Chapter 6 - Defined contribution schemes

Question 1

What default investment option must be offered under an employer’s group stakeholder pension scheme?

a.Cash fund.

b.Lifestyle fund.

c.With profits fund.

d.Fixed interest fund.

Answer 1

b.Lifestyle fund.

New customers must be offered a lifestyle arrangement for the default investment choice.
Lifestyling is an investment strategy that automatically moves the member’s funds away
from riskier investments

Chapter reference 6E

Question 2

The pension income figure shown on a Statutory Money Purchase Illustration assumes that the pension income will be:

a.converted into today’s terms assuming inflation of 2.5% p.a. and future charges and expenses will be ignored.

b.converted into today’s terms assuming inflation of 2.5% p.a. and future charges and expenses will be taken into account.

c.shown in monetary terms assuming a growth rate of 7% p.a. and future charges and expenses will be taken into account.

d.shown in monetary terms assuming a growth rate of 7% p.a. and future charges and expenses will be ignored.

Answer 2

b.converted into today’s terms assuming inflation of 2.5% p.a. and future charges and expenses will be taken into account.

• The projection is converted into today’s terms assuming inflation of 2.5%p.a.
• The effect of future contributions is taken into account, where these are deemed to be part of a regular pre-determined series of contributions. Where they are earnings related, earnings are assumed to increase in line with inflation at 2.5%p.a.
• Future charges and expenses must be taken into account.

Chapter reference 6A4

Question 3

Bill, who is 63, has an uncrystallised executive pension plan [EPP] that has a normal pension age of 65. Bill would like to transfer this fund to his personal pension plan and should be aware that he has the right to a transfer value:

a.up to the date that the benefits are crystallised.

b.until the age of 75, even if the EPP benefits have been crystallised.

c.until he reaches the age of 64.

d.until he reaches the age of 65.

Answer 3

a. up to the date that the benefits are crystallised.

Benefit categories within a scheme are defined as either flexible or safeguarded. Flexible benefits are defined contribution benefits, cash balance benefits and any benefit that is calculated by reference to a fund.

A deferred member of an occupational defined contribution scheme with flexible benefits has the right to a transfer value up to the date of crystallisation of benefits, even after they have reached the scheme’s normal pension age.

Chapter reference 6D2

Question 4

Sarah, aged 38, joined her employer’s occupational defined contribution scheme in March 2022 and left the scheme in May 2024. At that time her fund was valued at £28,000. What early leaver options must Sarah be offered?

a.A transfer value only.

b.A preserved [paid up] fund and a transfer value only.

c.A preserved [paid up] fund, a transfer value and a refund of member contributions.

d.A preserved [paid up] fund only.

Answer 4

b.A preserved [paid up] fund and a transfer value only.

An employee who has at least three months’ service has the option of taking a transfer value to another scheme.

Preserved benefits must be offered. The member may, at any time, choose to transfer this to an individual pension arrangement or to the occupational pension scheme of a new employer.

A member leaving a defined contribution occupational scheme is only entitled to a short service refund if they leave the scheme with less than 30 days’ qualifying service.

Chapter reference 6D1

Question 5

Saba is a member of her employer’s contributory group personal pension and will shortly reach the scheme’s selected pension age [SPA] of 65. If she intends to continue working for at least another three years and she wishes to remain a member of the scheme, her employer:

a.can demand that she takes her benefits when she reaches the scheme’s SPA.

b.must allow her to remain a member of the scheme and they must also continue to make employer contributions on her behalf.

c.must allow her to remain a member of the scheme but can cease making employer contributions and can also refuse to accept any further contributions from Saba.

d.must allow her to continue to contribute to the scheme but can cease making employer contributions once she reaches the scheme’s SPA.
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Answer 5

b.must allow her to remain a member of the scheme and they must also continue to make employer contributions on her behalf.

If the scheme is an employer sponsored arrangement, e.g. a group personal pension plan, a selected pension age may be set for the scheme as a whole, but the employer cannot demand that benefits are taken at this age. If employees continue to work beyond it, they are eligible to remain in the scheme. Thus an employer that contributes to the scheme must continue to do so while the member remains in employment, even if this is beyond the selected pension age.

Chapter reference 6C1

Question 6

Independent Governance Committees must have a minimum of how many members?

a.Four.

b.Three.

c.Six.

d.Five.

Answer 6

d.Five.

The Government requires contract-based workplace pension schemes to have Independent Governance Committees (IGCs). IGCs must have a minimum of five members, the majority of whom should be independent. These rules apply to any workplace scheme, not just automatic enrolment schemes.

Chapter reference 6B3A

Question 7

Jenny, who is a member of her company’s group personal pension plan [GPP] has been given permission to take early retirement at the age of 50 due to ill-health. Her condition isn’t immediately life threatening and the GPP offers all of the flexible benefit options. Which option will NOT be available to her?

a.Uncrystallised funds pension lump sum.

b.Serious ill-health commutation lump sum.

c.Drawdown pension.

d.Lifetime annuity.

Answer 7

b.Serious ill-health commutation lump sum.

If the member has a life expectancy of less than one year, it is possible to commute all their
arrangements for a ‘serious ill-health lump sum’. It can only be paid out of uncrystallised funds. This means that funds that have been crystallised, e.g. via a drawdown pension, cannot be taken as a serious ill-health lump sum. However, where only some of a member’s benefits have been crystallised, the remaining uncrystallised rights can be paid as a serious ill-health lump sum. Again, certain conditions must be satisfied.

If the member has a substantially reduced life expectancy, it may be possible to obtain favourable lifetime annuity rates from a life office specialising in impaired life annuities.

Chapter reference 6C3

Question 8

An individual defined contribution pension was started in 1986 and offers a generous guaranteed annuity rate at age 65. What type of arrangement is this most likely to be?

a.A self-invested personal pension.

b.A Section 32.

c.An executive pension plan.

d.A retirement annuity contract.

Answer 8

d.A retirement annuity contract.

A retirement annuity contract is an individual defined contribution arrangement. It is similar to
a personal pension plan, though the benefits offered could differ in two ways:

• some offer a guaranteed annuity rate at retirement
• the benefits payable on death before retirement depend on the rules – the fund may be returned as a lump sum on death, but in some circumstances, the death benefits are more restrictive:

Chapter reference 6A1D

Question 9

Michael joined a stakeholder pension on 20 January 2004. What is the maximum annual charge that can be applied to the value of his fund?

a.0.5%.

b.1.5%.

c.1.25%.

d.1%.

Answer 9

d.1%.

The maximum annual charge depends on when the individual joined the stakeholder scheme:

Those who joined before 6 April 2005, the maximum annual charge is 1% of the value of the fund

New members after 5 April 2005, the annual charge must be no more than 1.5% p.a. for the first ten years and after ten years must be reduced to a maximum of 1% p.a

Chapter reference 6E

Question 10

Alice, who is a basic rate taxpayer, contributes £200 per month gross into her personal pension. She also pays a premium of £5 per month gross into a pension contribution insurance [PCI] contract. Her payments will be:

a.£4 per month into the PCI contract and in the event of a claim the insurer will pay £160 per month into her personal pension plan.

b.£5 per month into the PCI contract and in the event of a claim the insurer will pay £160 per month into her personal pension plan.

c.£4 per month into the PCI contract and in the event of a claim the insurer will pay £200 per month into her personal pension plan.

d.£5 per month into the PCI contract and in the event of a claim the insurer will pay £200 per month into her personal pension plan.

Answer 10

b.£5 per month into the PCI contract and in the event of a claim the insurer will pay £160 per month into her personal pension plan.

Pension contribution insurance (PCI)

PCI allows an individual’s and/or an employer’s contributions to be paid if the individual is unable to work due to ill-health or incapacity.

PCI premiums are paid into a separate insurance contract and are not eligible for tax relief.

The contribution made to the
personal or stakeholder contract is paid net, so tax relief is awarded on the contribution made.

Chapter reference 6C3A

Question 11

What is the essential difference between a defined benefit scheme and a targeted money purchase scheme?

Answer 11

A defined benefit scheme benefit is a promise enforceable at law. With a targeted money purchase scheme all that is promised is the proceeds of the invested contributions.

The initial level of the employer contributions to a targeted money purchase scheme would have been calculated by an actuary (and regularly reviewed and possibly adjusted) to ensure, as far as possible, that the desired benefit is produced, but there is no guaranteed commitment on the employer’s part.

If there is a shortfall at retirement the employer may choose (but is not obligated) to make good this amount out of company resources or, if there is one, a special unallocated section within the scheme

Chapter reference A1F

Question 12

Julie is employed and has relevant UK earnings of £70,000. She wants to make a single contribution of £2,000 (gross) into her personal pension. Explain how Julie will
obtain tax relief on this contribution

Answer 12

Julie will receive tax relief on her contribution as follows:

• the contribution will be made net of basic rate tax (i.e. £2,000 less 20% = £1,600); and
• she will be eligible for further tax relief of 20% (i.e. a further £2,000 × 20% = £400).

Chapter reference A3B

Question 13

Why might a higher rate taxpayer prefer to be a member of a trust-based pension scheme?

Answer 13

A higher rate taxpayer who is a member of a trust-based scheme will receive immediate higher rate tax relief as they make their contributions using the net pay
arrangement. If they were a member of a contract-based scheme, they would have to claim the difference between the basic and higher rate tax relief through their self-assessment tax return or by an adjustment to their tax code.

Question 14

Alice, who is in good health, was born on 1 May 1970. She contributes to a personal pension plan.

Under current legislation, what is the earliest date on which Alice will be able to take the benefits from her personal pension plan?

Answer 14

Under current legislation, the earliest date on which Alice would be able to take her pension benefits will be 1 May 2025 – in other words, her 55th birthday.

Question 15

What are the main risks that apply to members of a defined contribution scheme, but
which do not apply to members of a defined benefit scheme?

Answer 15

Members of defined contribution schemes are subject to investment risk and, if an annuity is purchased, annuity rate risk. These risks do not apply to defined benefit schemes because benefits are guaranteed as a proportion of final salary at or close to retirement

Question 16

Alan joined his employer’s occupational defined contribution pension scheme on 1 January 2023. He leaves his employment on 1 May 2024. What options must he be given in relation to his scheme benefits?

Answer 16

Alan is not eligible for a refund of his own contributions. As he completed more than three months’ pensionable service in an occupational pension scheme he must be offered:

• a transfer value based on his own and his employer’s contributions

or

• preserved benefits under the scheme.

Question 17

Multi-choice

Which of the following types of defined contribution scheme would be classed as occupational schemes?

a. Group personal pension plan.
b. Executive pension plan.
c. Retirement annuity contract.
d. Small self-administered scheme (SSAS).
e. A contract-based self-investment personal pension (SIPP).

Answer 17

a. No. A group personal pension plan is a group of individual defined contribution schemes.

b. Yes.

c. No. A retirement annuity contract is an individual defined contribution scheme.

d. Yes.

e. No. A contract-based SIPP is an individual defined contribution scheme.

Question 18

Multi-Choice

Which of the following statements relating to a statutory money purchase illustration issued on or after 6 April 2024 for a regular premium contract are TRUE?

a. The accumulation rate is determined according to the fund’s volatility group.
b. Inflation is allowed for at a rate of 2.5% p.a.
c. The pension figure illustrated always assumes that the annuity purchased increases each year in line with inflation.
d. The pension figure illustrated must always include a 50% spouse’s pension.
e. It must be assumed that no lump sum is to be paid at retirement date.

Answer 18

The correct statements are a, b and e.

Statement c is incorrect because the pension illustrated must be assumed to be level in payment.

Statement d is incorrect because the pension illustrated must be assumed to be on a single life basis.

Question 19

Peter, who was married, died in May 2024 at the age of 46. his personal pension fund was valued at £140,000 and this was his only pension plan.

Describe the death benefits that will be paid to Peter’s widow and explain how they will be taxed.

Answer 19

Peter’s widow can receive the entire fund as a lump sum, free of all taxes. Alternatively, she can use the fund to provide an income via a dependant’s annuity or flexi-access drawdown. This income would be paid free of income tax as Peter died before the age of 75

Question 20

Brenda, who is 53, is in serious ill-health and has been given permission to commute her entire personal pension fund for a serious ill-health lump sum in 2024/25. Brenda’s fund is currently valued at £2.1 million. She has no other pension benefits
and she has registered for fixed protection 2012.

Explain the tax treatment of Brenda’s benefits when they are taken as a serious ill-health lump sum.

Answer 20

As Brenda has registered for fixed protection 2012, she has a protected LSDBA of £1.8 million. Her benefits of £2.1 million exceed her LSDBA by £300,000 (£2.1 million – £1.8 million). The excess of £300,000 will be taxed as Brenda’s pension income via
PAYE.

Question 21

Multi-Choice

Which of the following statements relating to Jennifer’s stakeholder pension plan, which she set up in 2010, are true?

a. The minimum permitted contributions to the stakeholder pension plan must be no
higher than £20 per month.
b. Jennifer can choose to pay any stakeholder pension contributions by cash.
c. The maximum annual charge levied by the stakeholder pension plan must be no more than 1.5% p.a. for the first ten years and a maximum 1% p.a. thereafter.
d. Jennifer must be offered the option of a lifestyle fund as the default investment choice.

Answer 21

The correct statements are c and d.

Statement a is incorrect because the minimum permitted contribution is £20, with no
reference to a required frequency, so a contribution of £20 could be made as a one-off contribution. Therefore the minimum contribution cannot be set as £20 ‘per month’.

Statement b is incorrect because contributions must be accepted by cheque, standing order, direct debit and direct credit, but payments by cash can be refused.

Question 22

Which of the following statements relating to a targeted money purchase scheme are true?

a. The minimum pension the scheme will provide members with is a proportion of final salary at or close to retirement or, if greater, the benefits that can provided by the defined contribution fund.

b. The contribution that is paid into the scheme will be the estimated cost of providing the target level of benefit.

c. The contribution rate for each member will be regularly reviewed.

d. If a member’s fund at retirement is not large enough to provide the targeted benefits the employer must top up the member’s fund.

e. If the employer becomes insolvent the trustees would have no claim against the employer’s assets, unless scheme contributions were in arrears.

f. Early leavers from the scheme will be entitled to a preserved benefit, the defined contribution assets or a cash equivalent transfer value based on the targeted level of benefits, whichever is the greater.

Answer 22

The correct statements are b, c and e.

Statement a is incorrect because the scheme will aim to provide a target level of pension based on final salary at or close to retirement. However, there is no guarantee that the targeted level of pension will be provided, as a minimum, and the member may receive a lower level of pension in retirement.

Statement d is incorrect because the targeted benefits are an aim and not a promise; the employer can choose to top up the benefits, but does not have to.

Statement f is incorrect because early leavers from a targeted money purchase scheme will usually only be entitled to a preserved benefit of the defined
contribution assets.

• early leavers from a targeted money purchase scheme would normally only be entitled to a preserved benefit of the defined contribution assets
• even for those who stay until normal pension age, the employer may at any time choose to disconnect from the funding target and treat the scheme as conventional defined contribution
• if the employer became insolvent, the trustees would have no claim against the employer’s assets, unless the scheme contributions were in arrears
• disconnection from the target benefit level for any reason is likely to have a serious effect on the benefit expectations of the scheme members, particularly if they are close to
  retirement

Question 23

Where a statutory money purchase illustration is required, how often must they be sent out?

Answer 23

Members must be sent an illustration annually

Question 24

What is an Independent Governance Committee?

Answer 24

• For contract-based workplace pensions
• To ensure that all aspects of value for money are independently reviewed

Question 25

How is an uncrystallised funds pension lump sum taxed?

Answer 25

• Typically, 25% is paid tax free
• Remainder is taxed as pension income via PAYE

Question 26

An early leaver has the option of taking a transfer value if they have had at least how many months’ service?

Answer 26

At least 3 months’ service

Question 27

What term does the FCA use to describe transfers between DC schemes?

Answer 27

FCA uses ‘pension switching’ to describe transfers between DC schemes

Question 28

The main assumptions for a Statutory Money Purchase Illustration would include
A. an accumulation rate of 5% for volatility group 4.
B. conversion into today’s terms based on inflation at 2%.
C. retirement expenses of 4% of the annuity value.
D. payment of a 25% lump sum at retirement.

Answer 28

C. retirement expenses of 4% of the annuity value.

Assumptions include an accumulation rate of 7% for volatility group 4, inflation of 2.5%, retirement expenses of 4% of the annuity value and no lump sum payable at retirement.

Chapter reference 6A4