Pensions Flashcards
What are the current issues surrounding retirement planning?
1) Inflation
2) Life expectancy increasing
3) Annuity Rates are low
4) Increasing state pension age
Why is inflation an issue for retirement planning?
Pensioners tend to be on fixed incomes (e.g. annuities) - when prices rise pensioners can be hit worst.
although state triple lock has reduced the effect of this
What is a pension shortfall?
Not having enough to support a modest retirement
21% of ppl do not have a pension (much of the 79% have a shortfall)
What are some of the reasons for pension shortfalls?
1) Pensions are long term - hyperbolic discounting prevents people saving
2) Pensions are complex & expensive (e.g. advice costs)
3) Mis-selling scandals have put people off
4) Pension fraud has put people off
5) Govt can change their rules dramatically (e.g. pensions in IHT)
Why does hyperbolic discounting cause pensoin shortfalls?
People aren’t able to see the benefit in long term investing
They overweight the immediate gratification of spending now.
What is the retirement planning process?
High level overview
1) Establish current position (and current strategy)
2) Establish health
3) Establish aspiratoins
4) See what capital is needed
5) Develop appropriate strategy
6) implement
How can pensions be categorised?
1) Trust Based vs Contract Based
2) Occupational vs Individual
3) Defined Benefit vs Defined Contribution
What is the difference between trust based and contract based pensions?
in terms of who uses them / types of schemes
Trust based is usually occupational & contract based tends to be personal
What is the difference between trust based and contract based pensions?
in terms of how they operate
1) Trust based is ran by a board of trustees who choose the professionals to manage the scheme. **THEY HAVE A DUTY OF CARE TO ACT IN BEST INTERESTS **
2) Pension provider, such as an insurance company has a contract with the employee and not the firm
What is a Collective Money Purchase Scheme
Risk is shared by members
aims for a target level of benefits
Benefits can be adjusted based on fund assets
Royal Mail use this scheme
Since “A-Day” what must all registered pension schemes have?
A registered scheme administrator
Usually outsourced to professionals
What is the purpose of having a trust based pension?
Trustees act in the best interests of the schemes members - the structure also ring fences the assets incase the employer becomes insolvent.
What is the current minimum age at which pension benefits can be taken?
also what and when does it increase to
Age 55
Increasing to 57 in 2028
the maximum age has been phased out and now people can work for as long as they wish
What exceptions are there to the minumum age of 55?
1)People who retire due to ill health (needs written opinion from dr.)
2) Old schemes with contractual rights to retire early
3) People in special occupations such as footballers etc.
How does the state pension work vs how it used to
Single tier - based upon years of NI contributions
Used to be 2 tier (basic rate + earnings bonus)
How many years of NI contributions are needed for a full state pension?
35 years of contributions
can be topped up through other means
What is the current value of the full state pension?
£11,502
What is the minimum amount of NI contributions needed to receive the state pension
10 years minimum
Other than NI contributions how can one earn credit towards the state pension?
1) Unemployment, sickness and maternity benefit
2) Parents receiving child benefit (child under 12)
3) Approved foster carers
4) Carers who care 20+ hrs per week
5) >18 in training that does not last more than 1 year
Can also pay 6yrs backdated - class 3 voluntary NI contributions
What does SPA mean and what is it currently?
State Pension Age - minimum age at which one can claim the state pension
Currently 66 (increasing to 67 in 2026)
Do not have to take the state pension at 66
What are the rules around State Pension deferral?
9 Weeks minumum
How much extra is earned for deferring the state pension?
yearly and per 9 weeks
1% per 9 weeks
5.8% for every year deferred
Who would pension deferral be particuarly attractive to?
Those on the additional rate of tax
can wait until earnings are lower in order to be taxed less on pension
What is a defined benefit scheme?
Promises a given level of income at retirement
Based upon years of service and individual’s salary
What will a DB scheme always be?
Trust Based
also vary rarely tend to be private sector (bin men and MPs still get DBs as public sector workers)
How can the final salary calculation vary from scheme to scheme
1) Definition of pensional employment
2) Accrual rate used
3) Definition of pensionable salary
What are the two most common accrual rates?
1/60
1/80
1/60 private sector and 1/80 usually public sector
If a final salary isn’t used what might be taken instead?
Career Average
Can be revalued by RPI
How can a member of a DB scheme boost their pension?
Additional Voluntary Contributoins (AVCs)
1) Buy extra years (employer determines to cost - can also set a maximum)
2) Invest extra into a seperate fund
What are the drawbacks of a DB member doing AVCs into a seperate fund?
1) Limited fund choice
2) Employer may not contribute
How can benefits be taken from a DB scheme?
A specific date (normal retirement date) - specifies date at which benefits are expected to be paid:
1) Lump Sum (tax free as long as it doesn’t exceed PCLS rules)
2) Death-in service benefit
3) Pension Income (taxed)
How does a death in service benefit work for a DB pension?
If a DB member dies before “normal retirement age”
Death in service benefit will be paid which is usually a multiple of pensionable pay (usualy 4x)
What is the formula for Final Salary pension calculation
1/60th * No of Years * Final Salary
1/60th is the accrual rate could be 1/80th if public sector
What is the formula for an average earnings pension calculation
1/60th * No of Years * Career average earnings
1/60th is the accrual rate could be 1/80th if public sector
Why are defined benefits less common?
Employers struggle to afford them
many schemes that still exist place new hires onto DC schemes instead.
What age can benefits be taken from in a DB pension?
55
can be taken earlier for ill health early retirement
What is the main advantage of a DB pension scheme?
It provides certainty over what amount of income will be received
(Allows for retirement planning)
What is a potential disadvantage of DB pension schemes?
In the final years working, an employee may not be at their maximum earning power anymore.
What is a defined contribution pension scheme?
Pension schemes that do not guarentee a level of income.
Employer and employee agree on a set amount to be contributed to the scheme.
What does retirement income from a DC pension depend on?
1) Level of contributions
2) Fund return
3) How benefits are taken
How can benefits from a DC pension be taken?
1) Buy an annuity
2) Pension Income Drawdown
3) PCLS
If an individual leaves a pension scheme, what determines their “leaver options”
The time spent in “pensionable service”
amount of time worked for company
If an individual has spent less than 3 months in a pension scheme - what leaver option is most likely?
A refund of contributions
unlikely to be able to transfer out
If an individual has spent 3-24 months in a pension scheme - what leaver option is most likely?
Refund of contributions OR transfer out
If an individual has >2 years of pensionable service what leaver options are available?
All except refund of contributions
1) Preservation of benefits
2) Transfer Out
3) Vesting benefits (from age 55)
What is an ill-health early retirement?
Can draw benefits before NMPA (55).
Must have evidence from medical practicioner.
Can be suspended if member gets better
What is TVAS and what does it do?
Transfer Value Analysis
Calculates the “critical yield”
What is critical yield?
The investment return required to match the benefits available from a DB scheme.
return after fees
What are the two types of Critical Yield?
Type A & Type B
What is Type A Critical Yield
Growth rate needed on drawdown investment to match an annuity
rate required to keep drawdown income in line with an annuity which could have been bought instead
What is type B critical yield?
Growth rate necessary to maintain a selected level of income
e.g. want to maintain £1000 a month forever - rate of return required to do this
What are the FCA guidelines on Type B critical yield?
in regards to presenting an illustration
Cannot be supplied in isolation (must be with a type A)
What are the FCA guidelines on Type A critical yield?
Must show annuity purchases at ages: 65, 70 & 75
What factors effect the transfer value calculation?
1) Discount Rate Used
2) Assumed Annuity Rates
What is the FCAs default position on DB transfer outs?
It is NOT APPROPRIATE to transfer out so adviser needs to show why it is.
What is the 4 step process for transfer value analysis?
1) Calculate pension value at leaving date
2) Revalue to nromal pension date
3) Convert to cash equivelant (based on annuity rate)
4) Discount cash value to today’s date
What tax relief to HMRC provide to incentivise retirement planning?
1) Tax relief on contributions
2) Tax free lump sum (25%)
3) Fund grows free of UK tax (cgt etc)
4) Currently exempt from IHT (but is set to change)
To receive tax relief on contributions, what must a person be?
A relevant individual
Who is a “relevant UK individual”?
Under 75 (and meets 1 of the following:)
1) UK Earnings chargeable to income tax
2) Resident in UK at some point in year
3) Resident at any point of previous 5 tax years before contribution was made
Or they / spouse have earnings from overseas crown employment
What is salary sacrifice?
An agreement between employer & employee to give up part of salary in exchange for an employer pension contribution
must have a written agreement in place
Can not reduce salary below minimum wage
What are the advantages of salary sacrifice?
to an employee giving up salary
1) Take home pay is same or higher
2) NI & Tax Savings
3) Can reinstate personal allowance (if earning >£100k)
What are the disadvantages of salary sacrifice?
to an employee giving up salary
1) Salary reduced for things like death in service
2) May reduce borrowing capacity
e.g. could affect ability to get a mortgage
What is the current annual allowance for pension contributions?
£60,000 per annum
What are the rules around carry forward for pension contributions?
how much would the max be?
Can carry 3 previous years forward
1 x £60,000
2 x £40,000
What might prevent someone from being able to carry forward?
They have triggered the money purchase allowance
What is the annual allowance charge?
A charge levied against anyone who exceeds the annual allowance for pension contributions.
How does the UK pension allowance taper?
Every £2 earned above £260k adjusted earnings tapers by £1
adjusted income includes employer pension contributions (& your own)
What is the maximum the pension allowance can taper down to?
£10,000
MPAA & Taper both £10k
What can trigger the money purchase annual allowance?
- Flexi-access drawdown
- uncrystallised funds pension lump sum
- Purchasing a flexible annuity where your income could go down
What doesn’t trigger the MPAA?
1) Small pots valued at less than £10,000
2) Take TFCLS and buy an annuity that either stays the same or increases
3) Flexi-access drawdown but don’t take an income
If you trigger the MPAA, what can’t be done in a DC contribution?
Cannot carry forward in a DC (only in a DB)
What did the lifetime allowance do?
Limited amount of savings which can be built up in a tax advantaged environment.
it has now been scrapped (as of 24/25 tax year)
What is the money purchase annual allowance
If triggered - it limits the level of tax releived pension contributions an individual can make in a year
can be triggered from 55 once benefits can be taken.
