DB Transfer AF7 Flashcards
DB transfer statutory process
1 - member requests statement of entitlement
2 - within one month trustee must write to member confirming the need for them to take independent advice (£30,000)
3 - Within three months of the application the guarantee date should be set (Date Transfer value to be calculated)
4 - within 10 days of the guarantee date the trustee must provide a statement of entitlement and reminds the member on deadline for confirming that the advice has been received
5 - within three months of guarantee date the member must confirm they want to proceed with transfer in writing.
6 - within three months and 10 days of guarantee date the member must have confirmed/provided proof they had received independent advice
7 - Within six months of the guarantee date and having checked that independent advice has been received by the member the trustee makes the transfer having confirmed independent advice received and advisor has appropriate permissions and new plan is appropriate.
Remember most of the timescales refer back to the guarantee date which is three months from the request for a statement of entitlement.
Hurdle rate and critical yield. What are they?
The hurdle rate is the annual investment return required after charges to provide a capital sum sufficient to purchase a single life annuity with no guarantee period that matches the initial level of scheme pension payable from Scheme normal pension age.
The critical yield also includes the capital cost of future escalation for the pension payment, dependents benefits and any guarantee period.
Pension protection fund
Andy is a member of a defined benefits pension scheme and is about to reach his normal pension age under the scheme. He is considering his retirement options but is concerned about the future security of his benefits as he is aware that the sponsoring employer is in financial difficulty.
(a) outline the criteria that must be met for the pension protection fund to assume responsibility for the scheme
(b) Outline the protection that will be provided in respect of Andy’s benefits assuming the scheme enters the PPF and he takes his benefits at normal pension age
(c) outline the protection offered if the scheme enters the PPF before he reaches retirement
(a) The employer must suffer insolvency event and have no chance of being rescued.
There must be insufficient assets in the scheme to secure pension benefits on wind up that are at least equal to the compensation that the PPF would provide.
(b) Andy would receive 100% of his pension income as he is at scheme NPA however the escalation would be restricted to CPI capped at 2.5% in relation to post 97 benefits only. Pre 6th April 97 Benefits would receive no escalation.
There would be a spouses pension of a maximum of 50% of the members pension in payment.
(c)Members who have retired but have yet to reach the scheme normal retirement age or deferred members who have not reached the scheme normal retirement age would receive 90% of benefits subject to an annual overall cap ( £39,006 this year ) at age 65 i.e. maximum compensation payment of £35,105 pa. The cap is reduced in line with the members age at the time of payment if they are under age 65. Members who defer receiving the compensation until after 65 will have the cap increased
Documentation records
State the main documentation the adviser would retain on file to demonstrate compliance with regulatory requirements for pension transfer advice (10)
Fact find questionnaire
Supplementary DB transfer specific questionnaire
Disclosure documentation
Transfer value analysis system(TVAS) Report. Now appropriate pension transfer analysis (APTA) and transfer value comparator (TVC)
Statement of entitlement
Ceding scheme information
Personal pension research, illustration and key features document.
Suitability report
Proof of pension transfer specialist sign off.
Flexi access drawdown annual review requirements. (6)
Review income requirements
Review investment performance against the relevant benchmark
Review expected returns and long-term sustainability of income
Run a cash flow analysis and stress testing
Review attitude to risk and capacity for loss
Carry out a review of overall financial position to account for changes
Calculating maximum PCLS from a DB scheme
Scheme offers £50,000 per annum pension
Commutation factor is 12:1
Remember no tax-free cash can be taken from any GMP element.
HMRC maximum PCLS:
50,000×12/1+(0.15×12) which equals £214,286
To calculate the pension given up take 214,286÷12 which equals £17,857
Therefore the remaining pension is £50,000 -£17,857 which equals £32,143
Always use 0.15 in the Calc.
Legislation allows for two methods of calculating CETV
Best estimate method
Alternative method (enhanced)
Document process to calculate CETV
1- calculate the preserved pension at date of leaving scheme
2- Revalue preserved pension to Scheme NRA
3- Calculate the capital cost of buying the revalued pension scheme NRA factoring in spouses pension, indexation as per scheme
4- Discount the cost back to date of calculation. Resulting figure is the initial cash equivalent (ICE)
5- Make any necessary adjustments to ICE (underfunding/discretionary increases)
Revalued pension at date of leaving to Scheme normal pension age using assumptions on RPI,CPI,NAE.
Capitalise using assumed annuity rates to get the monetary amount needed to purchase an annuity giving the same benefits as the scheme
Discount this amount back to date of leaving to give Initial cash equivalent –CETV (assumptions are investment returns or if less than 10 years to NRA Gilt returns are used)
Calculate preserved pension/revalue / capitalise / Discount back/I CE/best estimate method or alternative method/CETV
Regulatory background
The pension regulator regulates UK work based pension schemes on remit of the DWP.
Principal focus – protect members of work based pension schemes
The financial services and marketing act 2000 defines the regulated activity of advising on transfer of safeguarded benefits.
Pensions act 2014 effective April 15. Pension freedoms
Safeguarded benefits and DB transfers greater than £30,000 required advice
Conduct of business sourcebook 19.1
01/10/2018 TVAS replaced with appropriate transfer value analysis (ATVA) And transfer value comparator (TVC)
ATVA personalised, TVC is not.
TVAS impersonal and assumed an annuity would be purchased at retirement, maximum tax free cash would be taken and spouses benefit will be needed.
TVAS - Assumptions made on RPI, AEI, CPI, annuity interest rates, mortality rates.
Advice is necessary whether it is to transfer or not.
Regulatory background 2
Firm must follow the steps below
Ask the client to seek guidance or regulated advice
What are the risk factors? The core Risk factors FCA expect firm to consider when establishing risk warnings are appropriate to customer considering transferring from DB scheme.There are 11 in total.
Retirement risk warnings
What are the risk factors. Don’t need to ask questions for £10,000 or less.
Core risk factors FCA expect firm to consider when establishing risk warnings appropriate
to customer consider transferring from DB scheme
- State of health
- New guarantees
- Is there a partner/dependent
- Inflation
- Shopping around
- Suitability of income in retirement
- Tax implications
- Charges
- Impact on means tested benefits
- Debt
- Investment Scams
Personalise the risk warnings and retain records indefinitely
What are safeguarded benefits and what are classed as flexible benefits
Flexible benefits are money purchase benefits and cash balance benefits
Safeguarded benefits are benefits not falling into money purchase or cash balance.
These can be guaranteed pensions such as defined benefits, guaranteed minimum pension (GMP) or guaranteed annuity rates (GAR)
Hybrid scheme is Another type of scheme that you may come across which can be a MP scheme with a DB underpin or DB scheme with an MP underpinned.
Statutory right to transfer pensions act 1993 – safeguarded benefits if more than one year before scheme NRA.
List the criteria which have to be met for a scheme member to be entitled to a statutory transfer value (8)
When does a member of the statutory right to transfer flexible benefits from the scheme pension?
- must not have made a request within last 12 months (1)
– Must have ceased accrual (in deferment) (1) - must make the request for statement of entitlement in writing
– Member must have made a formal application to transfer (1) after receiving a statement of entitlement. (1)
– The request must be made at least one year (1) before schemes normal pension age (1) - they must transfer all safeguarded benefits within the scheme (1) unless the receiving scheme is unable to accept GMP benefits (1)
As opposed to safeguarded benefits scheme member Has the right to transfer flexible benefits at any time as long as they have not crystallised them so for example they can transfer when they are passed scheme retirement age Or before they have reached scheme retirement age.
Calculating the value of BCE benefits
In June 2012 John crystallised benefits valued at £600,000 and in May 2014 crystallised a further £625,000.
Calculate the value of benefits.
Formula method
Event 2 Event 2. Total
Amount of BCE. 600,000. 625,000.
LTA in year of BCE. 1,500,000. 1,250,000
Revalued amount. 600,000 x 1.03/1.5 625,000 x 1.03/1.25
= 411,999.96. = 515,000. £926,999.96
Remaining LTA
£1.03m - £926,999.96 = £103,000.04
Percentage method
Event 1. Event 2. Total
% of LTA. 600,000/1.5m =40%. 625,000/1.25m = 50%. 90%
Value of current LTA. 40% 1.03m = 412,000. 50% 1.03m = 515,000. 927,000
Remaining LTA
£1.03m - £927,000 = £103,000.
Calculating the amount of LTA Used when someone goes from capped drawdown to Flexi access drawdown.
Jamal started taking a drawdown pension income in 2005 when he reached the age of 55. In April 2011, with the introduction of the drawdown rules changes he became subject to the capped drawdown rules. September 2017 he decided to crystallise all his remaining pension funds – his first BCE since sixth April 2006. This means that Jamals capped drawdown pension must now be valued to determine how much of his LTA is available.
At the most recent review in October 2015 the maximum annual income on the Jamals capped drawdown fund was established at £16,000 (I.E.this amount is 150% x base amount)
In May 2018 Jamal notified his scheme administrator that he wished to convert his capped drawdown to a Flexi access drawdown fund.
Calculate the amount of Jamals LTA That is used up by his Flexi access drawdown fund.
As he was in capped drawdown when The BCE occurs in September 2017 The calculation against his LTA is based on 25 times 80% of the maximum annual income that can be paid as a capped Drawdown pension at the date of the BCE i.e. 25 x (£16,000 x 80%)
Therefore the amount of Jamals lifetime allowance that is used by his capped drawdown fund is:
25 x (80% X £16,000) = £320,000.
You are preparing a lifetime cash flow model for a client who is considering transferring their defined benefits Pension into a personal pension plan to utilise Flexi access drawdown.
Describe how an increase in inflation assumption used will impact the cash flow model and the potential suitability of a transfer
7 point
- Inflation reduces the spending power of income and therefore a higher income would need to be taken from the fund which may lead to earlier than expected fund depletion.
– Higher returns may be required to sustain the fund value which may lead to an inappropriate level of investment risk being taken
– Revaluation and escalation Will be increased within the defined benefits pension scheme
– this all may result in making a transfer out of the scheme less suitable for the member
Arthur, age 62, is divorced with two non-dependant children. He is a deferred member Of a defined benefit pension scheme and is considering how to take his benefits at retirement.
Outline the potential death benefits payable to his children, including the income tax treatment, if Arthur takes his benefits from:
a) The defined benefits pension scheme; 4
b) The Flexi access drawdown plan following transfer. 6
a) – The balance of payments under a guarantee period, paid as an income, and taxed as the children’s income PAYE
- defined benefits lump sum death benefit payment
b) - Lump sum
– Nominees lifetime annuity
– nominees Flexi access drawdown
- No income taxes payable if the member dies under age 75 and the death benefit is designated within two years
- If a member dies over the age of 75 or designation is outside of two years, then any benefit is taxed as an earned income for the recipient.
TVAS - critical yield figure
Client age 58. Scheme normal pension age 60 and critical yield is 32.4% per annum. Single and wants to take income I lump sums in an ad hoc basis from the scheme.
- Explain why the critical yield is so high
- Explain why the critical yield may be less relevant when deciding whether a members should transfer the benefits from the pension scheme to access them flexibly.
- The critical yield will be high as the initial setup charges and the assumed investment returns will be analysed over less than 2 full years
- critical yield will be less relevant in this case because the client wants to access funds flexibly
- Critical yield assumes a lifetime annuity purchase At scheme retirement age
– member wants to take ad hoc lump sums as required and therefore the fund will remain invested for a longer period
– critical yield assumes that a spouses pension is being provided but as member is single it is unlikely he will need a spouses pension
Cash equivalent transfer values
David receives a cash current transfer value of £465,000 today having received one of £340,000 in 2015.
Outline seven possible reasons for the increase in the CETV
- Previous transfer value may have been reduced due to scheme under funding
– scheme funding may have improve
– Annuity rates may have fallen - Revaluation and escalation rates have increased
– life expectancy assumptions have increased - Discounting rate has reduced (Assumptions on equity based investment and gilt rates have reduced)
- discretionary increases have been added to the scheme (alternative method)
Remember the usual way of calculating CETV is the best estimate method
David single never married will be 59 in May 2018. He is a deferred member of the following DB pension schemes both of which were previously contracted out
Francisco. Bertram Date joined. 9/9/83. 1/1/99 Date left. 31/12/98. 30/6/17 Projected pen at NPA. £18,983. 11,240 NPA. 65. 60 CETV. £465,000. £393,200 Part transfer allowed. Yes. No TV enhanced. No. Yes Early retirement factor. Available 60-3% pa. available 55 - 3%pa
David is self-employed and plans to retire no later than 60. He estimates he will initially need net income between £17,000 and £20,000 per annum. While he would prefer a part of his income to be secured from the commencement of his retirement, he would like to have the flexibility to take ad hoc lump sums as required. David will receive his state pension at age 66. He has a low to medium attitude to risk.
Based on the information provided in the case study relating to Davids two pension schemes outline the factors that you would consider when advising him whether or not he should transfer some or all of his deferred benefits in order to meet his objectives. 10 points available
- Strength of employer covenants And the health of the sponsoring employer
– both schemes are protected by the pension protection fund
– Bertram Cash equivalent transfer value has been enhanced
– David wants part of his income to be secure and part of it to be accessed flexibly
– Francisco would be a higher initial income than Bertram
– David is not married therefore a spouses pension is not required
– an actuarial Reduction will apply to Francisco pension scheme if drawn before age 65
– the Bertram Scheme is available from age 60 without penalty
– he will receive his state pension at age 66 - Francisco will permit a partial transfer
One option David is considering is to draw his scheme pension from the Bertram pension scheme at age 60. He would then also take a partial transfer from the Francisco pension scheme to cover as additional income needs to reaching State Pension Age.
Intention is that the transferred funds would be exhausted at the point of David’s state pension benefits becoming payable.
Explain why you should recommend that the transferred funds should be held in cash rather than invested in any other asset class.
7 points.
– David has a low to medium attitude to risk and intends to deplete the fund over the next six years up until state pension age
– He has no need to take any investment risk and he has a known amount of required income
– cash is liquid and immediately available when required
– fixed interest and equities may be volatile
– property may be illiquid
Ian age 45 is married to Kate 42. They have two daughters aged 15 and 13.
Ian was made redundant from Pringle limited in November 2017. Ian and Kate have recently set up the coffee shop and the first signs are that the business is doing well.
Ian is a deferred member of his former employers defined benefits pension scheme. The scheme is underfunded and a recovery plan is in place.
Ian deferred benefits in the pension scheme as follows:
Date of joining scheme November 1999. Date of leaving scheme November 2017
Pension at date of scheme closure £12,400 per annum.
Spouses pension 2/3 of members pre commutation pension
Increase in deferment is fixed rate of 4% per annum
Increases to pension payment – statutory minimum
Normal pension age 65
Early retirement – available from age 60 with 5% reduction per annum.
Cash equivalent transfer value – £385,000 including a reduction to account for scheme underfunding
Ian would like to consider his options in respect of the defined benefit pension scheme and whether he should retain the preserved pension benefits or transfer to a personal pension plan. Your transfer value analysis report has been produced that shows a critical yield of 9.2% per annum to age 65.
Ian and Kate are both in good health and both have a medium attitude to risk.
A)– State the additional information that you would require from Ian before advising him on the merits of transferring from as existing DB scheme
B)– The Pringle pension scheme is underfunded and Ian is concerned that if the sponsoring employer becomes insolvent this may mean the scheme will enter the pension protection fund. In the event this occurs explain in detail how Ian‘s benefits under the scheme will change in respect of:
- rate of revaluation applied while in deferment
- Level of pension benefits provided by the scheme in retirement
C)-You have recommended that he should not transfer his benefits from the Pringle defined benefits pension scheme to his personal pension plan. Explain in detail the reasons for this recommendation.
A) Income and capital requirements in retirement Expected retirement age Other assets and pensions available Debt and other liabilities Any plans to use the pension funds to help with the business Importance of guarantees Importance of death benefits Any expected inheritance Investment experience Family history of longevity
B) scheme rate of revaluation while in deferment will be as follows:
Benefits accrued before sixth of April 2009 are revalued in line with CPI capped at 5% and the average over the deferment period maybe less than 4% offered by the scheme.
Remaining benefits are revalued in line with CPA capped at 2.5% which will be less than 4% offered by the scheme.
If the scheme goes into the PPF the pension will reduced to 90% of his revalued Entitlement subject to cap
Spouses pension will reduced to 50% of his reduced entitlement
All his benefits will escalate in line with CPI capped at 2.5%
C) No loss of guarantees or investment risk
They are both in good health and therefore no longevity risk
They have a new business which carries a high level of risk
Any future pension contributions Will be subject to investment risk
No apparent reason to transfer at this time and make an irreversible decision
CETV is currently reduced due to underfunding
A recovery plan is in place to return to fully funded in the future - CETV may improve
Critical yield is high and likely to be unachievable based on attitude to risk
The pension scheme appears to be his only pension benefit therefore has little capacity for loss
High level of spouse pension payable
High level of fixed revaluation
Simple to understand and there is no need for ongoing advice costs
Insistent client
The adviser recommended that the defined benefit pension transfer does not proceed. However the client wants to transfer to their personal pension plan against the advice received.
A) State the pension transfer suitability report requirements in relation to pension transfers that are contained in the FCA Conduct of business rules (COBS)
B) Outline the three key steps that the FCA expects a firm to take when advising insistent client
A) the suitability report should confirm the clients needs and objectives and confirm any advantages and disadvantages to the client of the recommendation, Any material information and an analysis of the financial implications. This is in line with normal rules of suitability.
In addition for insistent clients, The firm must include in the suitability report:
– a clear statement about the risks of the alternative course of action; and
– Confirmation that the client is acting against the firms advice.
B) the three steps the FCA expect a firm to take when advising insisted clients are as follows:
- Provide advice that is suitable to the individual client in line with the normal advice process. The process includes gathering information about the clients personal information circumstances and establishing their needs and objectives.
- Make clear the risk of the alternative course of action
- Make it clear that the actions are against the advice provided by the firm.
Under C0BS 19.1.7, If a firm arranges a pension transfer or pension opt out for a client Without making a personal recommendation it must make a clear record of the fact that no personal recommendation was given to the client and retain the record indefinitely
CETV and TVAS report
Jennifers DB scheme has provided her with a CETV of £565,000. She has received a transfer value analysis system (TVAS) report in relation to her deferred benefits. Critical yield is 9.5% based on her selected pension each of 63.
A) Describe to Jennifer how a CETV is calculated
B) explain briefly how the assumptions used to calculate the critical yield in a TVAS Differ from those used to calculate a CETV
A) the CETV is calculated as follows:
The deferred pension at date of leaving is revalued in line with the scheme rules to normal scheme pension age.
The figure is then capitalised using a scheme appropriate annuity rate And then discounted to the date of the calculation using an appropriate assumed Investment return for the timescale.
ICE - Initial cash equivalent
(Equity returns or gilt returns if less than 10 years to scheme NRA)
This figure can be further adjusted in line with the scheme actuary recommendations due to scheme funding giving the final cash equivalent transfer value.
Best estimate method or alternative method may be used.
B) the difference between the assumptions on the CETV and the TVAS report and as follows:
The scheme sets the assumptions used within the CETV whereas a TVAS Report uses FCA Prescribed assumptions. The main assumptions are for inflation, national average earnings and then annuity interest rate.
Under funded schemes and employer covenant
An underfunded defined benefits pension scheme continues to offer unreduced cash equivalent transfer values to deferred members because of a strong employer covenant.
Explain what is meant by the term employer covenant and its relevance to the schemes ability to avoid offering reduced cash equivalent transfer values.
7 Marks
The employer covenant is the sponsoring employer’s legal obligation and financial ability to reduce and eliminate any scheme under funding and to maintain the funding on a long term basis. This means that trustees can be confident in future funding and do not need to reduce CETV’s As the remaining members in the scheme are unlikely to be disadvantaged as a result.
EPP with GAR
John, age 65, as been a member of his employers executive pension plan Since 1979 and is considering accessing his pension benefits flexibly. His current fund value is £675,000 and has a guaranteed annuity rate.
A) stated additional information that you require in respect of the EPP before advising John in relation to drawing his pension benefits. 7 points
B) state, giving you reasons, the steps that John must take Before he would be able to transfer his fund into a suitable pension plan to allow him to access his pension benefits flexibly. 5
A) The information you would need to know regarding the EPP is as follows:
– any protected tax-free cash
– rate of guaranteed annuity
– terms of the guaranteed annuity e.g. death benefits
– any transfer penalties
– availability of pension flexibility options
– charges
– investment fund options
– plan death benefits
B) as the pension plan has safeguarded rates and the fund value is over £30,000 he must provide evidence to the ceeding scheme showing that independent advice has been taken From a suitably qualified adviser with the relevant regulatory permissions
Key questions to ask a person considering the transfer of DB benefits. Additional information needed.
Assume the person wishes to take pension benefits from 60
8 marks
- Income required and likely expenditure in retirement
– capital requirements in retirement
– any other assets and pensions they hold
– Any liabilities
– state of health and family longevity
– Any expected inheritances or future capital receipts e.g. sale of business
– any plans to take any pension benefits before age 60
– attitude towards the loss of guaranteed benefits and replacing them with flexible benefits
Triage service.
Many advisors operate a triage service as part of the defined benefit transfer advice process.
What does the triage service involve?
Triage takes place where firms have an initial conversation with potential customers. Its purpose is to give the customer sufficient information about safeguarded and flexible benefits so they can decide whether to take advice on the transfer or conversion of the pension benefits.
The FCA Considers that triage can be useful to educate customers on some of the basic features of different types of pensions and the transfer process including the costs involved.
In the FCA’s View, if triage is to be a non-advised service, It should be an educational process so that customers can decide whether to proceed to regulated advice. Firms can achieve this by providing generic, balanced information on the advantages and disadvantages of pension transfers.
And individual has to pay a sum of £10,000 in 12 years time.
Assuming a growth rate of 8% per annum How much would need to be invested?
The calculation is as follows:
£10,000 / (1.08)12= £3971
Therefore £3971 needs to be invested at a return of 8% per annum for 12 years to reach the value of £10,000
On calculator 10,000 divided by X to The power of 12 where X is 1.08. Use the X button with the small solid square at the top right corner.
‘Safe withdrawal rate”
Explain what is meant by safe withdrawal rate in relation to pension drawdown and the method of calculation. 6
Safe withdrawal rate is the percentage of the initial investment that can be withdrawn each year over a given quantity of time including adjustments for inflation that does not lead to complete portfolio failure.
Failure Is defined as a 95% probability of depletion to zero of the fund Within the specific period.
Safe withdrawal rate commonly used is 4%.
Pension credits and the lifetime allowance (LTA)
Pension credits received as a result of divorce proceedings will have an impact on an individual LTA.These credits are treated differently depending on whether the effective date of the sharing order was before 6th April 2006 or came into affect on or after this date.
Example – Kate divorced in 2003 and was awarded pension credits of £137,500. From her ex-husband’s pension scheme in February 2003. Eventually credit was valued at £150,000 on 6th April 2006 after applying the increase in the RPI from February 2003 to April 2006.
As a result of the pension credit, calculate Kate’s LTA Enhancement.
As a result of the pension credit, Kate’s LTA will be enhanced by:
150,000/1,500,000 = 0.1 =10%
Kate was issued with a certificate from HMRC showing the enhancement to standard LTA as a factor of 0.1.
LTA And divorce
Melissa was divorced in June 2009. She received a pension credit from your ex husband’s pension scheme in respect of a scheme pension that came into payment in May 2007. Since her ex husband’s pension is already in payment it was tested against his LTA in 2007/2008.
Melissa’s pension credit was valued at £595,000 and the standard LTA in 2009/10 when she received the pension credit was £1.75 million.
Calculate Melissa’s enhanced LTA Due to the pension credit.
£595,000/£1750,000= 0.34 or 34%
In May 2018 Melissa decides to crystallise a road pension benefits. Her personal lifetime allowance taking into account the pension credit is calculated as:
Standard lifetime allowance plus (£1.8 million X 0.34) personal lifetime allowance of £1.03 million plus £612,000 = £1,642,000
Transitional protections
When valuing pensions for the purposes of transitional protection, crystallised and uncrystallised pension rights must have been combined and valued at 5/4/2006. For occupational pension scheme benefits, able to protect it was restricted to the maximum permitted pension (MPP) The MPP Is the amount of pension that could’ve been paid to the member (assuming they were in good health) on 5/4/2006 without giving HMRC grounds for withdrawing approval of the scheme.
Transfer of any benefits with protection could reduce the lifetime allowance for the individual. You must be aware of this.
Name the 6 LTA enhancements or protections that can give a member a personal lifetime allowance higher than the standard LTA.
- enhanced protection (EP) – primary protection (PP) – fixed protection 2014 (FP 2014) – individual protection 2014 (IP 2014) – Fixed protection 2016 (FP 2016) – individual protection 2016 (IP 2016)
Primary and enhanced protection. Webinar 2h30m.
Prior to A-Day An individual with a pension fund of £2 million (subject to it providing a pension within HMRC limits Imposed by previous regimes) would not have had to pay a LTA tax charge.
The government didn’t want to unfairly penalised individuals who had accrued benefits under the old regime, so they introduced options for individuals to protect their pre-A-Day pension rates from the LTA excess charge, provided these are not excessive by reference to pre A-Day limits.
For occupational pension scheme Benefits, we are not protected was instructed to the maximum permitted pension (MPP). The MPP Is the amount of pension that could have been paid to the member on 5th April 2006.
What did primary protection cover and what did enhanced protection cover
- If an individual opted for primary protection, only the amount up to the value of the MPP could be made subject to primary protection.
– Where the individual wish to opt for enhanced protection the XS must first be surrendered before 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:
– refund to the employer less tax at 35%
– Augmentation of other scheme members benefits; or
– the XS being used to pay future scheme premiums for any remaining members.
Primary protection
This was available to individuals with pension rights, valued on 5 April 2006, that had ,a capital value that exceeded £1.5 million. By registering for primary protection, such individuals would receive a PLTA meaning that their pension benefits are protected to the extent that the value of their benefits on 5/4/2006 exceeded £1.5 million. The percentage which the members pension rights exceed £1.5 million is used to give the member a LAEF (Lifetime allowance enhancement factor). This is a percentage increase to standard LTA applicable in the tax year in which benefits are crystallised.
Legislation which introduced reduction of the LTA also included additional protection for individuals with primary protection, stating that the underpinned LTA would be greater of the current standard LTA At the date of the BCE and the £1.8 million Maximum.
Example - At 5 April 2006, David occupational money purchase pension benefits valued at £2.4 million. He opted for primary protection and has not contributed to any other pension arrangements or received any pension benefits after A-Day. He retired on 6 March 2017 by which point his fund had gone to £2.65 million. (The client should also Have given serious consideration to opt for enhanced protection as well – which would have taken precedence – but for the purposes of this example it is assumed that he opted for primary protection.) Calculate Davids Protected lifetime allowance at date of crystallisation
Step 1
Calculate the Lifetime allowance enhancement factor (LAEF)
(Value of pension benefits on 6/4/06 -£1.5 million) divided by £1.5 million
£2.4 million -£1.5 million/£1.5 million= 0.6
Step 2
Calculate the PLTA at date of BCE
Underpinned LTA + (Underpinned LTA x LAEF) £1.8 million is greater than the LTA At 6/3/2017 so £1.8 million is used.
£1.8 million + (1.8m x 0.6) = £2,880,000. Simply put £1.8 million is increased by 60%.(Remember Always use the greater of current LTA or £1.8 million)
LAEF = Lifetime allowance enhancement factor.
Fixed protection
FP 2012
FP 2014
FP 2016
Individuals can apply for FP 2016 whether benefits exceed £1 million or not, as long as they do not already have one of the previous protections.
Fixed protection will continue to play provided that the member does not accrue any further pension benefits under the registered scheme owner after 6 April 2012/2014/2016
Detail the levels of protection each one gives
FP 2012 preserved a LTA Of £1.8 million
FP 2014 preserved A LTA of £1.5 million
SP 2016 preserved a LTA of £1.25 million
Valuation method of pension benefits For primary and enhanced protection purposes
1 - Stakeholder, personal pension, retirement annuity contract.
2 – DB schemes
3 - Occupational money purchase pension schemes
1 - Stakeholder/personal pensions/retirement annuity contracts –value of the uncrystallised benefits was the market value of the fund.
When crystallised benefits were multiplied by a factor of 25 to convert the income stream to a capital sum that then could be measured against lifetime allowance. If funds in drawdown it’s the maximum allowable income calculated at the last review date that’s multiplied by 25.
2 - DB schemes - The uncrystallised pension was calculated using service to 5 April 2006 and multiplied by 20, althought this was limited to 20 times the MPP (maximum permitted pension)
Where a separate Cash sum is available it is added to the capitalised value of the income.
Crystallised pension square multiplied by25 to get the capital value.
3 - occupational money purchase pension schemes – for uncrystallised benefits it was the market value of the fund at 5/4/2006 (restricted to20 times the MPP)
Crystallised pensions or multiplied by 25 to arrive at the capital value.
Income drawdown – maximum permitted income as determent at last review date is multiplied by 25
Options at retirement
Author will reach age 65 in two months and has a retirement annuity contract valued at £120,000. The pussy offers a guaranteed annuity rate of 8.5% with only on a single life basis, paid annually in arrears with no escalation. He is married to Theresa and one of his objectives is to provide financial security for her in the event of his death
A) outline the factors that should be considered by Arthur before transferring to a personal pension to access his pension benefits flexibly. 6
B) State 2 other options that should be considered before transferring Arthur’s fund. 2
A) - Arthur’s willingness and ability to give up guarantees and take investment risk.
– Health, lifestyle and life expectancy of Arthur and Theresa
– requirement for advice and cost of advice
– target income v guaranteed annuity rate v Open market annuity rates
– death benefits available
– other assets and pension arrangements
B) – investigate other options and structures with his existing provider
– take benefits and used part of income to be for life assurance.
Pension increase exchange (P I E)
PIE has the benefit to the scheme of spreading the enhancement over time whereas offering a higher transfer value is an immediate extra cost.
You could not give up the statutory minimum pension increases. We are only talking about scheme increases above the statutory minimum that can be used.
List the benefits and drawbacks of PIE:
Benefits
Higher initial income, higher PCLS, higher spouses pension,
May benefit those with reduced life expectancy or who intend to spend more early years of retirement.
Drawbacks
Member may live past the break even point
Higher value tested against LTA
May affect the members state benefits
Inflation may be higher than expected
May push member into higher income tax bracket
