Pension Re-read Flashcards
What were the two major pension reforms?
A Day
Pension Freedoms Reform
What investment strategy can be used for pensions as one ages?
Lifestyling
also known as glide path
What is lifestyling?
Reducing exposure to risk as a person approaches retirement age and their focus shifts to capital preservation.
Generally decrease equities & increase fixed income
When can liftstlying not be suitable?
If an individual wants to take a drawdown approach as opposed to an annuity.
The lack of risky assets can see the capital shrink quickly.
When should an advisor start discussing lifestlying?
5-10yrs before client retires - should aim to hold yearly reviews
What ways can lifestyling rebalancing take place?
1) Automatically through target date funds
2) Regular manual rebalancing to account for market moves
What is a target fund?
Pension funds which have a set retirement date and an automatic glide path managed by a PM.
one stop shop for lifestyling
How does the UK state pension work?
Single tier system
Benefits are the same for all, based upon years of NI contributions.
Min years to receive state pension?
Years to max state pension?
10 yrs
35 yrs
What is the state pension age?
What will it rise to and when is this reviewed?
66
set to rise to 67 and then 68
reviewed every 5yrs
How much is the state pension?
Per annum & weekly
£11,502
£221.2
How can an individual increase their state pension past £11,502
By deferring the state pension, it increases by 1% for every 9 weeks.
To a maximum of 5.8% per year
Why does the state pension constantly increase?
Triple Lock
rises by highest of CPI, Wage Growth or 2.5%
What is a defined benefit scheme?
A pension scheme which promises a given level of income based upon a proportion of earnings.
How are DB pensions calculated?
Salary * Yrs of service * Accrual Rate
What salary can be used for the DB pensoin calculation?
Final Salary
Average Salary
What happens if a DB member dies before their normal pension date?
A death in service benefit is paid (usually 4x salary)
How can benefits be taken from a DB pension?
Tax free lump sum
Pension Income
can do both so long as lump sum is under the PCLS threshold
What happens if an individual dies shortly after taking their DB pension?
There is often a period where the spouse is paid.
What type of pension is a DB pension?
A scheme pension
No choice around how to draw benefits - to get this freedom a member would have to transfer to a DC pension.
What criteria does a scheme pension have to follow?
1) Payments must be annual at a minimum
2) Guarenteed period does not exceed 10yrs
3) Pension amount cannot be reduced
4) Payments must be by the scheme administrator
Give 3 advantages of DB schemes
1) Retirement planning is easier
2) Certainty of Income
3) Death in Service Benefit
Give 4 disadvantages to DB pensions
1) Earning potential lower in final years
2) Funding concerns (scheme may struggle to pay out)
3) Final Salary calculated less attractively
4) Difficult to transfer
What is a defined contribution scheme?
Most common form of pension - pension pot based upon contributions from self & employer
How can DC benefits be taken?
Drawdown
Purchase an annuity
PCLS can be taken first before the above
What are DC scheme benefits dependant on?
Level of contributions
Fund performance
Charges
Who arranges DC schemes?
The employer, if they are large enough
Or group pension providers offer services to smaller firms
Who has to be offered a workplace pension?
Eligible workers
What 3 criteria are requied to be an eligible worker
1) Between 22 - 66
2) Working in the uK
3) Earning more than £10,000
Who holds the funds in a DC scheme?
Trustees
Can a DB scheme be transferred to a DC scheme?
Yes, providing you have not started taking an income
Give 4 points around DB to DC transfers
1) Advisors must start out assuming it is unsuitable
2) A CETV must be calculated to provide a figure on how much will be transferred to a DC scheme
3) If a pot exceeds >£30,000, must speak to an advisor
4) It is irreversible
cash equivalent transfer value
Give 3 advantages of transferring from DB to DC
1) Can access benefits earlier
2) Choice of annuities
3) Flexible income drawdown
Disadvantages of transferring DB to DC
1) Investment & Sequencing Risk
2) Longevity risk of drawdown
3) Complx to understand options
For a firm to reduce theri DB liabilities, what might they offer?
An enhanced value transfer
still often not worth transferring even with an enhanced value
What is a CETV?
Cash equivalent transfer value
The amount that would be transferred into a DC scheme from a DB pension
What factors effect the value of a CETV
1) Assumed Returns
2) Age
What is a personal pension?
A pension where an individual contracts with a pension provider
DC Scheme
What is a SIPP?
Who are they designed for?
A self invested personal pension - designed for more sophisticated investors
How can SIPPs be offered?
Through a provider - on an XO basis
or
Through an investment manager (advisory / discretionary)
How do XO and IM SIPPs differ?
IM SIPPs tend to have more fees (setup fees, admin fees etc)
What did the FCA find with SIPPs?
IMs were selecting non-standard investments which were unsuitable
There was a lack of due diligence and product understanding
What is a SSAS?
Small self administered scheme
How does a Small self administered scheme work?
What are the conditions?
Company directors can set up and provide pensions to themselves and other employees
Up to a maximum of 11 members allowed
It is a DC pension
How do SSASs differ from other pension schemes?
Wider variety of assets can be invested in (e.g. commercial property)
Not an FCA regulated product
What are the two main structures for Occupational pensions?
1) Trust Based Schemes
2) Contract Based Schemes
What is a trust based scheme
Run by trustees that are the legal owners - trustees appoint managers to look after the money in the best interests of the members
What is a contract based scheme?
Employer appoints an insurance provider - the contract is between the member and the life office
What age can a pension be drawn from? How does it differ for DB & DC
not state-pension
55 ( set to increase to 57)
Tends to be 60-65 for DB (normal retirement age)
max retirement age no longer exists - free to work as long as you wish
What exceptions apply to the 55 pension age?
Critically ill (signed off on by Doctor)
Work in certain industries (e.g. sports)
How does the tax free lump sum work?
how does it differ between DC & DB
can withdraw 25% of value of pension without paying any tax
DC pensions are straight forward 25% of value
DB pensions are more complicated as they have apply commutation
What is the max tax free lump sum?
£268,275
What is trivial commutation?
how does tax apply?
If over 55, and total value of benefits <£30,000 - they can be cashed in for a lump sum
first 25% tax free - rest at marginal rate
In addition to trivial commutation - what is the small pots rule?
any number of pots <£10,000 can be cashed out for a lump sum
25% tax free
How does taking a tax free lump sum effect a DB pension?
Lowers the income paid out
What are the 3 main options available when taking benefits from a DC pension?
after taking 25% tax free
1) Guaranteed Income (annuity)
2) Non-Guaranteed Income (drawdown UFLPS)
3) Take the whole pot
able to also do nothing or mix options
When can an annuity be taken?
anytime, can shop around for the best rate
What three things are annuity rates determined by?
1) Life expectancy
2) Gilt Yields
3) Options Chosen
What is flexible income?
take a flexible income through flexi-access drawdown or use an UFPLS. Drawdown allows one to take a tax-free lump sum and invest the remainder to provide an income.
What are the advantages of flexible drawdown?
- The remainder after taking tax free cash remains invested giving the potential for growth
- Can wait until annuity rates improve – can be purchased at any time
- Removes guess work from joint annuities.
- Can elect to purchase an annuity at anytime
What is critical yield?
this measures the rate of return needed for a drawdown to equal the purchase of an annuity.
What two forms does critical yield come in?
A & B
What is critical yield A?
Critical Yield A: is the rate needed to provide and maintain income equal to an annuity
What is critical yield B?
Critical Yield B: is the rate required to provide a specific amount of income (can be used to compare to a DB and its level of income)
What risk is present when drawing down from a pension?
Sequence Risk
What is sequence risk?
Sequence risk is the risk that the order of investment returns is going to be unfavourable. This risk exists at accumulation stage but it is amplified by withdrawals from a portfolio during the retirement stage.
What is the maximum tax relieved level of pension contributions that can be made each year?
£60,000
What two things reduce the £60,000 pension contribution allowance?
what does each one mean
1) MPAA - When someone has accessed their pension pot flexibly
2) Tapered Annual allowance - when income exceeds a limit
What triggers the MPAA?
Taking a flexible income e.g. a series of lump sums
a variable annuity
taking pension in one go (unless below £10,000)
What are the limits for the tapered annual allowance?
What is the lower bound?
Adjusted income above £260,000
Adjusted by £1 for every £2 above
Cannot fall below £10,000
Who can receive tax relief on pension contributions?
A relevant person on relevant earnings
What is a relevant person?
1) Resident in UK for tax that year
2) Resident in one of last 5
3) Overseas crown employee (or spouse is)
What are relevant UK earnings?
1) Income from employment
2) Income from trade
3) income from Intellectual property
4) Income from overseas crown employment
What are the 3 main methods of claiming tax relief?
1) Net pay - contributions made before any tax paid
2) Releif at source - contribution made less basic rate - admin claims back basic rate
3) Assesment - can claim back from HMRC
if >basic rate payer - can claim back more on self assesment
What was the lifetime allowance?
Previously capped the amount of tax advantaged money that could be saved within a pension - however, this has been scrapped in order to encourage people to work longer
What is a relevant benefit crystalisation event
an event where an individual receives a lump sum and a pension administrator needs to identify whether it breaches any lump sum allowances
What two allowances did relevant benefit events introduce?
how much are they?
Lump Sum Allowance = £268,275
Lump Sum and Death Benefit = £1,073,100
Who can take benefits before 55?
1) Impaired to the extent a medical professional beleives you will not return to work before retirement
2) Less than 1 year to live - confirmed by professional
3) Certain occupations (e.g. a sports person)
If you have less than 12 months to live, how is your pension taxed?
<75 tax free (can be taken in one lump sum)
>75 taxed @ marginal rate
How does UFLPS differ from drawdown?
Drawdown allows you to access your 25% tax free first and then remain invested in order to provide stability and growth to ensure your pot lasts as long as possible.
UFLPS on the other hand will likely stay invested over the long term as it was before which is not suitable for supporting withdrawals.
What are the risks of UFLPS?
not good for long term income. You may draw too much in one go. Only 25% of each UFLPS is tax free, you are paying more tax than is necessary.
How is pension income taxed?
Pension income is treated as earned income for tax purposes and will be paid at source by the administrator.
What is the usual DB death in service benefit?
4.5x salary
can also be a £ value multiplied by years of service
Who receives death benefits from pensions?
Dependants - usually a spouse
but can be a chlid <23 or >23 and mentally / physically impaired
or anyone deemed to be financially dependant by the scheme administrator
How to DC death benefits differ to DB?
More freedom after 2015 reforms - can receive a lump sum as well as regular income
Beneficaries have to be assigned within 2yrs of death
What are the 3 ways a pension can be divided in divorce?
1) Offsetting
2) Attachment ORder
3) Pension Sharing
What is offsetting?
Pensions & Divorce
CETV used to value pension - this value is added to total estate and other assets can be offset against it
What is an attachment order?
Pensions & Divorce
Effectively a court order to pay maintenance from pension income
court decides what level of payments to make
What is pension sharing?
Pensions & Divorce
Pension pot is split at divorce. each spouse recieves own share (can be kept at same provider to transferred out)
Who are the two main regulators for the pensions sector?
The Pensions Regulator and the FCA
HMRC also provide guidance / regulations
What are the 4 key areas of focus for pension regulation?
1) Ensuring pensions support adequate savings for later life
2) Promoting well funded & appropriately invested pension schemes.
3) Driving value for money while ensuring good governance
4) Improve people’s ability to make informed pension decisions
What are the pension regulators 5 statutory objectives?
1) Safeguard Benefits
2) Enhance management practices
3) Reduce claims on protection fund
4) Ensure employers meet responsibilities / laws
5) Balance DB funding with growth of employers
What is the pension protection fund?
PPF
Provides compensation for members of DB schemes which were unable to meet their liabilities.
How is the PPF funded?
DB schemes pay a levy
Under what circumstances does the PPF pay out?
- Employer becomes insolvent
- Pension scheme is underfunded
- No realistic chance of scheme being rescued
What level of benefit do members of DB schemes receive from the PPF?
100% if >retirement age when DB scheme failed
90% if <retirement age
What is the FCAs main area of concern around pensions?
Unsuitable transfers of DB to DC
What 3 things did the FCA highlight / implement in regard to DB transfers?
- Too many firms giving advice without having collected enough information
- Can no longer charge a fee which is dependant on the transfer going ahead
- Provide guidance on what information advisors require to assess a transfer.
Pension advice is regulated, however, what advice requires additional authorisation?
When there are safeguarded benefits,
What are safeguarded benefits?
1) Defined Benefit
2) Guaranteed Minimum Pension
3) Guaranteed Annuity Rate
other than money purchase or cash benefits
