October 2017 Exam Paper Flashcards
Section A
Q1.
A Financial Adviser has recommended that a defined benefit pension 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’s Conduct of Business
Rules(COBS) (4)
Model answer to Q1(a)
Suitable advice must be provided in writing and must contain the advantages and disadvantages of the recommendation, any material information and an analysis of the financial implications.
Section A
Q1.
A Financial Adviser has recommended that a defined benefit pension does not proceed. However, the client wants to transfer to their personal pension plan against the advice received.
(b) Outline the three key steps that the FCA expects a firm to take when
advising an ‘insistent client’. (3)
Model answer to Q1(b)
An adviser should always first provide advice following the normal advice process and if a client wishes to act against that advice the risks and implications of their actions should be reconfirmed along with a clear statement that they are acting against advice
Section A
Q2.
Jennifer’s defined benefit pension scheme has provided her with a cash equivalent transfer value (CETV) of £565,000. She has received a transfer value analysis system (TVAS) report in relation to her deferred benefits. The critical yield is 9.5% based on her selected pension age of 63.
(a) Describe to Jennifer how a CETV is calculated. (9)
Model answer to Q2(a)
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. This figure can be further adjusted in line with the scheme actuary recommendations due to scheme funding giving the final Cash Equivalent Transfer Value (CETV).
Section A
Q2.
Jennifer’s defined benefit pension scheme has provided her with a cash equivalent transfer value (CETV) of £565,000. She has received a transfer value analysis system (TVAS) report in relation to her deferred benefits. The critical yield is 9.5% based on her selected pension age of 63.
(b) Explain briefly how the assumptions used to calculate the critical yield
in a TVAS differ from those used to calculate a CETV. (3)
Model answer to Q2(b)
The scheme sets the assumptions used within a CETV whereas a Transfer Value Analysis (TVAS) report uses FCA prescribed assumptions. The main assumptions are for inflation, national average earnings and then annuity interest rate.
Section A
Q3.
An underfunded defined benefit 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 scheme’s ability to pay unreduced cash equivalent transfer values. (7)
Model answer to Q3
The employer covenant is the sponsoring employer’s legal obligation and financial ability to reduce and eliminate any scheme underfunding and to maintain the funding on a long-term basis. This means that trustees can be confident in the 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.
Section A
Q4.
Jonathan, aged 65, has been a member of his employer’s Executive Pension Plan (EPP) since 1979 and is considering accessing his pension benefits flexibly. His current fund value is £675,000 and has a guaranteed annuity rate.
a) State the additional information that you would require in respect of the EPP before advising Jonathan in relation to drawing his pension benefits. (7)
b) State, giving your reasons, the steps that Jonathan 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)
Model answers to Q4
a) 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 has safeguarded rights and the fund value is over
£30,000 he must provide evidence to the ceding scheme showing
that independent advice has been taken from a suitably qualified
adviser with the relevant regulatory permissions.
Section B
Case study 1
Q5.
Lizzie, aged 46, lives with her partner Jo, aged 43. Lizzie is divorced and has two children , age 15 and 12, from her previous marriage. She wants all of her assets to pass to her children following her death as Jo is independently wealthy.
Lizzie is currently a self-employed Accountant. She previously worked for a large firm and has the following deferred defined benefit pension:
Date of joining scheme: 1 September 1992
Date of leaving the scheme: 30 June 2014
Total pension at date of leaving: £32,000
Spouse’s pension: 50% of member’s pension
Children’s pension: 25% per child, payable to age 23
Revaluation and escalation: Statutory minimum
Normal pension age: 65
Early retirement available: From age 60 with an actuarial reduction
of 4% pa
CETV: £925,000
Critical yield: 8.5%pa
Lizzie plans to grow her business for the next ten years and would then like to gradually reduce her working hours until retiring fully no later than age 60. Lizzie has a low to medium attitude to risk and limited investment experience.
List the additional information you would require from Lizzie before advising on the suitability of transferring her defined benefit pension scheme. (8)
Model answers for case study 1 Q5
Additional information required:
-Income required and likely expenditure in retirement
-Capital requirements in retirement
-Any other assets and pensions Lizzie has
-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
Section B
Case study 1
Q6.
Lizzie, aged 46, lives with her partner Jo, aged 43. Lizzie is divorced and has two children , age 15 and 12, from her previous marriage. She wants all of her assets to pass to her children following her death as Jo is independently wealthy.
Lizzie is currently a self-employed Accountant. She previously worked for a large firm and has the following deferred defined benefit pension:
Date of joining scheme: 1 September 1992
Date of leaving the scheme: 30 June 2014
Total pension at date of leaving: £32,000
Spouse’s pension: 50% of member’s pension
Children’s pension: 25% per child, payable to age 23
Revaluation and escalation: Statutory minimum
Normal pension age: 65
Early retirement available: From age 60 with an actuarial reduction
of 4% pa
CETV: £925,000
Critical yield: 8.5%pa
Lizzie plans to grow her business for the next ten years and would then like to gradually reduce her working hours until retiring fully no later than age 60. Lizzie has a low to medium attitude to risk and limited investment experience.
Q6. Based on the information provided in the case study, explain the
factors that an adviser should consider before making a
recommendation on the potential transfer of Lizzie’s define pension
scheme. (8)
Model answers for case study 1 Q6
-she has a low to medium attitude to risk therefore losing guarantees
may not be appropriate and is unlikely that the critical yield will be
achievable
-She has limited investment experience
-she wants to pass her assets to her children, but the scheme offers
limited death benefits before age 60
-There is no access to the scheme benefits before age 60 and she may
wish to access them before for her children
-There is an actuarial reduction applied to the scheme benefits between
age 60 and 65
-She may wish to access her benefits flexibly
-There is a potential lifetime allowance charge following transfer but no
charge if she remains in the scheme
Section B
Case study 1
Q7.
Lizzie, aged 46, lives with her partner Jo, aged 43. Lizzie is divorced and has two children , age 15 and 12, from her previous marriage. She wants all of her assets to pass to her children following her death as Jo is independently wealthy.
Lizzie is currently a self-employed Accountant. She previously worked for a large firm and has the following deferred defined benefit pension:
Date of joining scheme: 1 September 1992
Date of leaving the scheme: 30 June 2014
Total pension at date of leaving: £32,000
Spouse’s pension: 50% of member’s pension
Children’s pension: 25% per child, payable to age 23
Revaluation and escalation: Statutory minimum
Normal pension age: 65
Early retirement available: From age 60 with an actuarial reduction
of 4% pa
CETV: £925,000
Critical yield: 8.5%pa
Lizzie plans to grow her business for the next ten years and would then like to gradually reduce her working hours until retiring fully no later than age 60. Lizzie has a low to medium attitude to risk and limited investment experience.
Q7. Explain the limitations of the critical yield produced by the Transfer
Value Analysis System (TVAS) report assuming the fund value under
a SIPP is likely to exceed the lifetime allowance. (6)
Model answers to case study1 Q7
TVAS does not take account of the fund reduction due to the lifetime allowance charge therefore the critical yield will be understated.
TVAS assumes an annuity is purchased on the same basis as the scheme benefits and does not take account of any flexibility options which may result in the critical yield being overstated.
Section B
Case study 1
Q8.
Lizzie, aged 46, lives with her partner Jo, aged 43. Lizzie is divorced and has two children , age 15 and 12, from her previous marriage. She wants all of her assets to pass to her children following her death as Jo is independently wealthy.
Lizzie is currently a self-employed Accountant. She previously worked for a large firm and has the following deferred defined benefit pension:
Date of joining scheme: 1 September 1992
Date of leaving the scheme: 30 June 2014
Total pension at date of leaving: £32,000
Spouse’s pension: 50% of member’s pension
Children’s pension: 25% per child, payable to age 23
Revaluation and escalation: Statutory minimum
Normal pension age: 65
Early retirement available: From age 60 with an actuarial reduction
of 4% pa
CETV: £925,000
Critical yield: 8.5%pa
Lizzie plans to grow her business for the next ten years and would then like to gradually reduce her working hours until retiring fully no later than age 60. Lizzie has a low to medium attitude to risk and limited investment experience.
Q8. Assuming Lizzie transferred to a self-invested personal pension
(SIPP) and nominated her children to receive any death benefits:
a) Outline the options available to the children, in the event of
Lizzie’s death before age 75. (5)
b) Explain why the completion of a nomination form does not
guarantee the children will receive the death benefits. (4)
Model answers to case study 1 Q8
a) The fund could be paid as a lump sum, dependants lifetime
annuity or dependants flexi-access drawdown as the children are
dependent however they would become nominees when they become
non-dependent.
b) Nomination forms are an expression of wish and not legally binding.
The trustees must investigate Lizzie’s circumstances and they have
the discretion to pay the death benefit to someone else if they deem it
more appropriate.
Section B
Case study 2
Q9.
Billy, aged 61, is married to Candice, aged 42. They have two children, aged 8 and 6.
Billy has worked as a civil engineer at the same company since leaving university and has now decided to retire. Recently, his health has deteriorated and he is concerned about his life expectancy.
He has been a member of his employers defined benefit pension scheme and has been offered the following retirement options:
Full immediate pension: £49,750
Or
Pension Commencement Lump Sum: £147,250
Plus reduced pension of: £37,480
Spouse’s pension: 50% of pre-commutation pension
Children’s pension: None
Increases to pension in payment: Statutory minimum
CETV: £1,492,500
Having reviewed their income and expenditure requirements, Billy and Candice believe they need an ongoing income of £35,000p. They have some capital spending requirements but these are covered by the pension commencement lump sum leaving a liquid emergency fund of £25,000.
Billy wants to ensure that Candice and the children are financially secure following his death.
Both Billy and Candice have a medium attitude to risk and some prior investment experience.
Q9. List six benefits and six drawbacks of Billy transferring his defined benefit pension scheme to a personal pension plan to access benefits flexibly. (12)
Model names to case study 2 Q9
Benefits:
-Funds available should be able to sustain the income they need
-Income from the plan can be varied
-Would allow benefits to be left to the children
-Death benefits are likely to be higher and have flexible options
-Death benefits will be tax-free if death is before age 75
-Pension commencement lump sum (PCLS) will be greater subject to
25% of lifetime allowance
Drawbacks:
- Loss of guaranteed pension and spouses pension
- Loss of guaranteed escalation therefore inflation risk
- Exposure to investment risk
- Fund could run out i.e. longevity risk
- Charges and complexity
- Potential lifetime allowance to charge
Section B
Case study 2
Q10.
Billy, aged 61, is married to Candice, aged 42. They have two children, aged 8 and 6.
Billy has worked as a civil engineer at the same company since leaving university and has now decided to retire. Recently, his health has deteriorated and he is concerned about his life expectancy.
He has been a member of his employers defined benefit pension scheme and has been offered the following retirement options:
Full immediate pension: £49,750
Or
Pension Commencement Lump Sum: £147,250
Plus reduced pension of: £37,480
Spouse’s pension: 50% of pre-commutation pension
Children’s pension: None
Increases to pension in payment: Statutory minimum
CETV: £1,492,500
Having reviewed their income and expenditure requirements, Billy and Candice believe they need an ongoing income of £35,000p. They have some capital spending requirements but these are covered by the pension commencement lump sum leaving a liquid emergency fund of £25,000.
Billy wants to ensure that Candice and the children are financially secure following his death.
Both Billy and Candice have a medium attitude to risk and some prior investment experience.
Q10. If Billy were to crystallise all of his pension benefits using flexi-access drawdown, he would exceed the lifetime allowance and be liable to tax charges.
Explain to Billy why he is unable to apply for any currently available transitional protections to reduce these tax charges. (7)
Model answers for case study 2 Q10
-FP16 is not available as benefits have accrued in the scheme since
6 April 2016
-IP16 is not available as the benefits are valued at 20x scheme pension
and were therefore valued as less than £1M on 5 April 2016
Section B
Case study 2
Q11.
Billy, aged 61, is married to Candice, aged 42. They have two children, aged 8 and 6.
Billy has worked as a civil engineer at the same company since leaving university and has now decided to retire. Recently, his health has deteriorated and he is concerned about his life expectancy.
He has been a member of his employers defined benefit pension scheme and has been offered the following retirement options:
Full immediate pension: £49,750
Or
Pension Commencement Lump Sum: £147,250
Plus reduced pension of: £37,480
Spouse’s pension: 50% of pre-commutation pension
Children’s pension: None
Increases to pension in payment: Statutory minimum
CETV: £1,492,500
Having reviewed their income and expenditure requirements, Billy and Candice believe they need an ongoing income of £35,000p. They have some capital spending requirements but these are covered by the pension commencement lump sum leaving a liquid emergency fund of £25,000.
Billy wants to ensure that Candice and the children are financially secure following his death.
Both Billy and Candice have a medium attitude to risk and some prior investment experience.
Q11. Explain what is meant by ‘safe withdrawal rate’ in relation to pension
drawdown and the method of calculation. (6)
Model answer for case study 2 Q11
It is the percentage of the initial investment that can be withdrawn each year over a period of 30 years taking account of inflation that does not lead to complete portfolio failure. Failure is defined as a 95% probability or more of total depletion of the fund.
Section B
Case study 2
Q12.
Billy, aged 61, is married to Candice, aged 42. They have two children, aged 8 and 6.
Billy has worked as a civil engineer at the same company since leaving university and has now decided to retire. Recently, his health has deteriorated and he is concerned about his life expectancy.
He has been a member of his employers defined benefit pension scheme and has been offered the following retirement options:
Full immediate pension: £49,750
Or
Pension Commencement Lump Sum: £147,250
Plus reduced pension of: £37,480
Spouse’s pension: 50% of pre-commutation pension
Children’s pension: None
Increases to pension in payment: Statutory minimum
CETV: £1,492,500
Having reviewed their income and expenditure requirements, Billy and Candice believe they need an ongoing income of £35,000p. They have some capital spending requirements but these are covered by the pension commencement lump sum leaving a liquid emergency fund of £25,000.
Billy wants to ensure that Candice and the children are financially secure following his death.
Both Billy and Candice have a medium attitude to risk and some prior investment experience.
Q12. As part of the advisory process, a lifetime cashflow model has been
put in place for Billy and Candice.
State six stress tests that could be undertaken as part of an annual
review of the cashflow plan. (6)
Model answers for case study 2 Q12
- Future returns are lower than expected
- More income is required than expected
- Sudden loss of assets such as a stock market crash
- Large unplanned capital requirement
- Inflation is greater than expected
- Living longer than expected
