Exemplar Exam Paper Flashcards
Passing first time with flying colours!
Section A
Q1.
Explain the meaning of the term ‘hurdle rate’ in the context of defined benefit pension transfer advice and how it is different from ‘critical yield’ (12)
Model answer to:
Q1.
The ‘hurdle rate’ is the annual investment return required after charges, to provide a capital sum sufficient to purchase a single life level 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 in payment, dependant’s benefits and any guaranteed period
Section A
Q.2
Sanjay is a member of a defined benefit pension 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
(PPF) to assume responsibility for the scheme. (4)
b) Outline the protection that would be provided in respect of Sanjay’s
benefits, assuming the scheme enters the PPF and Sanjay has taken
his benefits at normal pension age. (4)
Model answers
Q.2
a) - An 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 a least equal to the compensation that
the PPF would provide.
b) - Sanjay would receive 100% of his pension income, however, the
escalation would be restricted to CPI capped at 2.5% in relation to
post-97 benefits only.
- There would be a spouse’s pension of a maximum of 50% of the
member’s Pension in payment.
Section A
Q.3
A Financial Adviser has recommended a pension transfer from a defined benefit scheme to a personal pension scheme.
State the main documentation the adviser would retain on file to demonstrate compliance with regulatory requirements for pension transfer advice. (6)
Model answers
Q.3
Any of six of the following:
- Fact-find questionnaire
- Disclosure documentation
- Transfer Value Analysis System (TVAS) report
- Cash Equivalent Transfer Value (CETV) Statement of Entitlement
- Statement of pension entitlement and scheme information
- Personal pension research , illustration and key features documentation
- Suitability report
- Proof of pension transfer specialist sign-off
Section A
Q.4
Arthur will reach age 65 in two months and has a retirement annuity policy valued at £120,000. The policy offers a guaranteed rate of 8.5% but 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
flexibility. (6)
b) State two other options that should be considered before transferring
Arthur’s fund. (2)
Model answers
Q.4
a) - Arthur’s willingness and ability to give up guarantees and take
investment
- Health, lifestyle and life expectancy of Arthur and Theresa
- Requirement for advice and the cost of advice
- Target income v Guaranteed Annuity Rate (GAR) 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 use part of income to pay for life assurance
Section B
Case study 1
Steve, aged 46, is married to Daniella, aged 41 and they have two children, aged 6 and 4.
Steve is a deferred member of a defined benefit pension scheme. Two years ago Steve received financial advice in respect of a potential transfer into a personal pension scheme. At the time the transfer analysis critical yield was 9% and Steve’s attitude to risk was cautious. He was advised not to transfer. The details of his deferred benefits are as follows:
Date of joining scheme: January 1992
Date of leaving scheme: January 2014
Total pension at date of leaving: £14,750pa
Spouse’s pension: 50% in deferment and retirement
Children’s pension: 25% per child in deferment and
retirement
Increases in deferment: Statutory minimum
Increases to pension in payment: Statutory minimum
Normal pension age: 65
Early retirement available from age: Trustees discretion only on
application
In January 2016 Steve set up his own business and estimates his net profit to be £40,000 in the current tax year 2017/18. He intends to continue continue with some form of retirement provision but has not yet set-up any pension arrangements. Since setting up his own business Steve feels he now has a more adventurous attitude to investment risk.
Steve would like to fully retire by age 65 and hopes that his existing deferred arrangement will be sufficient to meet most of his target retirement income of £25,000pa. He would like to reduce his time spent at work gradually from age 55 onwards. Steve is also concerned about the death benefits available to his wife and children.
Steve has recently requested a new Cash Equivalent Transfer Value (CETV) from his pension scheme and has noted that it has increased from two years ago.
Q.5
Outline the actions a financial adviser would take when assessing Steve’s current pension provision against his target retirement income. (5)
Section B
Model answers
Case study 1
Q.5
- Confirm whether £25,000 is in today’s money or at his selected
pension age and if in today’s money then increase this to selected
pension age by agreed inflation factor.
- Obtain projection from pension scheme to selected pension age
and compare projected pension income with target amount.
- Check and confirm State Pension Age and obtain State Pension
projection
- Calculate funding required to achieve target income amount.
Section B
Case study 1
Q.6
State five potential reasons that may have caused the increase in Steve’s CETV. (5)
SectionB
Model answers
Q.6
- Scheme funding position may have improved
- Scheme discounting rates may have reduced
- The scheme annuity interest rate may be lower
- Higher future inflation assumption
- Shorter time to normal pension age
Section B
Case study 1
Q.7
Based upon Steve and Danielle’s current position and long-term objectives, identify six benefits of transferring into a personal pension and six benefits of remaining in the defined benefit scheme. (12)
Section B
Model answers
Q.7
Benefits of transferring into a personal pension:
- Able to retire at selected retirement age
- Flexible retirement income and lump sum death benefit options
- Tax-free death benefits on death before age 75
- His wife and children can be nominated to benefit from the full fund on
his death and they can appoint their own successors
- Pension commencement lump sum may be higher or could be used
during phased work reduction for tax efficiency
- Potential investment growth may exceed critical yield as has
adventurous attitude to risk
Benefits of remaining in defined benefit scheme:
- Guaranteed income for life
- Guaranteed revaluation and escalation
- No exposure to investment or longevity risk
- Simple to understand and administer with no ongoing advice and
related cost required
- Spouse and children pensions included
- Protection provided by Pension Protection Fund
Section B
Case study 1
Q.8
Outline briefly the potential death benefit options and their tax
treatment should Steve die before taking any pension benefits, if
payable from;
a) the existing defined benefit scheme. (3)
Section B
Model answers
Q.8
a)
- Spouse and dependants pensions taxable;
- on recipient as earned income
- Tax-free refund of contributions as a lump sum
Section B
Case study 1
Q.8
Outline briefly the potential death benefit options and their tax
treatment should Steve die before taking any pension benefits, if
payable from;
b) a personal pension plan should Steve decide to transfer. (5)
Section B Case study 1 Model answers Q.8 b) - Entire fund payable as a lump sum - Dependants or nominees lifetime annuity - Dependants or nominees flexi-access drawdown - All benefits tax-free - As death before age 75
Section B
Case study 2
Marko age 61 is married to Sue aged 63 and they have two financially independent children aged 25 and 22.
Marko has deferred benefits under a private sector defined benefit scheme. The details are as follows.
Date of joining scheme. : January 1988
Date of leaving scheme. : January 2008
Total pension at date of leavings : £12,000pa
Spouse’s pension. : 50% in deferment and in
retirement
Increases in deferment. : Statutory minimum
Increases to pension in payment. : Statutory minimum
Normal pension age. : 65
Early retirement available from age : 60, subject to 4%pa
earlyretirement reduction
Current cash equivalent transfer value:£380,000
Since leaving service in 2008 Marko has been running his own business. He has an adventurous attitude to risk and is prepared to give up any guarantees from his deferred scheme to provide flexibility for himself and his family. Sue has a cautious attitude to risk and has little knowledge or experience of investing.
He has accumulated £250,000 of investment capital and is prepared to use this to help fund his retirement objectives . In addition, he has recently inherited a property, valued at £400,000. Marko has expressed an interest in renting out his property to supplement his retirement income.
Marko is Planning to sell his business and retire within the next 12 months. In anticipation of this, he has read product literature from pension providers about the flexibilities, offered by personal pension plans. He is keen to explore the potential benefits and drawbacks of transferring his deferred benefits into a new personal pension. A transfer analysis system has produced the following results:
Scheme pension: Age 65 £15,312 Age 62 £13,475
Critical yield: 9.85% 38.32%
Hurdle rate: -3.6% -19.53%
Age funds run 102. 99
out at medium
growth rate
The TVAS report also shows that Marko has a normal life expectancy of 87 and Sue has a life expectancy of 85. He is keen to ensure that Sue and their children have flexibility in the event of his death.
Q.9
Explain briefly the limitations of relying solely upon the critical yield when assessing a potential defined benefit pension transfer, especially when there is less than 12 months to selected pension age. (6)
Section B
Case study 2
Model answers
Q.9
- One dimensional figure at a fixed point in time and assumes lifetime
annuity purchase in the format matching the scheme benefits
- Cannot compare to enhanced annuity rate if in ill health
- Does not take into account death benefit considerations
- Soft facts and client circumstances and objectives not considered
- Less then 12 months is short-time period and not enough time to
absorb initial advice and product costs, therefore the critical yield is
distorted
Section B
Case study 2
Q.10
Explain, in detail, the main drawbacks of Marko transferring out of his deferred scheme. (12)
Section B
Case study 2
Model answers
Q.10
- Loss of guaranteed income for Marko and Sue
- Exposure of investment risk until and beyond retirement
- Loss of guaranteed future escalation
- Loss of Protection provided by Pension Protection Fund
- Exposure to investment and longevity risk
- Exposure to shortfall and sequencing risk
- Current annuity rate not competitive with deferred benefit
- Exposure to potentially fluctuating market annuity rates
- Annuity rates low at current age
- Complex and requires ongoing monitoring and financial advice
- Sue is cautious and does not share Marko’s adventurous attitude to risk,
therefore a transfer may not be suitable for Sue in the event of Marko’s
death due to her lack of experience
Section B
Case study 2
Q.11
Identify 12 factors that suggest a transfer may be suitable for Marko based on the information provided in the case study. (12)
Section B
Case study 2
Model answers
Q.11
- Can retire at intended retirement date of 62
- Without scheme early retirement penalty
- Fund sustainable beyond life expectancy at medium rate of return
- Medium rate of return achievable within his risk profile
- He would be willing to give up guarantees and take on risks
- Critical yield not crucial to transfer as Marko planning immediate
crystallisation
- Flexible income and death benefits
- Nominees and successors benefits available
- Used to making decisions on his own account
- Likely to have capacity for loss
- Other assets available to produce income
Section B
Case study 2
Q.12
State 6 areas that should be reviewed on an annual basis to ensure that the ongoing risks of this course of action are monitored and managed effectively, should a transfer to a personal pension proceed. (6)
Section B
Case study 2
Model answers
Q.12
- Income requirements
- Investment performance against a relevant benchmark
- Expected returns and long-term sustainability of income
- Cash flow analysis and stress testing
- Attitude to risk and capacity for loss
- Review of overall financial position to account for changes
