Pension Annuity Glossary of Terms
This section details the terms used in relation to pension annuities. Annuities are a complex financial product, meaning that some of the terms may be unclear at first.
Use the annuity glossary as a guide to better understand what pension annuities are and how they can improve your retirement income.
Annuity (pension annuity) – A contract bought using a pension fund. The annuity provides a retirement income in regular payments for the rest of the pension holder’s life.
Annuity payments – A monthly payment made to the pension holder who has purchased an annuity. The level of annuity payments depends on the size of the pension fund, the annuity option chosen, the age, gender and health of the pension holder, and the additional benefits included in the annuity.
Annuity protection (value protection) – Annuity protection guarantees that the pension fund (less annuity payments already paid) is given to a named beneficiary after tax. Generally an option only for deaths before the age of 75.
Conventional annuity – A conventional annuity is a simple form of pension annuity that provides an income for life. These annuity payments are not subject to annuity risks such as investment risk or mortality risks. Income will continue to be paid out until the death of the annuity holder. Conventional annuities are the most common retirement income annuity.
Defined Benefit Pension Scheme (final salary pension scheme) – This type of pension scheme clearly outlines the retirement income that the employee gets, usually based on the number of years worked and the final salary before retirement or changing jobs.
Defined Contribution pension scheme (money purchase scheme) – This type of pension scheme describes a pension where the employer and employee pays a set amount into a pension fund. This type of scheme is subject to investment risk.
Enhanced Annuity – Enhanced annuities are a type of annuity that gives the pension holder a higher income due to a medical or lifestyle reason that shortens life expectancy. For instance, this may include habits such as smoking or drinking, medical history or lifestyle.
Escalation – Escalation is a way in which annuity income climbs every year. Annuities can be set at no escalation (known as a level annuity), a fixed increase annuity, or an annuity linked to the retail price index.
Guarantee period – If the pension holder dies after purchasing the annuity, they may feel that they haven’t received good value for money. Therefore, annuity buyers can stipulate a minimum guarantee period that means the annuity income will continue to be paid during the period, regardless of the death of the buyer.
Impaired Annuity (Impaired Life Annuity) – Impaired annuities are a type of annuity that pays out a higher income than an enhanced annuity. Impaired annuities are suitable for those people that have a significantly lower life expectancy due to an ongoing medical condition. Conditions that may qualify for an impaired annuity may include heart attacks, heart surgery or angina, life threatening cancers, organ diseases, strokes, diabetes and more.
In Advance/In arrears annuity payments – The annuity buyer can choose to set up annuity payments so that they start as soon as the annuity has been set up (known as advance) or at the end of the chosen payment frequency (in arrears.) Advance payments are more common.
Investment-linked Annuity – Investment-linked annuities are a type of annuity from which the retirement income may fluctuate. The value of the fund is linked to the performance of an investment fund, or spread across several investment funds. When investment returns perform well, the income from the investment improves and annuity income payments will increase. However, if investment returns are poor, then the annuity income payments may also fall. Investment annuities include with-profits annuities and unit-linked annuities.
Joint Life Annuity – A joint life annuity will transfer annuity income to a named dependant in the event of the death of the annuity buyer. The buyer chooses whether income is paid to a dependant.
Occupational pension – An occupational pension is a retirement income received from a scheme provided by an employer or previous employer/employers.
Open market option – An open market option provides the ability for the annuity buyer to use their pension fund to purchase an annuity from any annuity provider. The buyer can search the market for the best and most appropriate rate.
Annuity payment frequency – Annuity buyers can choose the frequency at which their annuities are paid. The frequency of the payments will depend on the retirement circumstances of the buyer. Annuity income is usually paid monthly, quarterly, half-yearly or on an annual basis.
Pension Commencement Lump Sum (Tax-free cash) – A percentage of a pension fund can usually be taken as a cash lump sum which is tax-free. This used to be referred to as a tax-free lump sum, and may be spent however the pension holder sees fit.
Pension fund – The pension fund refers to the total value of the pension plan built up through years of contributions, including those made by your employer or any tax relief or national insurance contribution rebates.
Personal pension – A personal pension is a financial services product taken out by an individual using an insurance company or bank. This type of pension scheme is available to both unemployed and self-employed individuals.
Short-term Annuity – Some retirees purchase a short-term annuity with some of their pension fund, leaving the remainder invested.
Third-way products – Third-way products are a financial services product that combines a guarantee and an investment.
Unit-linked Annuity – Unit-linked annuities ties the annuity income to the performance of an underlying investment asset. This asset is usually shares in a company or companies, chosen by a fund manager. Retirement income will vary and is not guaranteed.
Unsecured pension (Income drawdown) – Upon retirement, the pension holder can keep their pension fund invested and take income from that invested fund rather than purchase an annuity. There is an element of risk in this and it is generally recommended for those with a large pension fund or those with alternative sources of retirement income.
With-profits annuity – A with-profits annuity directly links annuity income with the performance of a with-profits fund. Therefore, the retirement income is linked to an annual bonus rate declared by the annuity provider, rather than a guaranteed lifetime income.
With/Without Overlap – Overlap is relevant in the case of joint life pension annuities with guarantee periods. If the pension holder dies during the guarantee period, with overlap means payments will begin immediately (including tax and less the annuity income already taken), whilst without overlap means that the dependents payments will start after the guarantee period.
With/Without proportion – Proportion is relevant to those annuity buyers who have chosen to receive their annuity income payments in arrears. With proportion means that the final proportionate payment is made to your estate to cover the period between last payment and death. Without proportion refers to final annuity payment a the last scheduled payment before death.
