Chapter 1 (5 Questions) Flashcards
Role of the Government and policy direction
shaped pension provision in the UK
changes to the rules and legislation applicable to pensions, to:
- increase protection available to members of pension schemes and
- to encourage pension provision.
Challenges to pension incomes (6)
Amount of pension savings
Falling stock markets, gilt yields and annuity rates
Pensions are complex
Incentives, disincentives and attitudes to saving
Corporate environmental factors
Impact of demographic trends on pension provision
Amount of pension savings
shortfall between what we should be saving and actually saving.
average UK pension pot at age 65 is £73,568
Many companies are closing their defined benefit (final salary) schemes and replacing them with defined contribution schemes, where the risk is borne by the member and guarantees are lost.
Falling stock markets, gilt yields and annuity rates
Annuity rates are based on gilt yields.
Pension annuity rates have increased over the last couple of years, but any cut in interest rates is expected to cause annuity rates to fall again.
Pensions are complex
Most people struggle to understand the different types of pension arrangement, and this confusion has been added to by the pension flexibilities.
Too many people believe that the State Pension is adequate.
Impact of demographic trends on pension provision
Increased life expectancy has:
* contributed to the move away from final salary schemes;
* reduced the annuity rates available; and
* increased the cost of providing the State Pension.
In addition, the pension flexibilities mean fewer people are buying annuities and have increased the risk that someone could outlive their funds.
Pension incentive - Corporate environmental factors (4)
auto-enrolment has increased the amount people are saving towards retirement;
pension flexibility encouraged those who were put off saving into a pension by the restrictions on how benefits could be taken to save towards retirement; and
the decline of defined benefit schemes: due largely to their cost, increased longevity and falling annuity rates.
the change in working patterns: instead of working for one employer and having one pension, people work for several employers
Pension incentives - Incentives, disincentives and attitudes to saving (7)
- income tax relief on contributions made by individuals;
- contributions made by employers treated as a business expense for corporation tax or income tax purposes;
- profits are exempt from income tax and CGT;
- tax-free cash lump sum (PCLS);
- take benefits from a defined contribution scheme when and how they choose as a result of the flexibilities; and
- the ability to pass defined contribution pension funds to any beneficiary and the more favourable tax treatment of death benefits.
Most employers offer a work based pension for their employees.
Disincentives (6)
- limit to the amount that can be taken as a tax-free cash lump sum.
- limit on how much is eligible for tax relief.
- Benefits cannot be taken before the minimum pension age.
- Pensions are complex
- People think that pensions are expensive.
- general mistrust of pensions
Attitudes to saving (3)
- affordability: other demands on a person’s income take priority;
- belief that the State Pension will provide; and
- retirement is a long time away so saving for it feels low priority.
State Pensions
The amount depends on their National Insurance contributions.
Those who retired before 6 April 2016 were eligible for the State benefits in force at that time. These included a Basic State pension plus a number of different types of earnings related additional State Pension.
Those who retired on or after 6 April 2016 receive the new State Pension. Any benefits accrued under the additional State Pensions, including any contracted out periods, are taken into account when calculating how much this should be.
Defined benefit (or final salary) schemes
These provide benefits that are guaranteed to be a proportion of final salary at retirement or death based on:
* pensionable service;
* pensionable remuneration; and
* the accrual rate.
A pension commencement lump sum is also payable.
Defined contribution (or money purchase) schemes
With a defined contribution scheme, a fund builds up and the benefits provided depend on the size of the fund.
If a lifetime annuity is chosen, then the amount of income will also depend on the annuity rates available at that time.
A PCLS, usually limited to 25% of the fund, is also generally payable.
May be an occupational scheme provided by an employer for the benefit of the employees, or it may be an individual arrangement funded by the member (and sometimes by the employer as well).
An individual can take as much or as little as they like from their defined contribution arrangements once they reach normal pension age, or earlier if they are in ill-health or have a protected pension age.
A lifetime annuity
- The fund buys a contract from an insurance company that provides an income for life. The amount depends on the size of the fund and the annuity rate.
A scheme pension
- The scheme administrator uses the balance of the fund to secure an income for life for the member. For a defined contribution scheme this is similar to a lifetime annuity in that the amount of income provided depends upon the size of the fund and scheme pension rates available.
A drawdown pension:
- An income is drawn directly from a defined contribution fund. There are two different forms of drawdown
Capped drawdown
- The amount of income that can be drawn each year is subject to limits set by the Government Actuary’s Department (GAD).
Flexi- access drawdown (FAD)
- There are no restrictions on the amount of income that can be drawn each year.
An uncrystallised funds pension lump sum (UFPLS)
- A lump sum taken from an uncrystallised defined contribution fund. The member can take as much or as little as they like. Up to 25% is tax-free, with the balance taxed as pension income via PAYE.
Dependant
Defined by HMRC as someone who meets one of the following:
* the member’s widow(er)/civil partner at the time of the member’s death; or
* a child of the member who is under the age of 23 at the date of the member’s death; or
* a child of the member who was dependent on them due to mental or physical impairment at the date of death; or
* a person who was not married to/in a civil partnership with the member at the date of the member’s death, but who, in the opinion of the scheme administrator, was;
– financially dependent on the member, or
– in a financial relationship of mutual dependence with the member, or
– dependent on the member because of their physical or mental impairment.
Nominee
A nominee is any individual, other than a dependant, nominated by the member to receive the benefits from a pension plan upon the member’s death.
Successor
An individual nominated by a dependant or nominee to continue to receive their flexi-access drawdown. A successor can also be someone nominated to continue to receive the income from a previous successor’s flexi-access drawdown.
Issue for pensions with People living longe
Proportion of people paying tax and National Insurance is falling compared to those receiving State Pensions, which is a problem because it is funded on a pay-as-you-go basis.
Pension Act 1995
Set up regulatory and compensation schemes for greater protection and brought in minimum funding and mandatory increases to pensions in payment
FRS17
2001 accounting rules. Required companies to report deficits and surpluses in that year
Pensions Act 2004
Introduced Pension Protection Fund ensuring members get some benefit in the event of employer insolvency
Minimum income guarantee
For poorest pensions to receiving minimum level of income
State Pension credit
- Means tested top ups for poorest pensioners
A Day
6 April 2006. Single tax regime introduced.
Introduced AA and LA. Both have been reduced so a number of transitional protections implemented.
6 April 2016
Tapered annual allowance for higher earners
6 April 2024
Lifetime allowance abolished and replaced with rules limiting tax free lump sum amount
Stakeholder pensions
Introduced 2001 and employers had to offer access to one
Automatic enrolment
October 2012
6 April 2015
Flexible benefit options introduced
Applied to DCS and independent advice required for those transferring out of DBS
PENSION wise introduced to offer guidance to those wishing to access savings
Pre April 2016 state pensions
Made up of basic state pensions and a number of additional state pensions
ASPs we generally only for employees and changed several times including intro of the State Second Pension in 2002
State second pension
2002
For low earners and those receiving state benefits eg. Carers allowance.
State pensions April 2016
Apart from state guarantee credit, all replaced by new State Pension (single tier).
Must have 35 years NI contributions to qualify in full.
Additional State Pension pre 6 April 2016
Possible to contract out ASP via a defined benefit scheme so member didn’t get any ASP for period of service. Instead scheme gave a minimum level of benefits.
State Pension Age
Men/woman
Until April 2010 - 65/60
SPA gradually increased for women to 65 over 8 years ending in November 2018.
Since dec 2018 SPA increase for both men and women to 66 in October 2020
Increase by 2028 67. Should be reviewed every parliament, meaning SPA of a 16 year old could be 77/78
Defined benefit schemeA
Pension is a proportion of the employee’s final salary at or close to retirement.
This is a valuable guarantee as it means their retirement income is unaffected
by fluctuations in investment returns or annuity rates as retirement approaches.
• pensionable service: this is usually the employee’s period of membership in
the scheme;
• pensionable remuneration: this is the definition of salary that is used to calculate the
member’s benefits; and
• the accrual rate: the rules of the scheme will determine the rate at which benefits accrue,
e.g. 1/60th of pensionable remuneration for each year of pensionable service.
Defined contribution scheme
Pension is provided from a pension fund and the employee bears both the
investment risk and, if an annuity is purchased, the annuity risk. If the fund
performs badly and/or annuity rates fall at or close to retirement, pension
income could be significantly reduced.
Basic State Pension
Provided to any individual with an
adequate National Insurance
contribution record.
State Graduated
Pension Scheme
Available between 1961
and 1975, this was the
first State pension
scheme to provide
employees with an
additional earnings
related pension on top of
the Basic State Pension.
State Earnings Related
Pension Scheme
(SERPS)
This is the earnings
related part of the State
pension that applied to
employees between
1978 and 2002.
State Second
Pension (S2P)
Replaced SERPS in 2002 and applies to the
employed, carers and some people with
long-term disabilities who have broken work
records.
