Defined & Safeguarded Benefit Schemes Flashcards
Explain the procedures involved in the CETV calculation for a member of a FS occupational scheme
- Calculate preserved pension at date of leaving the scheme/ leaving service
- Revalue preserved pension up to normal pension age, using the appropriate rates for revaluing different slices or parts of the GMP and non-GMP pensions
- Capitalise the revalued pension into a lump sum by using assumed/ stated annuity rates - actuary will take into account specific benefits of the scheme:
- level of indexation in payment
- level of any death benefits;
- including any spouse pension (irrespective of whether member was married or not)
- Discount the capital value back to today’s equivalent lump sum using appropriate discount rates - discount rates and annuity rates set by trustees on the advice of the actuary
Factors resulting in an increased transfer value
- Shorter term to NRD (as member gets older)
- Low equity yields = falling discount rate
- Annuity rates (at capitalisation) decrease - therefore larger lump sum
- Increase in inflation assumptions
- Discretionary increase
- Actuarial calculation method may have changed
- Existing scheme benefits could have increased
- Trustees decide to offer enhanced transfer value
How would an increase in the inflation assumption affect the funding position of the scheme?
- Higher revaluation and escalation
- Increase in liabilities increases strain on funding position
- Index-linked gilt holdings within scheme assets increases scheme asset value;
- offsets some of the increased liability
How would salary increases (in excess of assumptions) affect funding position?
- Liabilities increase and funding position worsens as benefits linked to salary
- Assets may increase if employer takes % from salary to fund contributions
How might members taking PCLS affect funding position?
- Long term liabilities reduce and improves funding position, especialliy if scheme offers a low commutation rate such i.e. lessPCLS per £ given up in pension income
Briefly explain actions trustees must take if a funding deficit has been identified.
- Must take advice from actuary and consult with employer
- Must agree recovery plan
- Must agree a payment or contribution schedule,
- or a strategy for making up shortfall
- Must inform The Pension Regulator
- They must monitor the position
How are scheme assets measured using IAS 19 valuation?
- Scheme assets measured at market value
- Scheme liabilities measured using an AA coporate bond discount rate
- Past service costs are a scheme liability
- Actuarial gains and losses to be immediately priced into technical provisions
How might trustees and employers reduce a scheme deficit?
- Increase level of member and/or employer contirbutions
- Accrual of future benefits can be reduced or stopped completely
- Scheme can switch from FS to CARE approcah;
- Accrual rate can be reduced
- Reval and escalation rates can be reducaed (not below stat minimums)
- Scheme NRA can be increased
- Scheme can be closed to new members
- Scheme can be closed to all future accrual
- Investment strategy can be revised to a more adventurous strategy if employer risk appetitie and liability profile permit
What points to assess for assessing strength of employer covenant?
- Through which employers can the scheme access value?
- What is the trustees assessment of the employer’s current and likely profitability and cash flows?
- How do these compare with the likely funding needs of the scheme (both now and in a downside scenario?)
- Over what period of time can the mployer afford to repay the funding deficit?
- Is the scheme being treated equitably with other stakeholders?
- Could the employer afford to increase deficit repair contributions in the event of adverse scheme experience, over what period of time?
- Do the employer plans for sustainable growth restrict support for the scheme?
- How much value could the scheme recover in the event of insolvency?
- What are the risks to the covenant and how may it change over time?
- Potential implications of all of this on scheme investment and funding strategies?
What is a section 143 valuation?
- Theoretical cost (buy-out)
- Of buying the schemes benefits with an insurance company (deferred annuities)
- Based on the PPF compensation level
This is done at the point of insolvency and the scheme is coming to an end. This is different from a s179 valuation which is the ongoing valuation at the PPF level.
What must trustees consider if an employer proposes a closure of a scheme?
- Ensure they act in accordance with their duties as trustees
- Exercise of schemes amendment power
- Identify and manage conflicts of interest
- Implications of closure on funding of scheme and investment strategy
- Communication with scheme members
Scheme actuary is responsible for:
- Preparing the periodical actuarial valuation (yearly and triennial)
- Providing advice on:
- Funding principles
- Calculations of technical provisions (TPs)
- Schedule of contributions
- Recovers plans or changes to future benefits
- Certifying the TP calcs is made in accordance with scheme funding regs and contributions are consistent with scheme statement of funding objectives. If not, must inform TPR.
Scheme administrator is responsible for:
- Registering scheme with HMRC
- Operating tax-relief on conributions under the RAS system
- Reporting events relating to the sceheme and scheme administrator to HMRC
- Making returns of info to HMRC
- Providing info to members i.e. LTA limits, AA limits, scheme pays etc
DB schemes covered by PPF if:
- Scheme must be eligible for PPF
- must not have started to wind up pre 5 April 2005
- Insolvency event must have occured
- must not be able to be rescued
- funding level of the scheme is below the level of PPF compensation
PPF compensation levels reached NRD/ pre NRD:
- Already retired at/on/over NRD of scheme
- 100% of pension in payment immediately before assessment date
- Applies to those in receipt of survivors pension or pension grounds of ill health
- Not reached NRD
- PPF will pay compensation of 90% of the pension payable immediately before the assessment date, subject to revaluation
From 1 April 2019 maximum pension of £40,020 (90% = £36,018) for someone aged 65.
If retired before NRD, what levels of compensation are attainable from PPF?
- Max = 90% of pension protection = £36,018 (100% = £40,020 age 65) actuarial reduction if retired before NRD and it is less than 65
- Escalation CPI max 2.5% pa on post 5 April 1997 only
- Spouse’s pension: 50% of member entitlement
- Revaluation: CPI max 5% on pensionable service pre 2009 and max 2.5% p.a. for accrual after 06/04/2009
- Tax-free lump sum of 25% of compensation
- Long service addition from 6 April 2017 - increase of the cap by 3% for each year above 20 years of scheme membership (max double standard cap).
The Pension Regulator’s 5 principles for incentive exercises:
- Principle 1: Clear, fair and not misleading
- An offer should be made in a clear, fair and not misleading way, to enable members to understand the implications and make decisions that are right for them.
- Principle 2: Open and transparent
- The offer should be open and transparent, so that all parties involved in the process are made aware of the reasons for the exercise and the interests of the other parties.
- Principle 3: Manage conflicts of interest
- Conflicts of interest should be identified and appropriately managed in a transparent manner and, where necessary, removed.
- Principle 4: Trustee consultation
- Trustees should be consulted and engaged from the start of the process, with any concerns arising through the exercise alleviated before progressing.
- Principle 5: Independent financial advice
- Fully independent and impartial financial advice should be made accessible to all members and promoted in the strongest possible terms. In almost all circumstances, the structure of the offer should require that members take financial advice. In some circumstances (such as some Pensions Increase Exercises) financial advice may not be required; however, the structure of the offer should provide detailed guidance instead.
What is a section 179 valuation?
A scheme’s s179 liabilities represent (broadly), the premium/ cost/ funding that would have to be paid to an insurance company to take on the PPF levels of compensation for members of the pension scheme.
This is an ongoing vauation - different to a s143 valuation which is done at the point of insolvency.
Section 179 is a basis of measuring scheme liabilities - what are three more and what do they entail?
- Full buy-out; what would have to be paid to an insurance company for it to take on the full payment of scheme benefits
- ISA19 or FRS17; the measures used in UK company accounts for balance sheet cost of the pension scheme
- Statutory funding objective (SFO); sometimes referred to as the technical provisions. Used in the regulator’s scheme funding regime for current scheme liabilities and cost of technical provisions is often used to discount any transfer values.
GMP revaluation for contracted out schemes prior to 6 April 1997, what options were/are available for trustees to revalue GMP?
- Full acceptance of the liability to increase in-line with earnings, many public sector schemes accept this liability in full and revalue GMP for early leavers in accordance with NAE - known as s148
- Private sector schemes however will limit their liability and give themselves some certainty on added liability from revaluation by revaluing at a fixed rate to NRA. Fixed rate has decreased over the years and currently stands at 3.5% for leavers after 5 April 2017.
- It was possible for leavers prior to 6 April 1997, to limit revaluation to 5% a year in exchange for paying the Department for Work and Pensions a “limited revaluation premium”. The DWP then made up the difference to the full level of s148 order increases. This is no longer an option for trustees and was stopped in 1997.
Revaluation rules for contracted out benefits changed from 6 April 1997. From that date early leavers pensions had to be split into two:
- Firstly, GMP which stopped being accrued after 5 April 1997 is separately identified and subject to the rules of revaluation described in above table
- Secondly, all benefits accrued after 5 April 1997 (RST benefits) have to be revalued in accordance with the CPI (RPI before April 2011) to a maximum of 5% (2.50% from April 2009) per annum averaged over the period from leaving to taking retirement benefits.
What is anti-franking?
Franking is the situation whereby, a scheme offsets revaluation increases to be paid on the GMP element of a pension against the amount of scheme pension in excess of the GMP accruing from 6 April 1997.
Anti-franking legislation addresses this issue by setting out additional requirements for the calculation of pension entitlement where GMP revaluation increases are applicable.
From the 6 April 2015, a trivial commutation lump sum can be paid from a defined benefit arrangement only, This can be paid if:
- The value from all defined benefit registered pension scheme sources including pensions in payment doesn’t exceed £30,000
- The person has reached NMPA (or the commutation is under ill-health rules - so earlier)
- Has some unused lifetime allowance left
- The payment eliminates their rights under that scheme
- The payment is made within 12 months of the first trivial commutation lump sum
Triviality rules can be used for both crystallised and uncrystallised rights, including GMP and section 9(2B) rights.
How are triviality and small pots payments taxed?
- 25% of the lump sum is paid tax free
- the balance of the fund (75%) is taxed as pension PAYE income with 20% deducted at source
Triviality and small pots are not taxed under the emergency tax month 1 rules, unlike FAD and UFPLS.
Treatment of tiviality lump sums and small pot payments for the LTA?
- Trivial commutation lump sums are not BCE events and do not use any of the LTA however there needs to be ‘available LTA;
- Small pots are treated in the same way, however do not require available LTA
A winding up trivial commutation lump sum (which has an £18,000 limit), is very flexible: winding up NMPA can be paid before NMPA and all benefits from other pension schemes can be ignored.
Survivors’ pension triviality: Trivial Commutation Lump Sum Death Benefit - key points:
- This extends to defined benefit or defined contribution schemes, payable to survivors on the member’s death.
- Survivor’s payments can be as a one off lump sum in some circumstances
- Allowed when the benefits are not valued at more than £30,000 and the lump sum is the full rights under the scheme
- Survivors are able to commute the remaining payments under a guarantee period under a lifetime annuity or a scheme pension,
- Normally, guarantee payments taxed as income. Any commuted guarantee is effectively taxed as income at the recipient’s marginal rate of tax i.e. no 25% tax free.
Section 32 buyout considerations - treatment of GMP?
Section 32 plans were introduced in 1981 to allow former final salary pension scheme members to transfer accrued benefits after leaving employment.
Transfer value was calculated and transferred value was invested in a plan, hoping it would secure a higher income than the FS scheme.
The S32 provider must accept responsibility for paying the GMP when it becomes due, therefore providing a guaranteed minimum benefit from an investment fund.
The main features of GMP are –
- Guarantees a minimum level of pension, payable from age 60 for a woman and age 65 for a man
- Calculated at the date of ceasing contracted out service
- And re-valued to age 60 for a woman and 65 for a man
- Between 6 April 1978 and 5 April 1988 and inflationary increases met by the state.
- And any post 5 April 1988 GMP increased by the Scheme each year in payment from 60/65 in line with inflation up to 3%
- With a 50% widow’s pension on the whole GMP, and a 50% widower’s, surviving civil partner’s* or same sex spouse’s on the post 5 April 1988 GMP
- With no tax-free cash available
Leaving service: short service refund - key points:
- Employees who leave with at least three months, but less than two years service, refund of employer contributions is as follows:
- First £20,000 of any refund taxed at 20%
- Excess taxed at 50%
- Tax liability falls on administrator who will deduct tax from member’s refund. Any interest paid on a refund of contributions is taxed as a scheme administration member pyment.
- This can be paid if:
- they have less than two years qualifying service
- they have not reached their normal pension date
- there have been no transfers into the pension scheme from personal pension schemes or retirement annuity
- no previous BCEs
- short service lump sum extinguihes members entitlement
- SSLS paid before member reaches age 75
- Those with between three months and two years qualifying service must be offered a CETV
The precise, exact and scheme specific way of calculating CETVs is a matter for trustees and their actuary. Assumptions must be used to achieve a best estimate of the cash needed provide equivalent benefits to the scheme at NRD.
What assumptions might trustees consider and who might they consult?
- Scheme specific, industry specific, and/ or member specific factors, i.e.
- mortality assumptions may be influence by, for example, employer industry and or/ geographical location
- Relevant scheme or external data from which average values can be deduced and trends observed
- Expert opinions on the likelihood of data remaining valid for the future, i.e. economists opinions.
- Investment strategy when choosing assumptions
- Scheme’s funding plan as set out in the statement of principles
The Pensions Regulator has issued its guidance on the calculation of CETVs, this guidance covers: (6)
- Trustees’ responsibility for the calculation basis
- basis for the assumptions used in calculation to be set by trustees, with actuary’s advice
- Minimum level for transfer values
- the will be a minimum permitted level for an initial cash equivalent (ICE), this is the new term under the amended 1996 regs for the members CETV before an permitted deductions are made
- Discretionary benefits and options
- When calculating ICE, only options that would increase the value of the benefits may be included in the best estimate calculation process
- Determination of assumptions
- Trustees must discuss with actuary main characteristics of the schemes membership profile when determining economic, financial and demographic assumptions to be used for ICE calculation
- Permitted reductions
- ICE may be reduced for reasonable admin costs - based on past experience
- Trustees must also offset admin savings gained from member transferring out
- Allowance for scheme underfunding
- Trustees may offer reduced CETVs less than the best estimate when the scheme is under-funded, but only after obtaining insufficiency report from scheme actuary.
- TPR guidance is that scheme must not offer reduced CETVs when under-funded if the covenant is strong and recovery period not too long
The transfer club, what is it?
What are the main conditions of membership?
The transfer club is a group of c. 120 nsalary-related schemes. Eligible private sector schemes are able to participate. Members of transfer club pension schemes are able to move from the employment of one transfer club member to another and receive full credit for their past service.
Main conditions of membership are:
- They are final salary occupational pension schemes (or can receive Club transfers on a final salary basis);
- Full HMRC approval
- Scheme’s trustees or managers agree to comply with the Club arrangements;
- Prior to 6 April 2016, the scheme was contracted out of the State Second Pension
Examples of members include the armed forces, police, firefighters and civil service pension schemes.
Transfer club transfers, how do they work?
- Transfer value calculations carried out as normal.
- When the transfer is received by the new scheme, it is required to pay an additional service credit based on assumptions about how much the member will be earning at retirement.
- This is to allow for anticipated future pay increases.
What is a scheme pension, and how must it be paid?
A scheme pension is a secured pension: a promise to pay an individual a given level of pension income. A scheme pension must be paid:
- by the scheme administrator (or insurance company)
- at least once a year
- for the life of the member
- without being reduced (with a few exceptions)
Can be secured via money purchase or defined benefit arrangement.
What is the commutation formula for calculating the lump sum benefits that can be taken from a DB scheme?
TFLS = 20 x P x C / [20 + (3 x C)]
or
TFLS = (P x C) / [1 + (0.15 x C)]
Recycling tax free cash, when do the rules apply?
- The tax free cash in any twelve month period is more than £7,500
- The pension contributions significantly (@30%) higher
- The total of increases in pension contributions is at least 30% of the tax-free cash
The significant increases in pension contributions can potentially take into account not just the tax year in which the PCLS was taken, but the two immediately prior to and the two immediately following.
The above only applies to pre planned recycling exercises.
The rules for taking a trivial commutation lump sum are as follows:
- The scheme must be a defined benefit scheme
- The member must be at least normal minimum pension age (55 at present), other than in the event of a protected pension age or serious ill health.
- The member has twelve months from taking the first trivial lump sum payment to take all of them.
- The trivial payment must extinguish the right to all benefits in that particular arrangement.
- The total cash value of a member’s pension benefits is less than £30,000.
