Lecture 7-Pensions Flashcards
Increasing life expectancy
People across the world are living longer due
to medical advancements, better living
standards and healthy diet. It is resulting in building up of an ageing population.
• However the cost of supporting old age is very
high.
• The more recently you were born, the more
long you are expected to live.
Baby boomers on life expectancy
• Living longer is the reason why population
across developed economies is ageing.
• Another reason for ageing is a bulge in births
during the period 1945 to 1965.
• This generation of baby boomers is expected
to exert a strain on economy when it reaches
retirement age.
• This will result in falling support ratio
What is the support ratio?
the number of people of working age for each person over pension age.
-Those who work create wealth for country. Part of this wealth is distributed among those who no longer work.
• If number of people supporting each pensioner
decreases then either the workers will have to
distribute more from their income, or pensioners will
receive less.
• However, not all pensioners completely stop working,
rather some carry on working part time.
• Also, the productivity of workers might be increased by better technology and machinery
Means tested retirement support
Support to finance those who have already
retired and are in poverty. Typically, this will top
up their income to a minimum level and might
include non-cash benefits as well, such as
subsidised travelling and help with heating bills
etc.
Mandatory state pension
Financed on a Pay-as-you-go basis
• It means that the money paid out to today’s pensioners
comes from taxes levied on today’s workers
• So money transfers from workers to pensioners
through tax and benefit system
• A tax called National Insurance Contributions (NIC) entitles people to old age pensions and benefits
• Workers pay NIC on the basis that when they will retire
themselves, they will also receive state pension
Entitlement of state pension in the UK
-UK citizens qualify for a state pension by paying NIC set as a proportion if their earnings from job or self-employment.
• They get credits when they are not working, for example,
because of disability, unemployment or illness.
• Citizens who reached state pension age before 6 April 2016 may get a flat rate pension, equal to about ¾ quarters of minimum income pensioners are deemed to need plus an
earnings-related pension.
• A person could ‘contract out’ of additional state pension. Thus they would have paid lower national insurance and
will not be entitled to additional state pension
-To qualify for full flat-rate pension, people need 35 years’ worth of
contributions and/or credits.
• A minimum of 10 years contributions/credits are required to qualify for
any state pension at all.
What are private pensions
-Used for building additional savings for retirement
-Pension schemes may provide tax benefits
– Tax relief on contributions
– Return from invested contributions
– Proceeds might be subject to tax-free withdrawal
• Private pension schemes can be organised by an
– Individual (Personal Pension Schemes) or
– Employer (Occupational Pension Schemes)
What is defined benefit pension?
These are also known as a salary related schemes
• Defined Benefit Schemes are when you are promised a certain level of pension when you retire. This typically depends on:
– Your salary just before you retire.
-Workplace schemes are usually based on a number of things, for example your salary and how long you’ve worked for your employer.
The pension provider will promise to give you a certain amount each year when you retire.
You can usually choose to get 25% tax free. You’ll get the rest as regular payments.
What are defined contribution schemes?
- occupational pension schemes where your own contributions and your employer’s contributions are both invested and the proceeds used to buy a pension and/or other benefits at retirement.
- The value of the ultimate benefits payable from the DC scheme depends on the amount of contributions paid, the investment return achieved less any fees and charges, and the cost of buying the benefits
-Up to 25% of the value of the pension fund -
can be taken as a tax-free lump sum.
• The remainder of the fund must be used to
purchase an annuity that pays out a regular
pension.
What does the defined contribution scheme depend on?
– How much has been paid in (by the employee and/or the
employer)
– How well the pension fund has grown i.e. how well the fund managers have done in investing the fund.
– What the annuity rates are at the time you retire and buy
one.
– Charges
What is a self-invested personal pension?
these allow you to control the specific investments that make up your pension fund
What are the ways to convert savings into income?
In defined contribution schemes, you receive
a pot of money at the time of retirement.
- Income drawdown
- Annuity
What is income drawdown?
-leave the money invested and draw out income and lump-sum as and when
needed
-The problem with this is exposed to longevity risk, the risk of outliving their savings. You will also continue to be exposed to investment risk and
inflation risk
How to counteract the problems of income drawdown?
-drawing off the natural income, leaving
your capital untouched.
-However, this means living on a lower income that might not be enough to meet your needs.
What are annuities?
-Is a guaranteed regular flow of income for the rest of life in exchange of pension pot.
