Chapter 2: Secured Income Options

Question 1

What are the two methods of secured income in retirement

Answer 1

Scheme pension and the lifetime annuity.

Question 2

What is a scheme pension?

Answer 2

A scheme pension is a pension paid to a scheme member directly from a registered pension scheme. Alternatively, it could be paid on the scheme’s behalf by an insurance company selected by the scheme administrator.

• DB schemes can only provide income benefits in the form of scheme pensions.
• Defined contribution (DC) arrangements have the option of offering scheme pensions but are not required to do so.

Question 3

What criteria must be met for an income to be qualify as a Scheme pension?

Answer 3

*Income must be paid at least annually for the remainder of individual’s life.
*Income only reduced in exceptional circumstances.
*Income will be paid by scheme or by chosen insurance provider.
*Benefits can include guarantee period, pension protection, dependant pension

Question 4

Under what circumstances can scheme pension be reduced?

Answer 4

*members ill health
*DB scheme reduces benefits due to financial reason
*Scheme was pension was temporarily high to bridge gap prior to State Pension
*Court order - pension sharing order
*Cases of fraud

Question 5

For members of DB scheme who have GMP and reached SPA on or after 6th April 2016 what are the escalation rules for payments

Answer 5

Pre 1998: GMP Scheme pays level pension, no gov top-up

Post 1988: GMP Scheme responsible for CPI capped at 3%, no gov top-up

Question 6

For members of DB scheme who have non-GMP and reached SPA on or after 6th April 2016 what are the escalation rules for payments

Answer 6

Accrual prior to April 1997: Scheme pays level pension, no gov top-up

Accrual between April 1997 and April 2005: Scheme responsible for CPI capped at 5%

Accrual post April 2005: Scheme responsible for CPI capped at 2.5%

Question 7

George has been a member of his employer’s defined benefit pension scheme since 1979. The scheme was contracted out prior to April 2016. He is about to retire and take his benefits from the scheme which provides statutory increases to pensions in payment.

State the statutory increases that will apply to George’s scheme pension once it is in payment.

Answer 7

• Pre-88 Guaranteed Minimum Pension (GMP) no increases.
• Post-88 GMP in line with CPI capped at 3% per annum.
• Pre-97 excess no increases.
• Post-97 in line with CPI capped at 5%.
• Post-05 in line with CPI capped at 2.5%.

Question 8

What is a pension increase exchange

Answer 8

Pension Increase Exchange (PIE) allows members to exchange future non-statutory increases for a higher initial pension income.

Question 9

Why would a DB scheme offer a PIE

Answer 9

reduce future DB liabilities

Question 10

Identify the key factors that should be considered when deciding whether to accept a PIE

Answer 10

*The level of increases being given up/the amount of increase being offered.
* Immediate income needs/retirement income needs.
* Inflation.
* Health/family longevity.
* Marital status/dependants/spouse’s pension.
* A higher level of pension commencement lump sum (PCLS) may be available.
* Whether PIE would lead to additional income tax liability/tax status.

Question 11

What is a bridging pension

Answer 11

Where a DB scheme has a NRD lower than SPA an increased pension is paid from NRD to SPA to bridge the gap. This extra pension reduces once SPA is in payment

Question 12

What are the death benefit options available to a member of a scheme pension?

Answer 12

Guarantee period

Pension protection (Lump sum)

Dependants continuing income

Question 13

What is the key consideration with regards to guarantee periods and income in the hands of the recipient

Answer 13

The remaining guaranteed payments under the balance of the guarantee period are taxable as income under PAYE for the recipient(s). This is irrespective of the age of the member when they die

Question 14

For lump sums paid from DB schemes on death of a member pre 75, what are the conditions?

Answer 14

*Classed as a relevant BCE.
*Tested against members LSDBA, if the lump sum falls within this value then it is taxed free
*Any excess taxed at recipient marginal rate
*death pre-75 therefore lump sum needs to be exercised within 2 years from date of death.

Question 15

For lump sums paid from DB schemes on death of a member post 75, what are the conditions?

Answer 15

*no two year timescale
*100% lump sum taxed in hands of recipient
*no check against LSDBA

Question 16

What is a pension protection lump sum?

Answer 16

*DB schemes may offer this as a death benefit
*Members income is capitalised by factor of 20:1
*Max lump sum paid out is 100% of capital less total income (income x years) received by the member.
*payment must be made by scheme within 2 years
*death pre-5 tested against LSDBA
death post 75 not test 100% taxable

Question 17

What is annuity protection

Answer 17

*Same as pension protection but comes from DC pot or annuity
*capital value of pot used to purchase annuity less total income payments
*may choose to add 50% capital protection, so value of DC pot would be haled
*paid out as lump sum tax-free within LSDBA pre-75
*fully taxable post age 75

Question 18

What are the death benefit options for a dependants pension from a scheme pension

Answer 18

A dependant’s benefits on the death of a member in receipt of a scheme pension paid from a DC arrangement can be made in the form of a scheme pension, lifetime annuity or drawdown pension, paid to a dependant of the deceased.

If the member’s scheme pension is paid from a DB scheme, the dependant’s pension can only be paid as a scheme pension.

Question 19

A dependant’s pension paid as a scheme pension has certain conditions attached to it:

Answer 19

• It must not be subject to any guarantee period.
• It cannot have pension/annuity protection.
• It cannot be surrendered or assigned except under a pension-sharing order.
• It can be transferred in payment.
• It cannot provide any further benefit on the dependant’s death.
• It is non-commutable other than on grounds of triviality.

Question 20

What is the key consideration regarding a dependant’s pension and age 75?

Answer 20

Death before the member reaches age 75, there are no restrictions on the size of the dependant’s benefits.

Death after 75 the aggregate of the dependant’s benefits cannot exceed the member’s scheme pension. Any excess dependant’s scheme pension is treated as an unauthorised payment and is taxed accordingly.

The member’s scheme pension at the date of death is calculated as:
* the member’s actual (and prospective) scheme pensions payable under the scheme in the year to the date of death; plus
* 5% of any PCLS (tax-free lump sum) drawn by the member.

Question 21

How is a dependant’s pension taxed?

Answer 21

Taxable in the hands of the recipient. Age at death is not a factor.

Question 22

To whom can death benefits from a Scheme Pension be paid to?

Answer 22

A dependant

Question 23

Who is classed as a dependant?

Answer 23

*Spouse/civil partner
*Child who is less than 23 or 23 and is dependant due to physical or mental on member
*An other who:
– the person was financially dependent on the member;
– the person’s financial relationship with the member was one of mutual dependence;
– the person was dependent on the member because of physical or mental impairment.

Question 24

when will an annuity trigger the MPAA

Answer 24

Where the income provided by the annuity increases and decreases, i.e. a flexible annuity this will trigger MPAA as annuitant is deemed to have accessed benefits flexibly.

MPAA will be triggered from date of first income payment is made.

Question 25

State eight factors that will influence annuity rates.

Answer 25

• Age/longevity/mortality rates.
• Fund size.
• Escalation.
• Survivors’ benefits/guarantees/annuity protection.
• Lifestyle/health/medical condition.
• Postcode/geographical location.
• Gilt yields/competitiveness of annuity market.
• Adviser charges/costs of setting up annuity.
• Payment frequency/in advance/arrears/with/without overlap.
• Length of fixed term.

Question 26

Difference between dependant and nominee

Answer 26

Dependant: Satisfies HMRC rules as stated above (Spouse, child under 23, a n other who is dependant)

Nominee: anyone essentially

Question 27

Death benefits available from an annuity?

Answer 27

1. survivor’s annuity;
2. remaining income due in a guarantee period
3. pension/annuity protection lump sums (also known as capital protection).

Question 28

How is dependant or nominee income from an annuity paid on death pre and post 75

Answer 28

Pre 75: tax-free (secured within 2 year period if from uncrystallised funds and income started post April 2015 to person who died)

Post 75: Taxable at marginal rate

Question 29

Conditions of beneficiary annuity?

Answer 29

• must not be subject to any guarantee period;
• cannot have pension/annuity protection;
• cannot currently be surrendered or assigned, except under a pension-sharing order;
• can be transferred in payment;
• cannot provide any further benefit on the beneficiary’s death; and
• is non-commutable, other than on grounds of triviality.