
Scheme –
See Defined Contribution Scheme

Pension Scheme –
An approved pension scheme established by an employer to
provide benefits for employees

Open Market
Option –
The option to purchase an annuity from any authorised provider to
secure a favourable annuity rate

Pension Plans –
An individual arrangement operating on a money purchase
basis introduced on 1 July 1988. Unlike occupational schemes, they are
available to individuals who are self-employed or in non-pensionable employment

Rights ñ
The benefits built-up in a contracted-out money purchase pension
arrangement from the payment of minimum contributions from the DSS

Annuity Policy –
An individual contract on a money purchase basis available
for individuals who were self-employed or in non-pensionable employment.
Replaced by Personal Pension Plans but increments can however be made to
existing contracts

Section 32
Policy –
A policy established under Section 32 of the Finance Act 1981 for
accepting transfers from occupational schemes

Personal Pension (SIPP) –
A personal pension arrangement whereby the member
has some degree of control over investments

Small Self
Administered Scheme (SSAS) –
An occupational pension scheme, normally with
less than 12 members, where at least one of those members is connected with
another member, or with a trustee or an employer in relation to the scheme. A
proportion of the schemes’ assets must be invested in non-insured products
(unit trusts, stocks and shares etc)

Pension –
An occupational money purchase or personal pension scheme which
meets the regulatory requirements introduced by the Welfare Reform and Pensions
Act 1999. Charges are restricted to a maximum of 1 per cent of Annual Fund
Management Charge

State Earnings
Related Pension Scheme (SERPS) –
Part of the state pension scheme which
provides earnings related benefits for employees. Based on earnings between the
lower and upper National Insurance earnings limits

State Second
Pension –
A replacement for SERPS as the second tier of state pension with
revised contracted-out rebates effective from 6 April 2002

Tax-free Cash –
A tax-free lump sum received by an individual from their pension fund.
Essentially, this means the individual takes some of their pension fund as a
tax-free one-off payment, rather than using the whole pension fund to provide a
regular income. The amount a person can take is subject to Inland Revenue
limits: for personal pensions the maximum is 25 per cent of the fund; under
retirement annuities, the maximum is usually three times the residual pension;
with occupational schemes, the maximum is 3/80ths of final salary for each year
of service

Schemes –
These are non-Inland Revenue approved schemes that therefore do
not attract the same tax advantages as ‘approved’ pension arrangements. They
are often used to provide benefits on earnings in excess of the earnings cap


Matt Haswell is a consultant
with Smith & Williamson, an independent professional and financial services
Tel: 020
7637 5377 E-mail:


Always take professional advice
before applying the contents of this article

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