Questions likely to come up

Question 1

Advantages of transferring the pension

Answer 1

Advantages
 Flexibility over the form in which the benefits are taken;
 Generally greater death benefits and ability to leave them to a wider range of recipients
(nominees and successors);
 Possibly increased flexibility over retirement date – this is dependent on scheme rules;
 Tax free death benefits on death prior to age 75 (this is not the case with DB income
benefits!!!);
 Possibly ability to retire early without incurring an early retirement reduction (in the
event that the scheme allows early retirement). Be careful with this one as annuities
will also generally provide lower rates and drawdown plans lower sustainable
withdrawal rates for earlier retirements;
 Likely entitlement to a higher PCLS (DC ones are generally higher – this can generally
be worked out from the information in the case study);
 Ability to benefit from investment returns;
 Greater control over the client’s tax position;
 Opportunity to benefit from investment returns (need to consider attitude to risk in the
context of critical yield. Is it achievable given the client’s risk constraints?)

Question 2

Disadvantages of transferring the pension

Answer 2

Disadvantages
 Loss of the guarantees provided by the scheme;
 Loss of the inbuilt revaluation and escalation;
 Loss of inbuilt dependants pensions;
 Loss of the protection offered by the PPF;
 The member is subject to investment risk;
 And shortfall risk;
 And potentially longevity risk;
 The DB scheme is simple to understand and administer;
 No ongoing advice/ monitoring fees with the DB scheme;
 Exposure to historically low and fluctuating annuity rates;
 Lifetime allowance issues are more likely to come into play given current transfer
values.

Question 3

Factors which would indicate that the client should/ should not transfer

Answer 3

An adventurous/ cautious attitude to risk;
 Significant other assets or other income (high capacity for loss)/ Minimal other assets
or income (low capacity for loss);
 Willing/ unwilling to give up guarantees;
 Need for flexible income/ no need for flexibility;
 Low expectations/ high expectations of inflation;
 Significant investment experience/ no investment experience;
 Poor health & low life expectancy (guarantees & escalation not likely to be as valuable)/
good health and long life expectancy (likely to be valuable). Also CETVs do not take
into account the health of the client. Need to consider IHT implications if in extreme
ill health;
 The client is close to retirement date and needs to consider the shape of their
retirement benefits/ some way from their retirement date and likely to have little
certainty over their future income and lump sum needs;
 Low critical yield/ high critical yield (also needs to be considered in the context of the
client’s attitude to risk);
 Willingness/ unwillingness to accept the uncertainty surrounding potential legislative
changes;
 Need for higher PCLS/ no need for PCLS;
 Non-dependent children or other family members who the client wishes to pass funds
to as part of their estate planning/ no relatives (need for flexibility in terms of death
benefits);
 Requirement for control over their tax position/ no such need;
 Ability to retire earlier – may be a positive factor depending when the client wishes to
retire and whether the scheme allows early retirement/ at what penalty;
 Lifetime allowance issues – transfer values are high and can sometimes result in LTA
excess tax charges;
 Protection issues – sometimes transfers may impact on the client’s LTA protection –
mainly an issue with ETVs;
 The scheme has a funding deficit/ is well funded;
 Willingness/ unwillingness to forego the protection offered by the PPF;
 Willingness/ unwillingness to pay ongoing monitoring and advice charges;
 Enhanced/ temporarily reduced transfer valu

Question 4

Additional information required regarding the DB scheme to provide advice

Answer 4

Accrual rate;
 Date of joining the scheme;
 Date of leaving the scheme;
 Scheme basis (FS/ CARE);
 Pensionable earnings;
 PCLS entitlement (separate/ commutation);
 Commutation rate (if applicable);
 Death benefits available pre and post-retirement;
 Scheme definition of dependants;
 Whether it was previously contracted out and for what periods;
 Revaluation rate GMP/ non GMP;
 Escalation rate GMP/ non GMP;
 Funding status;
 GMP entitlement if applicable;
 GMP revaluation basis;
 Pre/ post-88 GMP;
 Enhancement/ reduction to transfer value;
 Any state pension offset;
 CETV offered;
 Whether the scheme allows partial transfers;
 Early retirement factors/ late retirement increases

Question 5

Information required from the client in order to assess the suitability of a transfer

Answer 5

 Defined benefits lump sum death benefit;
 The client’s health/ life expectancy/ family longevity history;
 The intended current age and intended retirement date;
 Attitude to risk;
 Current financial position/ capacity for loss
 Expectations of inflation;
 Willingness to pay advice/ monitoring fees;
 Any significant lump sum capital expenditure requirements;
 Likely expenditure in retirement;
 Pattern of expenditure throughout retirement;
 Requirement for flexibility of income and importance against guarantees;
 The client’s likely retirement income tax rates;
 The client’s total pension provision and LTA position;
 Potential IHT position;
 State pension age and NIC record;
 Any outstanding liabilities and plans for repayment;
 Any expected inheritances/ capital lump sums;
 Any spouse/ dependants and ages they will be dependant until;
 Requirement to provide death benefits/ flexibility or death benefits.

Question 6

Potential death benefits and tax treatment

Potential death benefits available from a DB scheme and their tax treatment

Answer 6

 Defined benefits lump sum death benefit;
 Maybe a set amount, a multiple of salary or linked to some other measure;
 If the member was aged under 75 at the time of death then this will be paid free of tax;
 So long as it is paid within 2 years of the scheme administrator becoming aware of the
death;
 The payment will be tested against the lifetime allowance;
 If it is not made within 2 years, or if the member was over the age of 75, then it will be
taxed at the recipient’s marginal rate;
 And there will be no lifetime allowance test;
 Where benefits are paid to a non-natural person (trust etc…) a special lump sum death
benefits tax charge of 45% will apply;
 Usually free of IHT provided the nomination is not binding on the scheme administrator;
 Dependant’s pension paid as ongoing income;
 Taxed at the recipient’s marginal rate;
 Not tested against the lifetime allowance;
 Can only be paid to someone meeting the HMRC/ scheme definition of a dependant;
 Continuing income under a guarantee period;
 Can be paid to any nominated individual;
 Taxable at the recipient’s marginal rate;
 Can be paid for a maximum ten year period;
 Trivial commutation lump sum death benefit;
 Can be paid if the actuarial value of the benefits is under £30,000;
 Taxable as income in the hands of the recipient

Question 7

Potential death benefits and tax treatment

Uncrystallised DC schemes

Answer 7

 Lump sum return of the fund value;
 Dependant’s/ nominee’s flexi access drawdown;
 Dependant’s/ nominee’s lifetime annuity;
 Tax free if the member died under the age of 75;
 However, the value of the funds crystallised will be tested against the member’s lifetime
allowance;
 Excess benefits will be subject to an LTA excess tax charge;
 At 55% if taken as a lump sum;
 Or 25% plus income tax if taken as income;
 Taxed at the recipient’s marginal rate if the member died over the age of 75;
 Or if not paid within the 2 year period;
 However, there will then be no LTA test;
 Benefits are not subject to IHT;
 They can be paid to any nominee, not just dependants;
 Nominee’s FAD does not trigger the recipient’s MPAA

Question 8

Potential death benefits and tax treatment

Flexi access drawdown funds

Answer 8

 Lump sum return of the fund value;
 Dependant’s/ nominee’s flexi access drawdown;
 Dependant’s/ nominee’s lifetime annuity;
 Tax free if the member died under the age of 75;
 No further LTA test as the payment comes from crystallised funds;
 Taxed at the recipient’s marginal rate if the member died over the age of 75;
 Or if lump sum benefits are not paid within the 2 year period;
 Income benefits are tax free where the member was under 75 regardless of the two
year designation period;
 If over 75 and paid to a trust, subject to 45% lump sum tax charge;
 Benefits are not subject to IHT;
 They can be paid to any nominee, not just dependants;
 Nominee’s FAD does not trigger the recipient’s MPAA

Question 9

Potential death benefits and tax treatment

Lifetime annuity

Answer 9

 Joint life annuity;
 The second party can receive ongoing income payments tax free if the member was
under 75 on death;
 Or at the beneficiary’s marginal rate if over 75;
 No further LTA test;
 Continuing income payments under a guarantee period;
 No maximum term, subject to the commercial judgement of the provider;
 No LTA test;
 Tax free if the member was under 75 at the date of death;
 And paid within the 2 years;
 Taxed at recipient’s marginal rate if over 75/ outside 2 years;
 Not subject to IHT;
 Annuity protection lump sum death benefit;
 Tax free under 75/ marginal rate if over;
 Usually free of IHT provided the nomination is non-binding;
 Flexible annuities do not trigger the recipient’s MPAA;
 Payments can be made to any nominee, not just a dependant

Question 10

Process for carrying out a TVC

Answer 10

 Calculate the preserved pension at the date of leaving the scheme;
 Which will be based on a definition of pensionable salary, the scheme’s accrual
rate, and the length of time in the scheme;
 This is then revalued up to the member’s NRD in line with the scheme rules;
 Where information is known, such as fixed rates and historic inflation (i.e. from the
date of leaving to the date of the calculation) these known rates of revaluation are
used;
 Where information is not known, such as future inflation and future average weekly
earnings increases (particularly for S148 revaluation) an assumption is used, which
is set by the FCA;
 The revalued pension is then converted to a capital sum using mortality tables and
an annuity interest rate assumption set by the FCA;
 The annuity rate takes into account the PCLS payable, plus the value of any death
benefits such as guarantee/dependent’s pension, plus the rate of escalation in
payment, so the rate will include an inflation assumption where future increases in
payment are based on inflation;
 This future capitalised value is then discounted back to the date of the calculation
 Using a discount rate based on gilt yields;
 The gilt yield used is based on the fixed coupon yield on the UK FTSE Actuaries
Indices for the appropriate term;
 Product charges will be assumed during accumulation of 0.75%. There is no
explicit allowance for adviser charges during accumulation. This 0.75% is deducted
from the discount rate;
 This calculation provides the current cost of replacing the defined benefits. This is
the amount of money you would need to invest in today (using FCA assumptions),
which will grow between now and NRD, to give you an amount of money at NRD
to secure the defined benefits via an annuity;
 This is then compared to the CETV, and the shortfall between the CETV and the
“cost of replacement” identified;
 This must be explained clearly to the client;
 The TVC allows the adviser to illustrate to the client;
 This is how much you would need to replace the benefits you’re giving up, should
you transfer and change your mind at a later date, but based on the calculations
today;
 YOUR scheme is offering you £XXX less than the amount that I have calculated
(using the assumptions instructed by my regulator, the FCA) are worth;
 These calculations are prescribed by our regulator. This is how your benefits would
be valued and how much you would need, if you were to seek to replicate your
scheme pension benefits in the future, but outside the occupational pension
scheme.

Question 11

The main differences between a TVC and a TVAS

Answer 11

 TVAS calculates the critical yield;
 Which is the annualised return required, after charges, to match the capitalised
value of the defined benefits at NRD, and SRD if relevant;
 Critical yields give an indication of the value-for-money of the transfer; with high
CYs indicating lower value/lower CYs indicating higher value;
 Which intends to help advisers determine the suitability of the transfer;
 On the other hand, the TVC calculates the capitalised value of the DB scheme
based on the FCA’s assumptions – the “cost of replacement” of the DB scheme
benefits;
 Including a discount rate based on gilt yields;
 4% initial charge on annuity purchase;
 0.75% ongoing annual charge assumed during accumulation, reducing the
assumed yield;
 This is then compared to the CETV;
 To show the pounds-and-pence shortfall between the CETV offered by the
scheme, and the cost of replacing the DB benefits outside the scheme, based on
the FCA’s assumptions;
 Like TVAS, TVC is designed to help demonstrate suitability and value for money
of a proposed transfer;
 TVAS was a regulatory requirement for DB transfer advice up to 1st October 2018,
when it was superseded by TVC.

Question 12

The risks and factors to be covered as part of an appropriate pension transfer analysis
(APTA)

Answer 12

 Health status;
 Loss of guarantees;
 Whether the client has a partner of dependants;
 Inflation;
 Whether the client has shopped around;
 Sustainability of income;
 The client’s tax position;
 Charges;
 Impact on the client’s tax position;
 Debt

Question 13

The risks that the client is exposed to as a result of a decision to transfer out of a
defined benefit scheme

Answer 13

 Investment risk – the fact that the value of the funds could go down;
 Shortfall/ mortality risk - the risk of the client outliving their money and being left with
a shortfall;
 Inflation risk – the risk that inflation will rise more quickly than the return on savings
and investments reducing the purchasing power of those savings and investments;
 Transfer risk – The loss of guaranteed benefits as a result of the transfer out of the
arrangement;
 Behavioural bias – the risk arising from the natural human inclination to prefer
something in the hand now as opposed to something which will be of greater benefit
at a later date;
 Product risk – the risk of being unable to secure an annuity / guaranteed income in
the future;
 Sequencing risk – the risk of the sustainability of the client’s withdrawals from a flexiaccess drawdown arrangement being impacted by the sequence of returns;
 Liquidity risk – the possibility of the client’s ability to take withdrawals being impacted
by illiquidity within the underlying investments

Question 14

Another potential five marker would be the risk warnings required by the FCA to be covered
when recommending a flexi-access drawdown fund (COBS 9.4.10):

Answer 14

 The capital value of the fund may be eroded;
 The investment returns may be less than those shown in the illustrations;
 Annuity or scheme pension rates may be at a worse level in the future;
 The levels of income provided may not be sustainable; and
 There may be tax implications.

Question 15

Reasons for an increase/ decrease in transfer value
The calculation of a CETV relies on several assumptions made by the scheme actuary.
Transfer values are sensitive to changes in those assumptions.

Answer 15

 An increase in the assumption for future inflation rates would increase transfer values;
 This is because future revaluation would be carried out at a higher rate;
 And the inbuilt escalation in payment would also have a higher value placed on it;
 Conversely, a lower assumption for inflation would decrease transfer values;
 Increased assumptions for national average earnings may increase the transfer value;
 This would increase the revaluation applied to any GMP the client may have accrued;
 A decrease in annuity rate assumptions would increase a transfer value as has
happened over recent years;
 This is because lower annuity rates increase the value of the capital required to
purchase an income equivalent to the DB pension;
 An increase in life expectancy/ decrease in mortality may increase cash equivalent
transfer values as the scheme actuary would expect to be paying the income for longer;
 A decrease in expectations for investment returns would increase the CETV. This is
because the client would have to invest a higher amount in order to provide a lump
sum at retirement sufficient to replicate the DB benefits. Conversely, greater assumed
returns would reduce CETV;
 If the client is nearer to the NRD, this may increase the CETV as they would have less
time to make up charges on the investment;

Question 16

Other potential reasons for a higher transfer value:

Answer 16

 The member has accrued a longer period of service, hence the value of the pension
entitlement has increased (for active members);
 The member received a pay increase;
 The trustees have decided to offer an enhanced transfer value in an attempt to
encourage members to transfer (conversely, a reduced transfer value may be offered
if the scheme is in funding difficulties);
 The scheme funding position may have improved (as it may have been in funding
difficulties when the previous offer was made)

Question 17

What is a critical yield

Answer 17

 The critical yield is the rate of return;
 Which would be required on the transfer value;
 On an annual basis;
 After deduction of charges;
 To achieve a capital lump sum;
 At the member’s selected retirement date/ scheme NRD;
 Which would be sufficient to purchase an annuity;
 Offering equal benefits to those from the DB entitlement;
 Including dependant’s pension, guarantees and escalation

A hurdle rate is a very similar concept. However, this represents the rate required to provide
a lump sum sufficient to purchase a flat rate, non-escalating, non-guaranteed single life
annuity with the same starting pension. This is the key difference

Question 18

Factors that may increase the critical yield

Answer 18

 An increase in FCA assumptions regarding CPI/ RPI/ NAE relative to those of the
scheme actuary;
 A reduction in mortality rates, which would result in…;
 A reduction in FCA annuity interest rate assumptions;
 An increase in charges for the selected DC arrangement;
 The client is nearer to retirement and therefore has less time to make up for the effect
of charges;
 A reduction in the transfer value as a result of underfunding, which would mean a
higher rate of return needed to match the DB benefits.

Question 19

Limitations of critical yield as an indicator of whether to transfer

Answer 19

It is a stand-alone figure at a set point in time and is subject to change with underlying
assumptions;
 The figure does not take into account the client’s attitude to risk – it must be achievable
in the context of the client’s desired risk approach;
 The critical yield assumes that the client is going to purchase an annuity at retirement
– it is of limited relevance if the client intends to enter drawdown/ take a UFPLS;
 Following on from which, FAD is now the most popular way of taking retirement
benefits from a DC fund;
 Achieving the critical yield does not guarantee that an equivalent pension will be
achieved if the assumptions are not accurate. E.g. if annuity rates have dropped in the
meantime then an equivalent fund will not be able to purchase the same level of
pension;
 Does not take into account LTA issues, i.e. an LTA tax charge may significantly reduce
the benefits that can be purchased with a DC fund;
 Does not take into account potential enhanced annuity rates if in poor health;
 It is distorted if there is a very short time to retirement since there is not sufficient time
to absorb advice costs and initial charges;
 Does not take into account the enhanced death benefits which may be available from
a flexible benefit arrangement;
 The critical yield may be artificially high if the client is unmarried with no dependants,
given that it reflects the rate of return required to purchase an annuity with dependants
benefits built in.

Question 20

PPF eligibility criteria

Answer 20

 The scheme must be eligible for the PPF;
 It must not have started wind up before 5 April 2005;
 An insolvency event must have occurred related to the sponsoring employer (the
employer, not the scheme – don’t get mixed up);
 The relevant insolvency practitioner must have submitted a s120 notice to the PPF;
 The employer must not be able to be rescued;
 The funding level of the scheme must be below PPF compensation levels

Question 21

PPF compensation

Answer 21

For those who have reached NRD, or are in receipt of a survivor’s or ill health pension,
the scheme will generally pay 100% of the pension in payment immediately before the
assessment date. There is no cap;5
 For those who have not reached NRD, the PPF will generally pay 90% of the pension
payable immediately before the assessment date, subject to a cap resulting in a
maximum pension of £39,006.18 for someone age 65.

Question 22

Features of PPF compensation:

Answer 22

 Escalation – CPI capped at 2.5% on post 5/4/97 only;
 Spouses pension – 50% of member entitlement;
 Revaluation – CPI capped at 5% on pensionable service pre-2009 and 2.5% for
accrual after 6/4/2009;
 Tax free lump sum: 25% compensation;
 Long service additions payable from 6 April 2017;
 Applies to anyone who was a member for more than 20 years and had their
compensation capped;
 Those members will see an increase of 3% for each year above 20 years of scheme
membership to a maximum of double the standard cap;
 With effect from 1 April 2019, the cap will be £40,020 (£36,018 @ 90%);
 The long service cap will be 3% on top of this for each year from 21 onwards;
 The uplift will be applied to the cap in force on the date the person’s compensation
came into effect;
 The cap will be the lower of 90% of their original pension amount or the long service
capped amount;
 Increased entitlements will not be backdated;
 However, those who reached their normal pension age prior to April 2017 and had long
service will be able to have their cap increased for future years

Question 23

Transferring PPF benefits

Answer 23

 This will not normally be possible once the scheme has entered an assessment period;
 Unless the member has accepted a transfer value in writing;
 And designated a receiving scheme;
 Prior to the commencement of the assessment period;
 Even then only to the extent that it does not prejudice the interests of remaining
members;
 Which may involve a reduction in transfer value to take into account the underfunding;
 Once the scheme has been confirmed as unable to meet its promise and taken into
the PPF, it is extremely unlikely that a transfer value would be available

Question 24

Voluntary options for resolving scheme underfunding

Answer 24

 Close the scheme to new members;
 Close the scheme to future accrual;
 Switch a final salary scheme to a CARE one for future accrual;
 Put back the scheme’s normal retirement age;
 Increase employer contributions;
 Increase employee contributions;
 Alter the investment strategy to a more adventurous approach;
 Switch to statutory minimum escalation/ revaluation;
 Offer PIE to bring more certainty to liabilities;
 Offer transfer incentive exercises to bring more certainty to liabilities

Question 25

Areas which should be monitored on an ongoing basis should the client decide to transfer :

Answer 25

 The investment performance;
 Rebalancing/is a fund switch necessary;
 Change in attitude to risk/ capacity for loss;
 Changes in legislation/taxation/regulation;
 Economic/market conditions/new products/inflation;
 Income for the coming year/ future income requirements;
 Any lump sum capital requirements;
 Continued suitability of the current arrangement;
 State Pension benefits/other income/other assets;
 Change in circumstances/health;
 Death benefit nominations;
 Changes to Government Actuary’s department rates/annuity rates/gilt yields;
 The individual’s tax status and any opportunities for tax efficiency;
 Cashflow analysis & stress testing

Question 26

Factors to consider/ information needed when putting together a lifetime cashflow :forecast / advising a client on a potential transfer out

Answer 26

 The client’s health/ life expectancy/ potential long term care needs;
 The intended retirement age;
 Attitude to risk (this impacts potential investment strategies);
 Expectations of inflation;
 Any significant lump sum capital expenditure equirements;
 Likely expenditure in retirement;
 Pattern of expenditure throughout retirement;
 The client’s current/ likely retirement tax rates;
 State pension age and NIC record;
 Any outstanding liabilities;
 Any expected inheritances/ capital lump sums;
 Other non-pension assets, financial and non-financial;
 Provisions of the client(s)’ will/ intended lifetime gifting;
A potential variant on this question would be factors to consider when establishing a
sustainable withdrawal rate for a flexi access drawdown plan.

Question 27

Stress tests which should be used when putting together a lifetime cashflow forecast :

Answer 27

 Increase in tax rates;
 Significant increase in inflation over a sustained period of time/ higher than expected
expenditure in retirement;
 Sustained underperformance within the portfolio/ sudden stock market crash;
 Large unplanned lump sum expenditure;
 Significant increases in interest rates (where mortgage/ other liabilities are held);
 Health issues necessitating early retirement;
 Unexpected longevity (risk of outliving one’s money);
 Significant drop in annuity rates;
 In the case of couples, loss of income in the event of the death of either party

Question 28

Determination of any likely pension shortfall at retirement

Answer 28

 Select assumed growth rates and rates of inflation/ NAE increase;
 Revalue the DB benefits to retirement date based on inflation assumptions;
 Escalate any DC funds based on estimated investment returns to retirement date in
line with the client’s attitude to risk;
 Including planned future contributions;
 Calculate estimated annual income requirement in retirement;
 Allowing for inflation between forecast and retirement date;
 Deduct revalued DB benefits;
 Deduct expected benefits from the DC scheme, using a reasonable annuity rate;
 Or sustainable withdrawal rate should the client have indicated a preference for
drawdown;
 Obtain BR19 state pension forecast;
 Deduct estimated value of state pension;
 This will highlight if there is an expected shortfall;
 Calculate the funding requirement to achieve the target income amount