Chapter 5 Key Issues Relating To Pension Transfers

Question 1

Calculating the available LTA?

Answer 1

Refer page 278.

“Example 5.2
John is a member of a defined benefits arrangement. He decides to take his benefits in 2018/19 when the LTA is £1.03m. John has already used up 90% of his LTA and has no transitional protection in place. He is entitled to a scheme pension of £8,500 per annum and a lump sum of £42,500.

Before paying out, the scheme administrator calculates the value of these benefits to test against the LTA.

(£8,500 × 20) + £42,500 = £212,500
This amounts to 20.63% of the current LTA.
As John has already used 90% of his LTA, he only has 10% (£1.03 million at 10% = £103,000) of his LTA available to set against these benefits, therefore he will be subject to a LTA charge on the excess (£212,500 – £103,000 = £109,500).”

Question 2

Benefit Crystallisation Events:

Answer 2

“5A2 Benefit crystallisation events (BCEs)
A BCE arises in the following circumstances:

Benefit crystallisation event (BCE)

Valuation basis

See Note

BCE 1: Drawdown pension
The designation of money purchase assets to provide for the payment of a drawdown pension.
The market value of the fund.

1

BCE 2: Entitlement to a scheme pension
The member becoming entitled to a scheme pension.
Scheme pension × 20.

2

BCE 3: Excessive increase to scheme pension in payment
The increase of a scheme pension already in payment beyond a permitted margin.
The additional increase × 20.

3

BCE 4: Purchase of a lifetime annuity
The member becoming entitled to a lifetime annuity purchased under a money purchase arrangement.
The market value of the fund used to purchase the lifetime annuity.

BCE 5: Defined benefit test at age 75
The member reaching age 75 under a defined benefit arrangement without having drawn all or part of their entitlement to a scheme pension and/or lump sum.
Scheme pension × 20 plus the amount of the lump sum.

BCE 5A: Test at age 75 for drawdown pension
The member reaching age 75 with an earlier designated drawdown pension fund which has not been secured by a lifetime Annuity or scheme pension.
“Market value of the member’s capped drawdown pension at age 75 less the market value of that designated for drawdown pension at the outset.”

“BCE 5B: Test at age 75 for uncrystallised money purchase funds
The member reaching age 75 under a money purchase arrangement in which there are remaining uncrystallised funds.
The amount of any remaining uncrystallised funds.

BCE 5C: Unused uncrystallised funds designated for drawdown following the member’s death
The member dies before age 75 and uncrystallised funds remaining at death are designated (before the end of the two-year relevant period following the member’s death) to a dependant’s or nominee’s flexi-access drawdown pension.
The market value of the assets designated as available for drawdown.

4, 5

BCE 5D: Unused uncrystallised funds used to purchase a lifetime annuity following the member’s death
The member dies before age 75 and uncrystallised funds remaining at death are used (before the end of the two-year relevant period following the member’s death) to purchase a dependant’s or nominee’s lifetime annuity.
The market value of the assets used to purchase the lifetime annuity.”

“BCE 6: Relevant lump sums
The member becoming entitled to a relevant lump sum, e.g. on retirement.
The amount of the lump sum.

6

BCE 7: Relevant lump sum death benefits
A relevant lump sum death benefit being paid in respect of the member, either from a defined benefit scheme or from uncrystallised funds of a money purchase arrangement.
The amount of the lump-sum death benefit.

BCE 8: Transfers overseas
A transfer to a qualifying recognised overseas pension scheme (QROPS).
The amount of the transfer value.

BCE 9: Prescribed event
Where certain payments are made to or in respect of a member that constitutes an event that is prescribed in the regulations.
The amount prescribed in the regulations.”

“Similarly, under the BCEs that take place at age 75 (BCE 5, BCE 5A and BCE 5B), no lump sum is physically paid out to the member, because benefits have not yet actually been taken, so any LTA charge is at the rate of 25%.”

Question 3

When Benefits started before A-Day:

Answer 3

“If benefits were already in payment before A-Day, a different approach is used to determine the amount of unused LTA available.

A standard 25:1 valuation factor is used for pre-A-Day income benefits. A deemed BCE means that although the pre-A-Day payment will use up part or all of the member’s LTA, leaving less or no LTA for the actual BCE occurringto be tested against, it will nonetheless not result in a LTA excess charge being levied against itself.

Where the pre-A-Day income was in the form of a lifetime annuity or scheme pension the calculation is very straightforward. For example, if an annuity was purchased, £10,000 of annuity income is valued at £250,000. The factor is applied to the annual payment in force when the first BCE on or after A-Day occurs. Where the pre-A-Day payment escalates each year in payment, as with a defined benefit scheme, for example, then the valuation factor is applied to the amount payable at the date of the first BCE after A-Day when it is brought into charge, and not to the original payment. “If when valued the pre-A-Day payment exceeds the available LTA at the time of the BCE then there will be no LTA excess charge on the pre-A-Day payment (as it is a deemed BCE), but will have the knock-on impact for the actual BCE that is occurring at that time, leaving no LTA to test against. This means that the entire BCE will then be subject to a LTA excess charge and no PCLS will be available as no LTA remains.”

Question 4

More on valuation of benefits started before A-Day:

Answer 4

“The reason the calculation is now 80% of 25 × maximum GAD income is because the maximum income from a capped drawdown contract was increased from 120% of the basis amount to 150% of the basis amount on 27 March 2014.

When you multiply 150% by 80% you arrive back at 120%. Where the member had a flexible drawdown plan prior to 27 March 2014 the 80% does not appear in the calculation, because at the time the declaration was made the maximum income from a capped drawdown pension was still 120% of the basis amount. Effectively in all cases the calculation results in a figure of 120% of the basis amount (multiplied by 25).

The 25:1 factor (and the 80% where appropriate) is applied to the maximum permitted withdrawal as calculated at the most recent review. The actual level of income being drawn (which could be nil), PCLS received and fund value are all ignored.

The important point to note here is that the valuation of the benefits that started before A-Day only takes place on the first BCE that happens after A-Day. “This establishes the percentage of the LTA that was used up by the benefits that started before A-Day. This percentage is then used for all future BCEs – it does not have to be recalculated even if the value of the pre-A-Day income has subsequently increased (e.g. because of an increase in the GAD rate or escalation in annuity income).”

Question 5

Pension credits on Divorce?

Answer 5

Refer to pages 291 -293.

Question 6

Maximum Permitted pension:

Answer 6

“maximum permitted pension (MPP).

The MPP is the amount of pension that could have been paid to the member (assuming they were in good health) on 5 April 2006 without giving HMRC grounds for withdrawing the approval of the scheme. It takes account of the member’s service to 5 April 2006, the appropriate definition of ‘final remuneration‘ at that date, the occupational tax regime they belonged to and, in certain circumstances, retained benefits. This restriction was introduced to ensure benefits that were excessive under the regime applicable to the individual before A-Day are not afforded protection under the new regime.

If an excess amount was identified, the way in which it was treated depended upon the type of protection chosen. If an individual opted for primary protection, only the amount up to the value of the MPP could be made subject to primary protection. The excess capital value could have been carried over into a registered scheme and thus still be available to provide pension benefits. This excess capital value would normally be subject to a LTA charge although this will depend on both the rate of investment return achieved and the rate of increase in the standard LTA from A-Day until the member crystallises their benefits.”

“Where the individual wished to opt for enhanced protection, the excess must first have been surrendered before such a choice could be made. The rules of the scheme must have been followed to see what options are available regarding the disposal of any surplus. Options may include:

a refund to the employer less tax at 35%;
augmentation of other scheme members’ benefits; or
the excess being used to pay future scheme premiums for any remaining members.
It is important to note that the concept of an MPP is only relevant in respect of transitional protection. For individuals who have not sought transitional protection there is no such restriction.”

VALUATION OF PENSION BENEFITS; Refer page 295

Question 7

Primary Protection:

Answer 7

“5A4B Primary protection
This was available to individuals with pension rights, valued on 5 April 2006, that had a capital value that exceeded £1.5m”

Formula:

Value of pension benefits on 6 April 2006 - £1.5m/ £1.5m

Question 8

Enhanced Protection:

Answer 8

“5A4C Enhanced protection
This form of protection was available to anyone regardless of the capital value of their pension benefits at A-Day. Provided the member remains eligible for enhanced protection, all benefits coming into payment after A-Day will be exempt from the LTA charge.

Enhanced protection will continue to apply provided that the member does not accrue any further pension benefits under a registered scheme on or after 6 April 2006. This is known as relevant benefit accrual.”

Question 9

Definitions of Relevant Benefit Accrual for Enhanced Protection:

Answer 9

“Type of scheme

Definition

Money purchase arrangements

Finance Act 2004, sch. 36, paras. 13(a) and 14

When a relevant contribution is made after 5 April 2006:

A relievable pension contribution paid by the individual or any third party.
A contribution to the arrangement in respect of the individual paid by their employer.
A contribution paid otherwise than:
by the individual (or on their behalf); or
by their employer in respect of the individual (which is subsequently allocated to the individual’s arrangement).
Hybrid schemes

Finance Act 2004, sch. 36, para. 13(a)

The nature of a hybrid scheme means that relevant benefit accrual could be tested by either the test for money purchase schemes or defined benefit depending on what has been promised. This will not be known until benefits are actually provided.

Contributions can continue to a hybrid scheme after 5 April 2006 without immediate loss of enhanced protection. However, where the benefits to be provided are money purchase then enhanced protection will be lost.

DB and cash balance schemes

Finance Act 2004, sch. 36, paras. 13(b), 15(1) to (4).

Payments from a cash balance arrangement or defined benefits arrangement that are either:

a benefit crystallisation event; or
a permitted transfer to a money purchase arrangement.
Either of the above would trigger a test for relevant benefit accrual and if this has occurred enhanced protection will be lost. Relevant benefit accrual is deemed to have occurred where benefits paid from a cash balance and/or DB scheme are more than the ‘appropriate limit’ (see following text for further details).”

“The amount of earnings to be used in the calculation of the pension rights is the lesser of:

pensionable earnings immediately before the date of first taking benefits under the arrangement or the date of the ‘permitted transfer’, using the definition of such earnings as applied under the arrangement on 5 April 2006; and
the ‘post-commencement earnings limit’ as defined in the Finance Act 2004, sch. 36, paras. 15 and 16.
If the individual has benefits in a number of related arrangements the calculation is made when the first benefit crystallisation event or permitted transfer to another money purchase arrangement occurs in any of the arrangements.”

Question 10

Fixed Protection:

Answer 10

“Fixed protection will continue to apply provided that the member does not accrue any further pension benefits under a registered scheme on or after 6 April 2012/2014/2016 – whichever applies. This is known as benefit accrual.”

“For example, for FP 2016 to be valid there can be no benefit accrual after 5 April 2016. It is lost on the day benefit accrual occurs, which includes:

any pension contributions paid to a defined contributions scheme; and
pension growth in a defined benefit scheme that exceeds a relevant percentage.”

“Any transfer of benefits to other schemes must be a permitted transfer in order for fixed protection to be retained.”

Question 11

Individual Protection:

Answer 11

“Individuals will have an individual LTA equal to the capital value of their benefits at 5 April 2016 but subject to a maximum cap of £1.25m.”

“IP 2016 allows individuals to accrue further benefits in defined benefit schemes (and continue to make contributions to defined contribution schemes), without the risk of losing this protection.

Individual protection will remain dormant while the member holds the following:

Enhanced protection.
FP 2012.
FP 2014.
FP 2016.”

“Eligibility and application process
Individuals can apply to HMRC for IP 2016 as long as they do not have primary protection (active or dormant) and the capital value of their pension benefits, from all their registered pensions schemes is equal to or in excess of £1m as at 5 April 2016.
Applications are made online and individuals need to have an account set up with HMRC online services. In addition, the application will require the full value of pensions as 5 April 2016 and a breakdown of the amount as follows:”

Question 12

Interactiion between the different protections;

Answer 12

“Anyone with pension benefits in excess of £1m may elect for both FP 2016 and IP 2016 and should do so, provided there has been no benefit accrual on or after 6 April 2016. FP 2016 will be lost if any future contributions or benefit accrual takes place. However, if the individual holds IP 2016 in addition to FP 2016 the individual protection will remain in place.”

“This means that the individual electing for both protections will have an LTA of:

£1.25m if no contributions or benefit accrual takes place after 5 April 2016; or
their protected LTA (between £1m and £1.25m) if contributions or benefit accrual does take place after 5 April 2016.
There are no disadvantages in opting for both because, if when benefits are drawn the total value is below the protected LTA, it may be possible to make further contributions (or benefit accrual) to top the benefits up to that level.”

“Example 5.12
Ken has a personal pension scheme that was valued at £1.2m on 5 April 2016. He elected for FP 2016 and stopped making contributions into the scheme. He also decided to opt for IP 2016, so was given a protected LTA of £1.2m.
After two years Ken decides to crystallise his fund, but unfortunately the value has dropped to £1.12m.

As long as Ken has sufficient relevant UK earnings (in addition to his unused annual allowance) he can make a contribution of £80,000 into his personal pension (using carry forward) to bring the value up to £1.2m. Without also making a claimfor IP 2016 he would only be able to take the existing £1.12m as no further contributions can be made under FP2016.”

Question 13

Incentive Exercises:

Answer 13

“An incentive exercise (IE) is an invitation or inducement, generally referred to as an offer, provided to a member of a scheme, which upon acceptance would change the form of their accrued benefits in the scheme. This could be in the form of transferring their benefits out of the scheme, or a modification exercise such as full commutation and pension increase exchange (PIE).

An IE broadly meets both of the following criteria:

One objective of providing the offer is to reduce risk or cost for the pension scheme and/or sponsoring employer.
The offer or inducement is not ordinarily available to members of the scheme.”

Question 14

Incentive Exercises: The Trustees Role

Answer 14

“Trustees should start from the presumption that IEs are not in most members’ interests. Therefore, they should approach an IE cautiously, making sure they understand the extent of their legal obligations (including under legislation, trust law and their scheme’s governing documentation)”

“Trustees should also:

actively engage with the proposal from the start to so that members are properly informed and treated fairly;
ensure that have sound internal controls to ensure that can provide the additional services required, including increased levels of information requests from third parties involved in the advice process;
manage conflicts of interest in line with TPR requirements;
be aware of and meet their data protection responsibilities; and
consider the funding impact – there are potential implications for the strength of the employer’s covenant to the scheme (and its ability to fund the scheme) where its capital is used for an ETV exercise.”

Question 15

Incentive Exercises: The Regulators Role

Answer 15

“The regulator will investigate reports of cases where behaviours give cause for concern. Examples of issues that would raise concerns are:
selective offers to certain scheme members which are seeking to give advantage to one section of membership over another;
any attempt to exploit the protection of the Pension Protection Fund (PPF);
funding exercises in a way that could have an adverse effect on the employer’s ability to fund the scheme deficit (and any future deficit) in accordance with the existing recovery plan; and
coercing or placing undue pressure on members to transfer or give up their benefits.”

“Where significant concerns exist in this area, the regulator has powers to intervene (such as the removal of trustees or the appointment of an independent trustee).”

Question 16

Enhanced Transfer Values

Answer 16

“There are a number of reasons why a higher transfer value may be offered, however one of the most common reasons is where the employer and/or the trustees wish to de-risk their scheme by offering deferred and/or active members a cash incentive to transfer their benefits from the scheme. This is generally known as enhanced transfer value (ETV).”

“The employer covenant means that this liability is shown on the company accounts, and is also a drain on company resources with usually large ongoing contributions required to maintain the funding level of the scheme at acceptable levels. These problems are compounded where the scheme is underfunded, and it is a possibility that the pension debt could effectively make the company insolvent. There are only a couple of options available to an employer wanting to deal with this problem: offer an ETV, or go into buyout. However, the second option is prohibitively expensive for most companies, leaving an ETV exercise as the more likely route.”

Question 17

Pension Increase Exchange?

Answer 17

“Many defined benefit schemes now offer a pension increase exchange (PIE) where the member can give up future guaranteed increases to their pension in return for a higher initial pension with no future increases. Note that a PIE can only be applied to non-statutory increases; i.e. the option of a PIE cannot be offered if the scheme benefits escalate in payment in line with the statutory requirements we have just outlined.

It is popular with defined benefit schemes because:

pensions that escalate in payment are expensive to provide and increasing longevity means the cost is rising;
the cost of the increases is an unknown liability for the scheme as future life expectancy and inflation are unknown, so offering a pension increase exchange means future liabilities may reduce and there is less longevity risk and inflation risk for the employer; and
the employer does not suffer a large one-off ‘cost’ in offering the pension increase exchange.”

Question 18

Pension Increase Exchange, Benefits and Drawbacks

Answer 18

“Benefits

Drawbacks

A member may prefer a higher initial income to enjoy whilst they are active and healthy in the early years of their retirement.

A member who lives longer than the average may, over the longer term, end up worse off than if they had selected an escalating pension. This is very difficult to assess, but if the member is in good health with a family history of longevity an escalating pension may be preferred.

The member may also be entitled to a higher pension commencement lump sum (PCLS) if the scheme calculates the entitlement as the maximum permitted under HMRC rules.

PCLS examined further inPension commencement lump sum (PCLS)

The value of the member’s benefits for the purposes of testing against the lifetime allowance (LTA) will be higher (since the scheme pension is valued using a factor of 20:1).

In 2018/19 an annual pension of £50,000 would be valued at £1m. Therefore, LTA issues are an additional consideration if a pension increase exchange would push the value of an entitlement above the member’s remaining LTA.

“A member in poor health or with a less than average life expectancy may end up better off with a higher initial pension that does not escalate beyond the statutory requirements, as they may not live long enough to see the full benefits of an escalating pension.

Where the PIE is offered at retirement, the calculation of the pension input for the final year may result in a pension input that exceeds the annual allowance. This is because the closing value of the member’s accrued benefits will be based on the higher initial pension that is now being offered.”

“The higher initial pension may affect the member’s entitlement to any means-tested State benefits”

Question 19

Scheme Funding Status;

Answer 19

“Solvency is measured on two bases, the technical provisions or the cost of ongoing liabilities, and the cost of buying out all the benefits in full.”

Question 20

Scheme Funding Status; Technical Provisions:

Answer 20

“All schemes that provide defined benefits have a statutory obligation to have a funding objective that aims for the scheme to have sufficient and appropriate assets to cover its technical provisions. These measure the extent of the scheme’s liabilities in relation to past service as they fall due.”

“The trustees are responsible for choosing the assumptions to be used. These should be prudent and consistent with the overall requirements of the technical provisions.
Assumptions should be evidence-based, taking into account current conditions and expected future trends.
They should be scheme-specific and take into account the occupational and demographic groups of that scheme, such as mortality and early leaver rates.
Discount rates used in setting technical provisions must be prudent and take into account the yield on assets held in the scheme to fund future benefits, and the anticipated growth on those investments, or the market redemption yields on government or high quality bonds.”

“Trustees should aim for a funding outcome that reflects a reasonable balance between the need to pay promised benefits and minimising any adverse impact on the employer’s sustainable growth. This can be achieved by using the flexibility in the rules when setting discount rates for technical provisions, but in all cases these should be prudent and consistent with the scheme”

“Mortality assumptions
Trustees should pay particular attention to assumptions about future mortality bearing in mind that:
wide variability is observed between individuals;
there is variability year-on-year in the whole population;
long-term trends can be observed in age-specific mortality of cohorts; and
historically, experts have usually underestimated the rate at which mortality will reduce (longevity increase).”

“Statement of funding principles
The trustees are required to provide a written statement stating their policy for securing the statutory funding objectives are met. This should record any decisions by the trustees in relation to:
the methods and assumptions to be used in calculating the scheme’s technical provisions; and
details of any recovery plan in place where the statutory funding level has not been met.
This document needs to be maintained and reviewed on a regular basis as set out in the legislation.”

Question 21

Scheme Funding Status; Reduced Transfer Values

Answer 21

“In certain circumstances, trustees are permitted to offer transfer values which are less than the initial cash equivalent (ICE) calculated under the best estimate method. One of the permitted reductions is to allow for the funding situation of the scheme. However, trustees may only reduce ICEs for this reason after obtaining an assessment by the actuary of the funding of the scheme using the transfer value assumptions, and known as an insufficiency report. Reductions to ICEs to take into account scheme funding must not exceed the maximum reduction identified in the insufficiency report.”

“The degree of underfunding: the worse the funding position, the more necessary it may be to reduce ICEs to protect remaining members.
Their assessment of the strength of the employer’s covenant: the stronger the covenant, the less the trustees may feel it necessary to reduce transfers.
The structure of any recovery plan in place: the sooner a funding deficiency is being addressed, the less necessary reductions may be.
Any contingent assets in place and their form: if contingent security is available to plug a funding gap in the event of an employer’s insolvency, reductions in transfer values may be unnecessary.
Has the employer undertaken to make a compensatory payment to the scheme each time a transfer is paid at an unreduced level?”

Question 22

Pension Protection Fund?

Answer 22

“The Pension Protection Fund (PPF), which came into effect from 6 April 2005, is an insurance scheme designed to protect members of private sector defined benefit and hybrid schemes. It is run by the PPF Board, which is independent of The Pensions Regulator and is funded by an administration levy, a fraud compensation levy and a pension protection levy. The pension protection levy has scheme-based and risk-based components.”

Question 23

Entering the PPF:

Answer 23

“If the PPF is to take responsibility for a scheme a number of requirements must be met, in particular:

the scheme must not be a money purchase scheme;
it must not have commenced wind-up before 6 April 2005;
a ‘qualifying insolvency event’ must have occurred in relation to the scheme’s employer, e.g. an insolvency practitioner has notified the Board that the employer sponsoring the scheme is in administration;
there must be no chance that the scheme can be rescued; and
there must be insufficient assets in the scheme to secure benefits on wind-up that are at least equal to the compensation that the PPF would pay if it assumed responsibility for the scheme.”

Question 24

Entering the PPF; Prescribed Insolvency Event

Answer 24

“The insolvency event starts an assessment period, during which the scheme is considered to see if it meets the criteria for entry into the PPF. The PPF aims to complete this within two years. During the assessment period, the trustees remain in day-to-day control of the scheme, however:
no new members can be admitted, no further benefits can be earned and no transfer values can be paid;
benefits can be paid under the scheme but only to the level of PPF compensation;
the PPF can intervene in the management of the scheme and give directions to the trustees;
the PPF will review any ‘moral hazard’ issues;
the PPF will also review any recent (typically within the three years prior to the assessment date) rule changes, ill-health early retirements and discretionary increases granted which may lead to an increase in PPF compensation; and
the PPF will instruct the scheme actuary to carry out an actuarial valuation as at the day before the assessment period started (a Section 143 valuation).”

Question 25

PPF; Moral Hazard

Answer 25

“Examples of a moral hazard issue are where the employer agrees that a senior member of the board can retire due to ill-health on a generous pension shortly before the company goes into liquidation, or where discretionary increases to pensions in payment are made to some members shortly before the company goes into liquidation.
In these instances the PPF may view these actions as an attempt by the employer to benefit certain members over others and regard the benefits these members received to be excessive, placing too much strain on the resources of the PPF to continue paying them at that level.”

Question 26

PPF; Transfers Out:

Answer 26

“In most cases, once a scheme is in the assessment period the trustees are not in a position to pay out any transfer values. There may be an exception to this where the member:
requested and accepted the transfer value in writing before the assessment date (and also within the timescale set by the trustees in order that the CETV quoted is still valid); and
has designated a scheme willing to accept that transfer value (i.e. have completed all paperwork required by the scheme the funds are to be transferred to and have submitted these).

In these cases the trustees may only pay the transfer value if they:

are satisfied that they can still meet their objective of ensuring that protected liabilities do not exceed assets (or that where they do, the excess is kept to a minimum); and
reduce the transfer payment to ensure that it does not exceed the cost of securing the benefits that would be payable if the PPF were to assume responsibility.”

“Once the PPF has assumed responsibility for the scheme, a member is not entitled to a transfer payment, unless their pensionable service was ended by the start of the assessment period and they had less than three months’ pensionable service in the scheme.

Insufficient assets
An S143 valuation is carried out to determine whether there are insufficient assets within the scheme. This valuation is based on the theoretical cost of buying out the scheme’s benefits with an insurance company and the provision of the PPF compensation entitlement to each member.”

Question 27

PPF Compensation levels:

Answer 27

“Type of member/condition

Benefits provided

Members who have already reached the scheme’s normal retirement age when the employer suffers an insolvency event

100%

Members already in receipt of a survivor’s benefit at the point the employer suffers an insolvency event

100%

Members who have retired but have yet to reach the scheme’s normal retirement age when the employer suffers an insolvency event

90%: subject to an overall cap of £39,006.18 (2018/19) at age 65 (i.e. a maximum compensation payment of £35,105.56 p.a.). The cap is reduced in line with member’s age at the time of payment if they are under age 65. Members who defer receiving their compensation until after age 65, will have the cap increased.

Deferred members who have not reached the scheme’s normal retirement age when the employer suffers an insolvency event

As above.

Note: deferred members can choose to take their compensation later than the scheme’s normal retirement age and if they do so, their compensation is actuarially adjusted to reflect the period of postponement.

Survivors’ benefits for a spouse/civil partner/relevant partner coming into payment after the employer suffers an insolvency event (but see below)

50% of the member’s PPF entitlement[…]”

“Survivors’ benefits for qualifying children (where a spouse’s pension is also paid) coming into payment after the employer suffers an insolvency event

One qualifying child will receive 25% of the member’s PPF entitlement, increasing to a maximum of 50% if there is more than one qualifying child.

Survivors’ benefits for qualifying children (where there is no spouse’s pension paid) coming into payment after the employer suffers an insolvency event

One qualifying child will receive 50% of the member’s PPF entitlement, increasing to a maximum of 100% if there is more than one qualifying child.

Members already in receipt of a pension on the grounds of ill-health when the employer suffers an insolvency event

Up to 100%, but reviewed on a case-by-case basis.”

Question 28

More on PPF Compensation levels:

Answer 28

“Payment of spouse/civil partner/relevant partner benefits
Although the PPF includes a provision for a 50% spouse/civil partner/relevant partner pension, whether one is paid is determined by the rules of the original scheme.”

“Payment of survivor’s benefits to qualifying children
A qualifying child is one who is a natural child (either born or unborn at the date of the member’s death), adopted child or a child of the family who was financially dependent upon the member at the time of their death. They must be either under 18 or over 18 and under 23 and:
in qualifying education, i.e. attending a full-time educational or vocational course at a recognised educational establishment; or
have a qualifying disability, i.e. be incapable of engaging in full-time paid employment due to a condition defined as a disability under the Disability Discrimination Act 1995.”

“Application of the compensation cap
The Pensions Act 2014, schedule 20, included provisions to increase the cap for those with pensionable service over 20 years by 3% for every additional full year. From 6 April 2017, the ‘long service cap’ came into effect for members who have 21 or more years’ service in their scheme. For these members the cap is increased by 3% for each full year of pensionable service above 20 years, up to a maximum of double the standard cap.”

Question 29

Yet more on PPF Compensation levels:

Answer 29

“Deferred members of schemes within the PPF have their benefits revalued thus:

Benefits for service accrued prior to 6 April 2009

Increased each year in line with the CPI subject to a maximum of 5%

Benefits for service accrued after 5 April 2009

Increased each year in line with the CPI subject to a maximum of 2.5%

Once members start to receive their compensation their payments are increased thus:

Benefits accrued for service prior to 6 April 1997

No increases

Benefits accrued for service after 5 April 1997

Increased in line with CPI to a maximum of 2.5%”

Question 30

PPF Total Commutation of Benefits:

Answer 30

“The pension flexibilities do not apply to the PPF. A PPF trivial commutation lump sum can, however, be paid in respect of PPF compensation once the scheme has”

“been transferred and where the member:

has a minimum age of 55;
is under age 75; and
has £30,000 maximum overall benefits.
A twelve month ‘window’ applies (from the first trivial commutation payment) during which any schemes being commuted must be completed.”

Question 31

Financial Assistance Scheme:

Answer 31

“The Financial Assistance Scheme (FAS) is designed to assist those who had lost pension benefits through company insolvency but are not covered by the PPF.

In order for a scheme to be considered under the FAS rules the scheme must not be a money purchase scheme, and must meet the following conditions:

The winding up process began between 1 January 1997 and 5 April 2005.
It began winding up after 5 April 2005 but is ineligible for help from the PPF due to the employer becoming insolvent before this date.
It began winding up between 23 December 2008 and 28 March 2014.
It is winding up underfunded due to an insolvency event which occurred before 6 April 2005.
The relevant employer had ceased to be an employer in relation to the scheme prior to 10 June 2011.”

“The FAS will pay up to 90% of the pension the member had accrued before the scheme started to wind up. The compensation is a top-up to any pension that the scheme itself will pay, subject to an overall maximum. At the time of writing (March 2018) the cap that applies to those whose entitlement begins between 1 April 2017 and 31 March 2018, is £34,229 p.a. The cap is revalued annually in line with increases in the CPI. Given the level of CPI over the previous twelve months, it may be that the cap is not increased. Different caps apply depending upon the date entitlement starts.

With effect from 6 April 2018, the same ‘long service increase’ will apply to the FAS as applies to the PPF, allowing those with more than 20 years’ service to benefit from higher than the standard capped amount.

Payments received under the FAS will increase each year in line with increases in the CPI to a maximum of 2.5% p.a. for service from 6 April 1997 only. A surviving spouse/civil partner is usually entitled to 50% of the amount that the member was receiving or would have received.

“FAS payments to scheme members are made from the later of the scheme’s normal retirement age (NRA), subject to a lower age limit of 60, or from 14 May 2004. It may be possible for payments to start before the member’s NRA if the member is unable to work due to ill-health and is likely to remain so until NRA. Payments to members who are terminally ill can start at any age.

From the date the scheme winds up until the date the member reaches NRA, the member’s benefit must be increased in line with scheme rules:

Benefits accrued before 30 March 2011 will be increased at RPI to a maximum of 5%.
Benefits accrued from 31 March 2011 will be increased at CPI to a maximum of 5%.”

Question 32

Transitional Protection and Divorce:

Answer 32

“An individual with primary protection who gets divorced after 5 April 2006 may find that it affects their protection. If an individual is subject to a pension debit after 5 April 2006, their primary protection factor has to be recalculated as at 5 April 2006. This is done by taking the value of the pension debit rights away from the original benefit value on 5 April 2006 and recalculating the primary protection factor using the lower benefit value.”

“If the reduced value as at 5 April 2006 is lower than £1.5m then primary protection is lost. This is the only way that an individual can lose primary protection.”

“A pension credit may also have an impact if the recipient (i.e. the ex-spouse) has enhanced protection. If the ex-spouse has enhanced protection they may lose this as a result of receiving the pension credit. Whether or not this occurs depends on how the pension credit is received:

Destination of transfer

Effect on enhanced protection

New pension arrangement

Enhanced protection is lost due to the setting up of the new arrangement, because the transfer of a pension credit is not a permitted transfer.

Existing money purchase arrangement

Enhanced protection is not lost, because the transfer is not deemed to be a relevant contribution.

Existing defined benefit scheme or cash balance plan

Enhanced protection may be lost at a later stage if relevant benefit accrual occurs.”

Question 33

Offsetting:

Answer 33

“Under offsetting the value of the pension is ‘offset’ against the other assets of the marriage. The ex-spouse would therefore receive a greater share of the balance of the assets in return for the loss of their ‘share’ of the member’s pension.

The theory of offsetting works as follows:

The pension benefits are valued as an immediate asset, i.e. the pension is given a lump sum value in today’s terms.
This value is then taken into account when the assets and liabilities of each spouse are considered.
The ‘offset’ could be accounted for by way of physical assets or by providing some form of income, e.g. the ex-spouse could receive additional maintenance or income or deferred maintenance or a deferred lump sum.”

“Offset is made at the time of the divorce. Therefore, neither the death or remarriage of the member, nor the death or remarriage of the ex-spouse have any effect. However, if a death in service nomination was still in favour of an ex-spouse who remarries, the member may request that this now be overturned.”

“DB schemes
The CETV is used to establish the gross value of the member’s accrued benefits (see CETV calculation in Guaranteed CETV statement of entitlement). For DB schemes, the following is taken into account when determining the amount of ‘offset’:
The ex-spouse will no longer gain any benefit from the pension and tax-free lump sum once they come into payment.
The ex-spouse will no longer receive a spouse’s pension if the member predeceases them.
The loss of death-in-service benefit.
These benefits are paid at the discretion of the trustees and so the ex-spouse would not automatically have received this payment if they had remained married.”

“Money purchase schemes
With a money purchase scheme the loss to the ex-spouse is determined by agreeing a percentage or proportionate division of the fund value, taking the following into account.
Loss of pension benefits:

The value to the ex-spouse is calculated in the same way as for a pension transfer – the value is based on the cost of buying the benefits accrued to date.

It takes into account the possibility that the member may die before retirement.

Loss of spouse’s pension:

Calculated in a similar way as the pension, and mortality tables are used to determine the life expectancy of the member and the ex-spouse.

Loss of death-in-service lumpsum:

Death in service benefits are only paid if the member’s death occurs before they take their pension benefits from the scheme.

It is not certain that any benefits would have been paid to the ex-spouse as their payment is at the discretion of the scheme trustees who take into account the marital status of the member, the financial dependency of the ex-spouse on the deceased and any expression of wish completed by the”

Question 34

Earmarking:

Answer 34

“Under an earmarking award, the member retains ‘ownership’ of the whole pension fund. The earmarking award simply allows the court to direct the pension provider to pay some of the benefits to the member’s ex-spouse.

There are two types of earmarking order:

Earmarked periodic payment orders

Earmarked lump-sum orders

The court makes an order against the pension scheme requiring the scheme to pay part of the member’s pension to the member’s former spouse. As a result:

the payment to the ex-spouse will commence when the member starts to take their own benefits;
the payment to the member is reduced accordingly;
the order is expressed as a percentage of the member’s pension; and
a separate order is required for each pension arrangement held by the member.
The court makes an order to the pension scheme requiring part or all of the member’s tax-free lump sum to be paid to a former spouse. As a result:

the payment is made when the member comes to draw their retirement benefits; and
the lump sum may be in addition to the pension, or in return for a reduced pension.”

“Drawbacks of earmarking
The benefits earmarked for the ex-spouse do not become payable until the member secures their benefits.
The courts have no power to set a date by which the member must take their benefits (i.e. age 65) and if the member does defer taking the benefits, which they can do to any age, even beyond age 75, this can have a significant impact on the value of the earmarking order to the ex-spouse.
Pension benefits with earmarking orders attached to them may be transferred from one scheme to another.
The ex-spouse has no control over this – it is entirely the member’s decision.
Where all the benefits are transferred, the ex-spouse is notified by the original scheme so that they can apply for a variation of the original order.
However, where only part of the benefits is transferred the order does not transfer to the new scheme and the ex-spouse can only claim against the original scheme.
This means they must claim the balance owed from the member.
It is easy for the ex-spouse to lose track of the earmarking order, particularly if they change address, because the scheme is only required to write to them at the last known address.
The ex-spouse has no control over the member’s investment decisions. This means that the member could invest their funds in a manner contrary to their ex-spouse’s attitude to risk.”

“The use of an earmarking award can lead to issues upon death or re-marriage:

Member dies

Earmarked periodic payment order ends and ex-spouse loses the benefit, whether death occurs before payment starts or once it has commenced.

The lump-sum order can theoretically survive the death of the member, but it is often not possible for this benefit to be paid out, i.e. if the scheme in question is a defined benefit scheme.

If the death-in-service benefits are earmarked these will be paid out on the member’s death providing this happens before they have taken their benefits.

Ex-spouse dies

Order for periodic payment will cease – there is no value to their estate.

Lump-sum order may remain and will be payable to the ex-spouse’s estate, but only when the member draws their benefits.

Member remarries

The earmarking order continues.

Ex-spouse remarries

Any earmarked period payment order no longer has any legal standing, although the lump sum order remains in place. Thus, where remarriage of the ex-spouse is a possibility, earmarking the lump sum is preferred to earmarking the pension.

Even cohabitation can lead to the member seeking, and possibly gaining, a varying order in the courts.

“Impact on the lifetime allowance
Earmarking has no direct impact on either the member or the ex-spouse’s lifetime allowance (LTA) as the pension benefits remain in the ownership of the member, i.e. neither will have an adjustment made to their LTA. However, an earmarking award can have an indirect impact.
The member will have a lower pension income in retirement but, because they still own all the pension rights, these rights, including the income and/or lump sum paid to their ex-spouse, will be valued against their lifetime allowance. Where a member has pension rights valued at close to the LTA this gives them no scope to fund a pension to replace this income without risking a lifetime allowance tax charge.

The ex-spouse will receive a pension income that is not valued against their lifetime allowance, so they can fund pensions of their own to the value of the LTA plus receive the benefits under the earmarking, without paying a lifetime allowance tax charge”

Question 35

Pension Sharing:

Answer 35

“Pension sharing divides the scheme member’s pension rights at the time of divorce:

The split is not necessarily 50/50.
The ex-spouse may be entitled to a transfer value and/or membership of the member’s pension scheme.
The rights allocated to the ex-spouse are known as a pension credit if paid from uncrystallised funds, and as a disqualifying pension credit if this is paid from crystallised funds.”

“The following pension rights cannot be shared:

New State Pension.
Basic State Pension.
Graduated Retirement Benefit (GRB).
A widow(er)’s pension in payment.
The following pension rights can be shared:

Protected payments paid in addition to an individual’s entitlement to the new State Pension.
SERPS and S2P (although these have ceased to exist other than for individuals who had attained their SPA on or before 5 April 2016).
Occupational schemes, including AVCs.
Registered individual schemes (i.e. personal pensions, stakeholder pensions, retirement annuity contracts and S32 policies).
Statutory schemes (i.e. public sector).”

Funded MP Scheme:
“The courts will award a percentage share of the money purchase fund, e.g. 30% of a £100,000 fund would result in £30,000 of the fund being ‘given’ to the ex-spouse.
This can lead to one of two outcomes:

The ex-spouse could transfer their £30,000 to their own occupational scheme or to a personal pension.
The original scheme can, but does not have to, offer the ex-spouse membership, so that the value is retained within the member’s scheme, but in the ex-spouse’s name.”

“Funded defined benefit schemes
The award is based on a percentage of the CETV at the date of the pension sharing order.”

“Unfunded schemes
These are defined benefit pension schemes that do not have a pension fund and so retired members’ benefits are, technically, paid from current member contributions. These schemes include public sector schemes, such as the Civil Service scheme.
For these schemes, pension sharing works differently from a funded defined benefit scheme as the absence of a fund means that they do not offer a transfer value to the ex-spouse, but rather offer shadow membership of the scheme, i.e. the ex-spouse is granted their own membership of the scheme separate from the member they are divorcing.”

“Advantages of pension sharing
Advantages to the member:
They potentially lose less value than if offset or earmarking orders had been used.
It provides immediate settlement and a clean break.
There are no income tax implications for the member, so a lower gross value can be given up.
Advantages for the ex-spouse:

Benefits cannot be forfeited in the event of either party’s death.
There is no risk on remarriage or cohabitation.
It provides immediate settlement and a clean break.”

“Impact on the lifetime allowance
The ex-spouse was able to apply for an increase in their LTA to offset the pension credit. Where the ex-spouse applied for primary protection, there was no need to make a separate claim for the pension credit, as it was taken into account in calculating their primary protection factor. Any pension debit from a pension sharing order effected before A-Day was ignored”

Question 36

QROPS:

Answer 36

“A qualifying recognised overseas pension schemes (QROPS) is an overseas pension scheme that meets certain requirements set by HMRC and that has agreed to the HMRC reporting requirements concerning the payment of benefits. They are mainly of use to people who are planning to emigrate, or have emigrated, from the UK or are planning to leave the UK to return to their home country, as a QROPS can receive the transfer of UK pension benefits without the member incurring unauthorised payment and scheme sanction charges. A QROPS may also be of use to anyone planning to work or live overseas, or who is married to, or in a civil partnership with, someone from another country, although care is now required where the transfer is made without a ‘genuine need’. This genuine need is deemed to be met where:

both the individual and the scheme are within the European Economic Area (EEA);
if outside the EEA, both the individual and the scheme are in the same country; or
the QROPS is an occupational pension scheme provided by the transferor’s employer.”

“The requirements to be a ROPS also changed again when in the March 2017 Budget the Chancellor of the Exchequer announced that pension transfers to QROPS which were requested on or after 9 March 2017 could be subject to an overseas transfer charge of 25% on the value of the pension transfer. Individuals who transferred a UK pension to a QROPS before 9 March 2017, will not be affected by the overseas transfer charge.

The overseas transfer charge was introduced to deter people transferring pensions out of the UK for purely UK tax avoidance reasons and is designed to ensure that if a QROPS goes ahead, any potential lost tax revenue is recouped by the Government when the transfer is made.”

“A QROPS has to report to HMRC about the payment of benefits for at least ten years from the date of transfer. However, once the member has been non-UK resident for five complete tax years, they may then benefit from options that are more attractive than those permitted under a UK scheme.”

“HMRC requirements
A transfer of pension funds from a UK registered pension scheme to a QROPS is a benefit crystallisation event (BCE) under BCE 8. If the transfer exceeds the member’s available lifetime allowance, a lifetime allowance charge at the rate of 25% will apply to the excess before the funds are transferred (the rate is at 25% and not 55% because no lump sum is physically received by the member). The lifetime allowance charge is in addition to any liability that may arise to the Overseas Transfer Charge.”

TAX IMPLICATIONS:

“The member tax charges are levied at the same level as the unauthorised payments tax charge (40%) and surcharge (15%) and are levied on the member regardless of where they are resident at the time of the payment or transfer. They also apply where a QROPS pays what would be a UFPLS under a Registered UK Pension Scheme.

The overseas scheme may lose its QROPS status, preventing acceptance of any further UK pension fund transfers.”

REGULATORY CONSIDERATIONS:

“The scheme administrator of a QROPS must notify HMRC that the scheme meets the conditions to be a recognised overseas pension scheme every five years. When the new rules came into force on 6 April 2015 the re-notification deadline was delayed until 6 April 2016.”

TEMPORARY NON-RESIDENCE:

“Where such an individual takes benefits from a RNUKS during their period of non-residence, the pension received is only taxed in the UK upon the member’s return if the relevant withdrawals taken during that time, from both registered pension schemes and RNUKS, total more than £100,000. This excludes any tax-free entitlement such as a pension commencement lump sum (PCLS) or the tax-free part of an UFPLS. This is because tax will already have been paid in the country of residence when the benefits were taken from a RNUKS and this ensures that there is no additional income tax liability on return to the UK.”

Question 37

ATR & CFL:

Answer 37

“Attitude to risk is the extent to which a client is willing to accept risk with their investments in return for the potential of a higher return.

Capacity for loss is a distinct but related concept. If someone has no capacity for loss, then it does not matter how cautious or adventurous they are because they simply cannot afford to put any of their capital at risk.

The FCA defines capacity for loss as:

the customer’s ability to absorb falls in the value of their investment. If any loss of capital would have a materially detrimental effect on their standard of living, this should be taken into account in assessing the risk that they are able to take.”

“Timescale

A period of 20 or more years to retirement generally allows most clients to regard short-term fluctuations in investment values with some equanimity, thus allowing them to take the level of risk required to potentially achieve higher long-term returns.

As the client gets nearer to retirement the importance of reducing short-term fluctuations becomes greater and investment attitudes and strategy should be adjusted accordingly.

Wealth

If the pension is a relatively small proportion of a client’s overall invested wealth, the client may be prepared to take a higher risk approach. Someone who expects their pension to be their only source of retirement income is likely to be more cautious.

Past experience

Someone with a personal or family history of equity investment is likely to understand the basics of equity investment and the risks. Someone with no background of taking either investment or business risks may find equity investment uncomfortable.

Other investments

A client may have a different attitude to risk with regard to pensions from their other investments. A person may be risk-averse with respect to their pension funds but prepared to speculate with a personally owned lump sum.”

Question 38

Partial Transfers:

Answer 38

“If available, the scheme may allow a member to transfer a proportion of their benefits out of the scheme and retain some benefits in the scheme. This is will be in relation to the different elements of pension accrued such as guaranteed minimum pension (GMP), pre-97 excess and post-97 excess. Which parts to retain and which elements to transfer will depend on the individual benefit entitlements with each element of the pension.”

Question 39

“Block transfers and winding up”

Answer 39

“Under some of the pre-A-Day regimes, it was possible to accrue a tax-free cash lump sum that exceeded 25% of the value of the member’s benefits as at 5 April 2006. This scenario was most likely to apply to individuals who joined their occupational pension scheme before 17 March 1987 when benefits were subject to a very generous set of rules (known as the pre-87 regime).

The rules for those in this situation, whose benefits are valued below the LTA, are as follows:

Such individuals can protect their enhanced PCLS entitlement without applying to HMRC.
The onus falls on the existing scheme, which has to record the member’s entitlement to PCLS on an ongoing basis.
However, if benefits are transferred after A-Day, the higher PCLS is lost, unless the transfer is part of a block transfer.
There are effectively two sub-types of block transfer:

a ‘buddy’ transfer with another member; and
a transfer to a section 32 (S32) plan in connection with winding up a scheme (s32 plans are also referred to as trustee buyout plans or deferred annuity contracts) and a further onward transfer to another s32.”

“It is also possible for a member to have a protected pension age allowing them to take their benefits before the normal minimum pension age of 55. This right would also be lost on transfer unless as part of a block transfer.”

Question 40

Cash flow modelling and Stress Testing:

Answer 40

“Advisers whose clients are in drawdown will find cash flow modelling particularly important. This is because drawdown involves more risks than a pension fund in the accumulation phase. The usual investment risks are amplified because withdrawals are being taken from the fund and often these withdrawals are higher than the level of the ‘natural’ income (i.e. dividends, interest etc.) achieved by the fund”

“The main risks in retirement are that the client’s capital and income fail to provide enough to meet their wants and needs. This could happen because, for example:

Their income and/or capital suffers irrecoverable reductions in value because of some investmentloss.
The client’s income/capital needs are greater than expected, perhaps because of illness or some other major change in circumstances.
The real value of their income or capital is eroded by inflation.
The client lives longer than expected and runs out of resources.
Future returns are lower than expected.”

“Any cash flow model used should demonstrate how the portfolio might perform in a downturn or in various other scenarios. This can be termed a ‘stress test’ for the client: for example, could they cope if their capital ran out completely, or could they manage on a lower income during the downturn to ensure that the capital is not depleted too much? It is also important to bring potential changes in inflation into the stress test and build in a sufficient buffer to cover unexpected expenditure.”

“A cash flow model must take into account the effects of inflation as, even at low levels, inflation can have a significant effect on living standards over time. Over 20 years the impact of rising prices on a fixed income (such as a level annuity) is as follows:

Annual inflation rate

Reduction in real income

2%

one-third

3.5%

one-half

5%

two-thirds”

“The advice will be based on inflation assumptions, which are likely to change over the client’s lifetime. It is important therefore to consider how the plan will stand up to potential changes in the future to help the client understand the degree of risk they are taking on.”

“Major market loss
One of the most important factors to consider is the impact that poor investment performance will have on advice, as the client’s ultimate benefits will rely on this.”

“Monte Carlo simulations
These are used to model the probability of different outcomes in a process that cannot easily be predicted due to the intervention of random variables. This makes it ideally suited for financial planning where projections are based on a number of variables all which could impact on the outcome. This is particularly useful for stress testing cashflow models that are used in conjunction with direct benefit pension transfer advice.

Named after the gambling hot spot in Monaco, as chance and random outcomes are central to the modelling technique, much as they are to games like roulette, dice and slot machines. The technique was first developed by Stanislaw Ulam, a mathematician who worked on the Manhattan Project.”

“A typical Monte Carlo simulation calculates the model hundreds or thousands of times, each time using different randomly-selected values.

When the simulation is complete, we have a large number of results from the model, each based on random input values. These results are used to describe the likelihood, or probability, of reaching various results in the model.”

EARLY/LATE MORTALITY:

“Consideration should be given to the income available to any surviving financial dependants in the event of early mortality. This could include the following:

For accumulation clients, this should consider the situation both pre- and post-retirement and take into account all benefits available on death, such as death in service (DIS), life insurance and investments, that would be inherited. This should be considered in terms of the benefits available from the scheme and on transfer to an alternative contract.
For those at retirement, the focus would be on the benefits available to the survivor, again both retaining the benefits in the scheme and transferring to an alternative scheme.
Late mortality presents a different problem, that is the potential to run out of money. It is important to ensure that at least the basic income can be sustained at standard mortality and longer life expectations.”