Pensions Transfer

Question 1

Statutory increases to pensions in payment

Answer 1

. SPA = After 6th April 2016
. Pre 88 GMP = No escalation rate = 0%
. GMP = 88-97: 
>CPI to 3% = the scheme
>CPI above 3% = the state (excess only)
> Non GMP prior to 97 = No statutory escalation
. 97-05 = 5% max CPI P.A.
. 05 onwards = 2.5% max CPI P.A.

Question 2

GMP escalation rates

Answer 2

. GMP escalation rates are based upon when you exit the scheme:

. 78-88 = 8.5% per year
. 88-93 = 7.5% per year
. 93-97 = 7% per year
. 97-02 = 6.25% per year
. 02-07 - 4.5%
. 07-12 = 4%
. 12-17 = 4.75%
. After April 6th 2017 = 3.5%

Question 3

GMP general info

Answer 3

. Applicable to those whom contracted out between 6th April 1978 - 5th April 1997

. Employer in return for saving on tax and NIC’s had to make additions to the scheme in line with the additional state pension.

Question 4

Preserved DB pensions

Answer 4

. GMP = See GMP escalation rates

Non GMP:

. Exit before 1st Jan 1986 = No compulsory evaluation
. Between 1st jan 86 and 31st Dec 1990 = CPI to max of 5%
. 1st jan 1991 to 5th April 2009 = CPI to 5% max
. 5th April 2009 onwards = 2.5% CPI

Question 5

In receipt of benefits from a GMP

Answer 5

Before 6th April:
. Pre 88 GMP = 0%
. Post 88 GMP = CPI to 3% max

In addition to this the State pension is triple locked meaning that each year it will increase by either:
. Price inflation
. Earnings growth
. or 2.5%

Whichever is highest

. Any difference between the scheme specific increase paid on GMP and the increase to the basic state pension is added to the individuals entitlement to the additional state pension

Question 6

PPF - how a scheme enters

Answer 6

. Trustee’s can apply for a pensions scheme to enter into the PPF
. There is an assessment period which runs for a minimum of 12 months
. There are then 3 possibilities:
> The scheme has sufficient assets
> It can be rescued
> It will transfer to the PPF

. Once in PPF assessment, transfers are not available and early retirement is only available at the PPF compensation level

Question 7

Key elements of a statement of entitlement

Answer 7

. Name and reference number of a member
. Date of joining the scheme
. Date of leaving the scheme
. The guarantee date
. The transfer value amount
. The amount of the transfer value which is guaranteed
. The deferred benefits that the transfer value is based on
. The GMP age
. The normal retirement age
. Details of the deferred pension

Question 8

Four assumptions used to calculate critical yield

Answer 8

. Annuity interest rate
. Mortality rate
. CPI/RPI inflation rate assumptions for revaluation
. CPI/RPI inflation rate assumptions for indexation and escalation purposes

Question 9

Steps and timescales of transfer requests

Answer 9

. Within 1 month of receiving the request, they must notify the member that they must take independent advice

. Within 3 months of the request, issue a statement of entitlement with a formal quote of the Transfer value at the guarantee date

. Within 10 working days of the guarantee date give the member the statement of entitlement (asking for evidence of independent advice)

. Within 3 months of the guarantee date the member must make a further application in writing confirming they wish to transfer

. Within 3 months of the statement of entitlement, the member provides evidence of having taken independent advice

. The trustee’s must check that the member has received advice from an FCA authorised advisor

. If the scheme is willing to accept the transfer, the trustee’s must transfer the guaranteed transfer value within 6 months of the guarantee date

Question 10

Pension transfer suitability

Answer 10

. COBS 9.2 and 19.1
. The content of a suitability report is expected to include:

> A summary of the advantages and disadvantages of the personal recommendation made
An analysis of the financial implications if the recommendation is to opt out
A summary of any other material information

. The FCA expects that a firms starting point should always be that a transfer, conversion or opt out is not suitable

. Advice must be confirmed in writing, whether the recommendation is to transfer or not

Question 11

Three stage insistent client process

Answer 11

1. Provide advice that is suitable to the individual client in line with the normal advice process
2. Make clear the risks of the alternative course of action
3. Make clear that their actions are against the advice provided by the firm

. In addition the normal suitability rules apply
. Records need to be retained indefinitely, regardless of whether or not a transaction was subsequently arranged

Question 12

C.E.T.V.

Answer 12

2 methods

1. The best estimate - based on the expected cost of providing the members benefits in the scheme
2. The alternative method - where trustee’s wish to pay CETV’s above the minimum amount

Question 13

Best Estimate Method

Answer 13

. An initial cash equivalent (ICE) is calculated
. This can then be adjusted if necessary to arrive at CETV
. ICE is calculated based on value of accrued benefits with any options and discretionary benefits the trustee’s wish to add
. The trustee’s and scheme actuaries are obligated to decide what assumptions should be used to calculate the ICE
. The ICE should be a best estimate of the amount of money needed at the date of calculation to provide the scheme benefits if invested by the scheme

Question 14

The alternative method

Answer 14

. The best estimate method provides for the calculation of the minimum transfer value. Whereas the alternative method provides the basis for paying CETV’s at a higher amount.

. They pay a higher amount because:
> The employer or trustee’s may request it
> The scheme rules may require it
> The shared cost scheme may be in surplus

Question 15

Reducing transfer values

Answer 15

. Trustee’s can offer a transfer value that is less than the ICE in certain circumstances:

> To allow for underfunding in the scheme - an insufficiency report will need to be obtained
To allow for wind up expenses
Priority order allowance - to retain parity between those transferring and this remaining in the scheme

Question 16

Guaranteed annuity rates

Answer 16

. Availability of a guaranteed annuity rate is the guarantee applicable at a specific point in time, such as, normal retirement age, or is generally applicable when benefits are taken

Benefits provided:
.It is most important to establish whether the contract can offer benefits on any other basis than the standard offer

Early or late retirement:
. What are the options in relation to taking benefits early or late, and details of any penalties or enhancements that may apply

Question 17

Guaranteed pension at retirement

Answer 17

. The contract offers a basic guaranteed pension, which is increased by the addition of bonuses over time rather than a guaranteed rate.

The following additional information is needed for these:
> Previous history of reversionary and terminal bonuses
> The financial strength of the provider
> Whether a market value adjustment factor can be applied and if so on what basis. Understand the circumstances when an MVA would not apply.

Question 18

Employers covenant

Answer 18

. Covers the legal obligation and financial capacity of the scheme sponsoring employer to support the scheme

. The trustee’s have an obligation to understand and monitor the strength of the covenant and financial viability of the scheme, both now and in the future. an assessment should include:

> The employers legal obligation to the scheme
The funding needs and investment risk of the scheme
The financial support from the employer and any other entities which materially affect the covenant

Question 19

Employers covenant - legal obligations

Answer 19

. Trustee’s should identify any employers whom fall into the following categories:

> All employers participating in the scheme and bound by the schemes trust deed and rules are to contribute to the scheme

> Required by a statutory schedule of contributions to pay contributions to the scheme, and the proportion that they are liable to

> Could be liable now or in the future to pay a statutory debt under point 5.75 of the pensions act 1995

> Their insolvency could require the scheme to go into the PPF

Question 20

Employers needs and investment risk

Answer 20

. As the covenant is a measure of the employers ability to financially support the scheme, it is important to assess funding:

> the size of the schemes deficit relative to the size of the employer

> The level of investment risk

> The maturity of the schemes membership and the expected cash flows of the scheme

Question 21

Employers covenant - Current financial resources

Answer 21

Looks at the employers ability to pay and maintain contributions:

. The liquid financial resources available to the employer
. The capital structure of the employer, including term, date for refinancing, interest rate, insolvency priority, and covenants of debt
. The capital intensity of the business
. The level of working capital, relative to historical values
. the origin, size, counterparts and recoverability of significant inter company balances and group cash pooling arrangements
. Financial commitments including lease obligations and contracted capital expenditure
. Any contingent liabilities of the employer that are not recorded on the balance sheet

Question 22

Pension transfer suitability

Answer 22

. The FCA expects to see a comparison carried out that would explain the rates of return that would have to be achieved to replicate the benefits that are being given up and which should be illustrated on rates of return which take into account the likely expected returns of the assets in which the clients funds will be invested.

Advice should also take into account the associated risks and all the costs and charges that will be borne by the client

Question 23

Safe withdrawal rate

Answer 23

. Defined as the quantity of money
. expressed as a % of the initial investment
. Can be withdrawn each year for a given quantity of time
. Adjustments for inflation
. Ultimately leading to non P/F failure
. The most popular rule for the SWR is 4%

Question 24

Portfolio failure

Answer 24

. Failure is defined as a 95% probability of depletion to zero at any time within the specified period

Question 25

Additional guidance for transfers

Answer 25

The advice should clearly indicate the clients income needs and expectations, how these can be achieved, the role safeguarded benefits play in providing this income and the impact and risk if a conversion is made

. The specific receiving scheme thats recommended following the transfer and the investments being recommended within the scheme

. The way the funds will accessed, immediately or in future

. Alternative ways of achieving the clients objective

. The relevant wider circumstances of the individual

Question 26

Enhanced transfer values

Answer 26

. One of the most common resources is where the employer and/or trustee’s wish to de-risk their scheme by offering deferred and/or active members a cash incentive to transfer their benefits from the scheme

. Essentially when a fund becomes too expensive to run in the long run, schemes look to offload some of the long term expense by offering enhanced transfer values

Question 27

Enhanced protection

Answer 27

. Available to anyone regardless of the capital value of their pension benefits at A day

. All benefits coming into payment after A day will be exempt from the lifetime allowance charge

. Cannot accrue any further pension benefits under a registered scheme on or after 6th April 2006. This is known as relevant benefit accrual

Question 28

Primary Protection

Answer 28

. Available to individuals with pension rights, valued on 5th April 2006, that had a capital value that exceeded £1.5m

. Registering individuals would receive a personal lifetime allowance

. The % by which the members pension rights exceed £1.5m is used to give the member a lifetime allowance enhancement factor (LAEF). This is a % increase to the standard LTA applicable in the tax year in which benefits are crystallised

Question 29

Fixed protection

Answer 29

. The government has incrementally reduced the LTA from £1.8m to £1.5m from 06/04/2012, then £1.25m from 06/04/2014 and £1m from 06/04/2016

. FP 2012 = £1.8m LTA
. FP 2014 = £1.5m LTA
. FP 2016 = £1.25m LTA

. No further benefit accrual is allowed

Question 30

Individual protection

Answer 30

. Maximum cap of £1.25m
. Can take 25% tax free lump sum
. Can continue to accrue benefits without losing protection
. Protection remains dormant if they have another protection
. Can apply for individual protection as long as:

> They do not already have primary protection
The capital value of their pension benefits is equal to or in excess of £1m as at 05/04/2016

Question 31

Information needed to complete a TVAS report

Answer 31

. Full copy of CETV pack issued
. Trust deed and rules
. Members booklet
. Most recent scheme report and accounts
. Revaluation rates in deferment for all pension elements
. Pension increases in payment for each pension element
. History and details of any discretionary increases
. Early retirement factors and how these are applied
. Earliest age that early retirement is available
. Cash commutation rates at NRD and proposed age
. Is revaluation applied in whole years or years and months
. Are there any lump sum death benefits pre and post retirement and any associated rates of interest
. Does a guarantee period apply once benefits are in payment
. Are spouse benefits based on uncommitted benefits
. The % value of spouse pension pre and post retirement

Question 32

Recovery plans agreed with the pensions regulator

Answer 32

. The employer must keep an agreed amount aside to cover any scheme deficit
. There is likely to be an additional guarantee provided by the parent company
. The UK and global parent would both have to fail to make the scheme eligible for the PPF

Question 33

State the pension transfer suitability report requirements in relation to pension transfers that are contained in the Financial Conduct Authority’s (FCA) Conduct of Business Rules (COBS).

Answer 33

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.

Question 34

Describe how a CETV is calculated.

Answer 34

. 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).

Question 35

Explain briefly how the assumptions used to calculate the critical yield in a TVAS differ from those used to calculate a CETV.

Answer 35

The scheme sets the assumptions used within a CETV whereas a Transfer Value Analysis (TVAS) report uses Financial Conduct Authority (FCA) prescribed assumptions. The main assumptions are for inflation, national average earnings and then annuity interest rate.

Question 36

Explain what is meant by the term employer covenant and its relevance to the scheme’s ability to pay unreduced cash equivalent transfer values.

Answer 36

. 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 future funding and do not need to reduce CETVs as the remaining members in the scheme are unlikely to be disadvantaged as a result.

Question 37

State the additional information that you would require in respect of an EPP before advising in relation to drawing pension benefits.

Answer 37

• 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.

Question 38

State, giving your reasons, the steps that must be taken before you would be able to transfer an EPP fund into a suitable pension plan to allow access to pension benefits flexibly.

Answer 38

As the pension plan 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.

Question 39

The additional information required from a client before advising on the suitability of transferring from their defined benefit pension scheme

Answer 39

• 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.

Question 40

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.

Answer 40

. Transfer Value Analysis (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.

Question 41

Assuming Lizzie transferred to a self-invested personal pension (SIPP) and nominated her children to receive any death benefits:

Outline the options available to the children, in the event of Lizzie’s death before age 75.

Answer 41

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.

Question 42

Assuming Lizzie transferred to a self-invested personal pension (SIPP) and nominated her children to receive any death benefits:

Explain why the completion of a nomination form does not guarantee the children will receive the death benefits.

Answer 42

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.

Question 43

List six benefits and six drawbacks of transferring a defined benefit pension scheme to a personal pension plan to access benefits flexibly.

Answer 43

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 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 tax charge.

Question 44

State six stress tests that could be undertaken as part of an annual review of the cashflow plan.

Answer 44

• 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.

Question 45

Explain what is meant by ‘safe withdrawal rate’ in relation to pension drawdown and the method of calculation.

Answer 45

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.