Pension Transfers Chp 6 Applyimg Suitable Pension Transfer Solutions Flashcards
DB to DC
“However, following on from its 2017 consultation, from 1 October 2018 there is a requirement to undertake an appropriate pension transfer analysis (APTA) of the client’s options; and a prescribed transfer value comparator (TVC), indicating the value of the benefits being given up and the cost of purchasing the same income in a defined contribution environment. Further details of this can be found in Appropriate transfer value analysis (APTA).
Having carried out the comparison, the adviser’s role is to advise their client as to whether staying in the existing defined benefit scheme will provide the best means of them achieving their retirement planning objectives and meeting their retirement needs, or whether transferring fully or partially (if the option is available) into a defined contribution scheme that provides flexible benefits is the most suitable course of action to achieve the same ends.”
Safeguarded Benefit to DC
“Safeguarded benefits are defined as benefits that are not money purchase or cash balance benefits. They include defined benefits, defined contribution schemes with guaranteed annuity rates (GARs) and guaranteed pensions at retirement.”
“Guaranteed annuity rates: It is important to understand the exact nature of the guaranteed benefits provided by the contract in order to provide appropriate advice, therefore it is essential to obtain information about the terms and conditions of the guaranteed annuity rates as well as the rates themselves:
Is the guarantee applicable at a specific point in time, such as normal retirement age, or is it generally applicable whenever benefits are taken?
Generally, rates will be expressed as single life, paid annually in arrears with no indexation or guarantee period, as this is the most basic benefit available and therefore the highest starting point. It is important to establish whether the contract can offer benefits on any other basis, and to obtain details of these rates.
What are the options in relation to taking benefits early or late and details of any penalties or enhancements that may apply?
“Guaranteed pension at retirement: This is different from a guaranteed annuity rate plan in that the contract offers a basic guaranteed pension which is increased by the addition of bonuses over time rather than a guaranteed rate. Generally, these will be with-profits type plans so in addition to the details about the pension itself the following additional information would be required:
The previous history of reversionary and terminal bonuses for the provider.
Whether a market value adjustment factor can be applied and on what basis. Understand the circumstances when an MVA would not apply.”
“The most likely reason for a member to consider transferring away from a scheme with a guaranteed annuity rate is where it is only payable as at a certain date which doesn’t fit in with their retirement plans, and/or it is only available on a single life basis and the member is concerned that their partner is inadequately provided for, and would prefer a lower rate but on a joint life basis. Other reasons may be poor health, shortened life-expectancy or simply just not having the need for the secure income.
The most likely reason for a member to consider transferring away from a scheme which provides a guaranteed basic pension at retirement is that the annual bonuses being added are negligible and the overall likely pension at retirement is therefore unattractive to the member, and they do not see future bonus patterns changing. Again, other reasons may be poor health, shortened life-expectancy or simply just not having the need for the secure income.”
“When considering transferring away from a defined benefit scheme or a scheme providing any other form of safeguarded benefits, and into a defined contribution scheme, a comparison should be made at the scheme’s NPA and any other ages that are appropriate to the member’s requirements of the benefits likely to be paid under the existing scheme, with the benefits that would be available on transfer to a defined contribution scheme that provides flexible benefits. When doing so, reasonable assumptions should be used, with the FCA stipulating the assumptions that should be used specifically for defined benefits.
It is essential that in doing this comparison the firm clearly informs the client about the benefits they will be giving up and the implications of the loss of these benefits. Specifically, this should include the extent to which any replacement benefits may fall short of replicating those in the defined benefit pension scheme or other scheme with safeguarded benefits.”
Reconciling Client Objectives and Needs:
“It is not however simply a case of prioritising and compromising between diametrically opposed requirements, there are also other factors that need to be taken into account when establishing how best to proceed. These other factors include:
when the client intends to stop working and whether this will be a gradual reduction of working hours over time;
determining how best to access the pension benefits;
timing of taking an income from the State Pension;
alternative ways of achieving the client objectives other than by transferring;
features of the receiving scheme; and
suitability of the recommended investment strategy.”
DB Scheme Pensions:
“Defined benefit scheme pensions – benefits and drawbacks
Benefits
Drawbacks
Income paid to the member
Secure income for life of member.
Will usually increase in line with inflation (subject to scheme and DWP rules).
Liability for payment remains with the trustees and sponsoring employer.
Will not trigger the MPAA under most circumstances.
Once in payment income cannot usually be varied.
If the scheme member dies earlier than expected, the income ceases (unless a survivor’s pension guarantee period or annuity protection is included).
Continued payment is subject to the continued financial solvency of the scheme and the sponsoring employer.
Death benefits following death of the member
Will usually provide a spouse pension (spouse includes civil partners and same sex marriage) provided any conditions in the scheme rules are met.
“Benefits will generally increase roughly in line with inflation as per scheme rules and HMRC legislation.
May provide a guaranteed period of 5–10 years. Balance of payments can be commuted for a lump sum.
May provide for a dependant pension other than spouse, and possibly children’s pensions.
There is a huge variation in the definition of spouse and dependant, and often payment of benefits is at the discretion of the trustees.
Spouse and other pension benefits will be taxable as the recipient’s pension income under PAYE.
Payment of spouse benefits can be reviewed, reduced or withdrawn all together based on the scheme rules.
Can only be paid to a beneficiary who is a dependant as defined by the DWP/the scheme rules if more restrictive.
A survivor’s pension must cease when the survivor dies (i.e. the benefit cannot pass on through later generations).
No lump-sum death benefits unless annuity protection is selected. Any lump sum paid will form part of the survivor’s estate unless paid to a suitable trust.
General
Easy to understand – no need for ongoing reviews.
Provide certainty of income throughout life for member as long as the scheme remains able to honour its pension promises.
“Less costly than a drawdown pension.
May be suitable for clients who have a low capacity for loss.”
Lifetime Annuities:
“Life offices use external life tables and their own experience to work out life expectancy. This is especially true for individually written impaired life business and, to some extent, for enhanced terms smoker and ‘lifestyle’ business. Insurers also factor in improvement assumptions that allow for further increases in life expectancy among their annuitants in payment. Traditionally, a life office pools the risk so that underwriting gains from those who die early will be (to some extent) redistributed to help meet payments to those who live longer than expected.
The pension flexibility reforms have reduced the amount of new individual annuity business. This further reduces the scope for annuity cross subsidy, with continuing downward pressure on mainstream rates for younger lives relative to where they might otherwise have been. This is because many of those who choose to buy lifetime annuities will do so because they are in good health (and so are less likely to die earlier than expected) and so want to eliminate the risk of outliving their income.”
Lifetime Annuities Benefits and Drawbacks:
“Benefits
Drawbacks
Income paid to the member
Secure income for life.
Indexation can be included.
More flexible options now available including the amount of the income.
Payment from a conventional lifetime annuity will not trigger the MPAA.
Once purchased, the level of income cannot be varied unless a flexible lifetime annuity is selected.
If the annuitant dies earlier than expected the income ceases (unless a survivor’s pension is included).
Payment from a flexible lifetime annuity will trigger the MPAA.
“Death benefits following the death of the member
Can be set up to provide a guaranteed income for a beneficiary.
Beneficiary does not have to be a spouse, civil partner or dependant
May include annuity capital protection.
May include any length of guarantee period (subject to the provider’s rules).
Benefits are paid to survivors free of income tax if the member dies before the age of 75.
May be possible for the survivor’s pension and/or guarantee payments to be commuted for a lump sum if the triviality conditions are met.
Decisions relating to the inclusion of a survivor’s pension must be made at outset and cannot be changed.
A survivor’s annuity must cease when the survivor dies (i.e. the benefit cannot be passed on through later generations).
No lump-sum death benefits unless annuity protection is selected.
Once an annuity protection lump sum is paid out it is within the beneficiary’s estate for IHT unless paid into a suitable trust (and depending on the rules of the pension scheme).”
“General
Easy to understand – no need for ongoing reviews if a conventional (non-investment linked) annuity is chosen.
No investment risk for conventional annuity.
Less costly than a drawdown pension in terms of the need for ongoing advice.
May be suitable for clients who have a low capacity for loss.
Reviews are required if an investment linked or flexible lifetime annuity is selected.
Generally inflexible (other than where a flexible lifetime annuity is selected).
No ability to pass the pension through the generations.”
Flexible Income Options. UFPLS Benefits and Drawbacks
“UFPLS – benefits and drawbacks
Benefits
Drawbacks
Income paid to the member
Client has full flexibility to choose the amount of the lump-sum payment they take (i.e. can take the whole fund or a series of payments).
25% of each payment is tax free.
Can be used for tax planning to utilise the client’s personal allowance and/or basic rate tax band.
As withdrawals are in the form of a lump sum, the client can take funds for any purpose.
Payment of an UFPLS triggers the MPAA.
All in excess of the 25% tax-free element istaxable as the client’s pension income viaPAYE.
Any fund not taken as an UFPLS remains subject to investment risk.
Possibility that entire fund could be depleted and leave the client with insufficient funds to live on in retirement.”
“Death benefits paid following the death of the member
Any uncrystallised fund not taken as an UFPLS remains available for client’s beneficiaries (tax free on member’s death before the age of 75).
Uncrystallised funds can be used by the survivor to provide a lump sum, annuity income or be designated to drawdown.
If designated to drawdown the funds can be passed onto future generations within the pensions tax wrapper, thereby outside the survivor’s estate for IHT.
Any UFPLS taken and not spent is within the client’s estate for IHT.
Any uncrystallised funds taken as a lump sum forms part of the beneficiary’s estate for IHT for seven years.”
“General
Relatively simple to understand.
Full flexibility in terms of amount and frequency of UFPLS taken.
Can be used to phase retirement by taking a series of UFPLS withdrawals over time.
Any uncrystallised funds can be passed onto future generations.
Reviews still needed in respect of any uncrystallised fund, which may be costly.
Need to reclaim overpaid PAYE after each payment while the emergency tax code is applied.”
Capped DD Benefits and Drawbacks
“Capped drawdown pensions – benefits and drawbacks
Benefits
Drawbacks
Income paid to the member
Income taken does not trigger the MPAA rules (unless maximum permitted income is exceeded).
It may be possible to designate additional funds into an existing capped drawdown arrangement.
Access to a PCLS at outset in respect of newly designated funds.
Can be used for tax-planning to utilise the client’s personal allowance and/or basic rate tax band.
All payments made in excess of the PCLS are taxable as the member’s pension income via PAYE.
Unused funds remain invested and therefore subject to investment risk.
Possibility that entire fund could be depleted and leave the client with insufficient funds to live on in retirement.
Scheme administration charges may be higher due to the requirement to monitor income levels and undertake triennial or annual reviews.
Not all providers permit the designation of additional funds into existing capped drawdown arrangements.”
“Death benefits
Balance of the crystallised fund remains available for client’s beneficiaries.
No restriction on who funds can be passedto.
Beneficiaries can choose to continue with flexi-access drawdown, purchase a survivor’s annuity or take the funds as a lump sum.
Income or lump sum received by a beneficiary will be tax-free where the member’s death occurs before the age of75.
Income and lump-sum death benefits taxable as the recipient’s pension income via PAYE on member’s (or subsequent beneficiary’s) death where death occurs on or after their 75th birthday.
Any lump sum paid forms part of the beneficiary’s estate for IHT unless it is paid into a suitable trust.
If the beneficiary wishes to designate the funds to drawdown pension, then it will be a flexi-access”
“as it is not possible for a beneficiary to continue in capped drawdown.
General
Significant flexibility in terms of amount and frequency of income taken.
Can be used to phase retirement by taking flexible income withdrawals and/or utilising the PCLS in stages over time.
Beneficiaries who continue with drawdown can nominate someone to receive the funds following their death, allowing funds to pass ‘through the generations’ whilst remaining within the pensions ‘tax wrapper’ and thereby outside the survivor’s estate for IHT.
Complex option.
Needs ongoing reviews, which may be costly.”
Flexi access Dd Benefits and Drawbacks:
“Benefits
Drawbacks
Income
Full flexibility in the amount and frequency of income taken.
Access to a PCLS at outset.
Can be used for tax-planning to utilise the client’s personal allowance and/or basic rate tax band.
If PCLS only is taken (i.e. no income), the MPAA is not triggered.
The client can take funds for any purpose.
Income withdrawals from a flexi-access drawdown pension trigger the MPAA.
All of the payments made in excess of the PCLS are taxable as the member’s pension income via PAYE.
Unused funds remain invested and therefore subject to investment risk.
Possibility that entire fund could be depleted and leave the client with insufficient funds to live on in retirement.”
“Death benefits
Balance of the crystallised fund remains available for client’s beneficiaries.
No restriction on who funds can be passedto.
Beneficiaries can elect to continue with drawdown, purchase a survivor’s annuity or take the funds as a lump sum.
Income or lump sum received by a beneficiary is tax-free on the death of the member where the death occurs before
age 75.
Income and lump-sum death benefits taxable as the recipient’s pension income via PAYE on member’s (or subsequent beneficiary’s) death where death occurs on or after their 75th birthday.
Any lump sum paid will form part of the beneficiary’s estate for IHT unless it is paid into a suitable trust.”
“General
Full flexibility in terms of amount and frequency of income taken.
Can be used to phase retirement by taking flexible income withdrawals and/or utilising the PCLS in stages over time.
Beneficiaries who continue with drawdown can nominate someone to receive the funds following their death, allowing funds to pass ‘through the generations’ whilst remaining within the pensions ‘tax wrapper’ and thereby outside the survivor’s estate for IHT.
Complex option.
Needs ongoing reviews, which may be costly.”
State Pension:
“Basic State Pension
Individuals who attained State pension age (SPA) before 6 April 2016 with at least 30 years of National Insurance contributions (NICs) will be in receipt of a Basic State Pension of £125.95 p.w., or £6,549.40 p.a in 2018/19. This income increases each year by the ‘triple lock’ guarantee (the greater of the Consumer Prices Index (CPI), average earnings or 2.5% and provides spouse’s benefits on death (as long as the spouse has not built up a full entitlement in their own right).
New State Pension
Anyone reaching their SPA on or after 6 April 2016 will qualify for the new State Pension. As long as they have at least 35 years of NICs, they will be eligible for a Pension of £164.35 per week, or £8,546.20 p.a. for 2018/19. This income also increases in line with the ‘triple lock’ guarantee; however, it does not provide spouse’s benefits on death.”
“Conversely, an individual may receive a higher amount of starting pension where they were contracted into the State additional scheme in its various guises. Given this variation in entitlement based on NICs, contracting-out status and qualifying years, and the changes to the State Pension from April 2016, it is essential for individuals to obtain a State Pension forecast. In the previous example, the State Pension payable is significantly less than the flat rate. Failure to address this issue could mean that the individual could face a significant shortfall in the future, which may be a surprise especially where assumptions have been based on entitlement to the full amount solely on the basis of qualifying years.”
Death Benefits alternative:
“A major consideration for many clients is provision of benefits on death. They have concerns that their spouse will have a reduced income, or they do not have financial dependants who would qualify in the event of their death. They may wish to ensure that some benefits are available to their children in the event of their death.
When comparing the death benefits under a DB scheme with those available from a money purchase scheme, it is important to not just compare the DB lump sum death benefit with the return of fund available under the proposed money purchase arrangement, but to also factor in the capitalised value of the DB scheme’s dependant’s pension(s). When doing so, it is important to bear in mind that any dependant’s pensions will be subject to PAYE in the hands of the recipient while any money purchase scheme death benefits (assuming a comparison based on death prior to age 75 and that the death benefits do not exceed the individual’s lifetime allowance) will, potentially, be paid tax-free.
“It may be possible to replace the lump-sum death benefits with a whole of life plan with a sum assured equal to the value of the death benefits they wish to provide . This should be written under trust for the intended beneficiaries. This would facilitate the payment of a lump sum on death and enable the member to retain their guaranteed pension benefits. The suitability of this option will depend on the state of health of the individual and the availability of cover at an acceptable cost. The ongoing cost of maintaining the premiums should be taken into account when considering the suitability of this option.”
Receiving Scheme features; death Benefits
“Nominee drawdown – This is any individual nominated by the member (other than a dependant), who is nominated to receive the benefits from the pension plan upon the member’s death. If there is no nomination made before death (either to an individual or a charity) and there are no dependants, the scheme administrator can make the nomination on behalf”
“of the scheme member.anyone who is not a financial dependant.
Successor drawdown – This is any individual nominated by a dependant or a nominee to continue to receive the dependant’s/nominee’s flexi-access drawdown upon the dependant’s/nominee’s death. It can also be anyone nominated to continue to receive the income from a previous successor’s flexi-access drawdown. If a nominee or successor fails to nominate someone to continue to receive the income from their flexi-access drawdown, then the scheme administrator can do so on their behalf. However, in some cases, the nomination made by the original member (e.g. in an expression of wishes) can still stop a scheme administrator from making a nomination.
Consideration should also be given to whether the plan is written under an individual or master trust as this will dictate who will make the ultimate decision of the recipients of death benefits.”
“Other considerations
The client may have specific requirements which a personal pension plan (PPP) or SIPP are unable to satisfy, for example, a small self-administered scheme (SSAS) is generally used by small business owners as it provides additional investment flexibility and enables them to use the pension benefits to help them grow and develop their business.”
What is Lifestyling?
“To deal with this situation some pension providers offer a lifestyling option, whereby the investment mix of the pension fund is automatically moved away from equities and into fixed interest investments and cash as retirement approaches. The assumption is that the member will use their fund to purchase an annuity after taking their full PCLS. Thus, the investment mix at the member’s selected retirement age is typically 75% in gilts and 25% in cash.”
“This happens as follows:
the switching begins between five and ten years before the individual’s selected retirement age;
this locks in the gains made and reduces the risk of the fund falling in value as retirement approaches;
including gilts within the fund also provides a hedge against falling annuity rates, since annuity rates are based on gilt yields; and
as the switching is automatic the individual does not have to remember to switch their funds as retirement approaches.”
“Lifestyling is a valuable option, but it does have some disadvantages:
It works on the basis that the individual will crystallise their benefits at their selected retirement date, they will take their full PCLS and purchase an annuity with the balance.
If the individual retires earlier than anticipated the fund may have a high exposure to equities at the point at which the annuity is purchased. If equity values are falling the fund will be reduced and hence so will the annuity. If a partial crystallisation takes place (e.g. to take a UFPLS) then a greater number of units will be crystallised to provide the sum required, affecting the future growth prospects for the remaining funds.
If the individual retires later than originally planned or they commence flexi-access drawdown, too much of the fund will be in more secure investments: the fund will have been switched into safer funds earlier than required and growth opportunities will have been lost.
The individual’s attitude to risk may alter over the time of the investment or the automatic switching of the fund may mean that it no longer matches their attitude to risk.
“Switching occurs automatically at pre-set times and does not allow for market conditions; consequently, switching may occur when equity values are depressed.”
What are Target Date Funds?
“Target date funds are used by the National Employment Savings Trust (NEST) as the default fund for its members (NEST calls them retirement date funds).”
“The member selects a fund that aligns with their intended retirement date. So, for example, someone who intends to retire in 2035 will select the 2035 target date fund. The fund invests in riskier growth assets initially, with the investments being moved into less volatile assets as the target retirement year approaches. Unlike a lifestyle fund, the fund is actively managed and so can take account of market movements”
“The fund’s investment is driven by the target retirement year and not by the member’s age. If the member decides to retire at an earlier or later date they can switch into a target date fund aligned with their revised retirement date.”
What does self-investment involve?
“At the upper end of the market, SIPPs may also be used as:
a wrapper in which to manage a directly invested portfolio of shares and bonds;
a means of investing in commercial (not residential) property;
a structure through which to operate drawdown pension; or
as a way to finance the member’s business, e.g. through the purchase of private company shares.
All registered pension schemes are subject to the same permitted investments, though the investments offered will depend on the rules of each scheme. SIPPs are likely to offer most, if not all, of the currently permitted investments.
There are few restrictions on the type of assets that a scheme can invest in, although there will be tax charges in relation to certain types of investments. In particular, the Government wishes to ensure that self-directed schemes (i.e. SIPPS) do not receive any tax advantages from investing in residential property and certain other assets, such as wines, classic cars, art and antiques.”
