R04 Chapter 5

Question 1

What is a defined benefit pension scheme?

Answer 1

An occupational pension scheme provided by an employer to employees. The main benefits are defined as a proportion of salary close to or at retirement. Also known as final salary.

Question 2

How does a private sector defined benefit scheme work?

Answer 2

Provide a pension based on a percentage of salary at or close to retirement. Have superior benefits to other pensions and are guaranteed. Contributions from employer and employee are invested into a building fund.

Question 3

What are the main types of DB schemes?

Answer 3

Hybrid (DB with some characteristics of a DC):
1. DB scheme with a DC underpin
2. DC scheme with a DB underpin
Defined Cash Scheme
Career Average Scheme
Integrated Scheme

Question 4

What is a DB scheme with a DC underpin?

Answer 4

Provides pension benefits at retirement or earlier death that are the higher of the benefits calculated on the normal DB basis and the benefits from a notional DC plan. Offers a transfer value for early leavers that is the higher of the fund built up in the DC and of the cash value of the DB.

Question 5

What is a DC scheme with a DB underpin?

Answer 5

The scheme has a DC account for each memeber plus a separate unallocated account tp meet the cost of the guarantee where there is insufficient in the member’s pot. It is now very rare.

Question 6

The is a Defined Cash Scheme?

Answer 6

They limited the benefit provided so that it fell within the pre-A-Day HMRC limits for tax free cash alone. Before PCLS introduction, schemes provided 3/80ths of final pay for each year of scheme membership.

Question 7

How are benefits accrued in a Career Average Scheme?

Answer 7

Member accrues a proportion of their pensionable salary for each year of service. Amount accrued per year is based on that year’s salary. Each year’s accrual is revalued to retirement in line with scheme rules (could be in line with inflation).

Question 7

What is a Career Average scheme?

Answer 7

Formula for benefits is based on the average earnings over a member’s career. Tends to reduce the benefits and the cost to the employer.

Question 7

What is an Integrated Scheme?

Answer 7

The provided pension is reduced in some way to take into account the State Pension. Usually includes a State Pension deducation. Deduction is equivalent to, or a percentage of, the State Pension.

Question 8

What are Additional Voluntary Contributions?

Answer 8

Top-ups to an inhouse occupational AVC scheme or a free standing AVC scheme (FSAVC).

Question 9

How do benefits accrue in an in-house AVC scheme?

Answer 9

Defined Contribution basis - AVCs are invested into a DC fund and proceeds provide an additional pension at retirement.
Added years basis - AVCs can be used to buy added years in the scheme. This is based on assumed salary increases and assumed growth of the underlying fund.

Question 10

In-house AVCs on a DC basis

Answer 10

Member’s contributions are ivested in a DC fund, and proceeds provide an additional pension at retirement. Sometimes possible to take the whole AVC fund as PCLS at retirement - still 25% available. If the whole AVC fund is taken as cahs, less of the DB pension needs to be commuted for PCLS.

Question 11

In-house AVCs on an Added Years basis

Answer 11

AVC contributions may be used to buy added years in service. Based on: assumed salary increases and assumed growth on the fund. Contributions usually expressed as percentage of pay. AVCs are invested along with main contributions.

Question 12

How to set up a DB scheme?

Answer 12

Set up under trust. Trustees hold the scheme for the benefit of the members. It must have its own set of rules. Trustees must administer the trust in accordance with trust law and the requirement of the Pensions Act 1995 and the Pensions Act 2004.

Question 13

What is a normal pension age? (normal retirement age)

Answer 13

Usually the age to which the employer will pay contributions and at which members
will usually retire. An individual does not have to retire to take benefits from the scheme.

Question 14

Can members take their benefits before their NRD?

Answer 14

Yes. The scheme can permit members to take benefits from the minimum normal retirement age (55). Members may be able to work beyond a schemes NRD.

Question 15

What is a bridging pension?

Answer 15

When a member reaches their NRD, a higher pension is paid until SPA is reached,. Then it reduces to reflect commencement of the State Pension. It’s a pension where the shcme’s NRD is lower than the State Pension Age.

Question 16

Do DB schemes have auto enrolment?

Answer 16

They can. Most employers would offer a DC scheme instead. Eligible jobholders are auto enrolled in a DC scheme and following an initial period and the meeting of scheme requriements, the DB scheme can be offered.

Question 17

What are the common eligiblity rules for a DB scheme?

Answer 17

1. Minim entry age (e.g. 18 or 21 etc)
2. Probationary/waiting period - usually a year
3. Differentiation between worker categories - e.g. management, staff, workers etc.
4. Different level of benefits for each category

Question 18

Is DB membership compulsory?

Answer 18

No. But if a scheme is being used as a qualifying pension scheme, all eligible jobholders have to be autoenroled. Employer can automatically enrol all employees, even if theyre not eligible jobholders.

Question 19

What factors affect benefits in a DB scheme?

Answer 19

1. Pensionable service
2. Pensionable remuneration
3. Accrual rate

Question 20

What is pensionable service?+

Answer 20

Laid out in scheme rules. USually an employee’s period of scheme membership. May not start till waiting period is over.

Question 21

What is pensionable reumeration?

Answer 21

The ‘salary’ used to determine benefits. E.g. the member’s basic salary at the point of retirement or death.

Question 22

What is an accrual rate?

Answer 22

The rate at which the scheme benefits accrue for each year of pensionable service. E.g. 1/60th of pensionable remuneration per year of pensionable service.

Question 23

How are contributions into a DB scheme treated for tax purposes?

Answer 23

There may be tax relief on member contributions via net pay or relief at source. Employer contributions are paid gross and are deductible as a business expense.

Question 24

What are the rules for employer contributions in a DB?

Answer 24

Employer must contribute each year and they must meet the cost of providing defined benefits on retirement or death.

Question 25

What factors affect costs of contribution into a DB scheme for an employer?

Answer 25

1. Level of member's final pensionable remuneration in future. 2. Investment returns 3. Annuity rates at member's retirement 4. Cost of guaranteed benefits to early leavers 5. Number of leavers who die before the scheme NRD 6. Profile of scheme membership - age and marital status of members etc.

Question 26

How is tax relief awarded on employee contributions into a DB under net pay?

Answer 26

Contributions are deducted from the emplyee's salary before tax is deducted. Tax relief will be obtained at source at the employee's marginal rate.

Question 27

How is tax relief awarded on employee contributions into a DB under relief at source?

Answer 27

Contributions are paid net of basic rate tax. Members have to reclaim any higher or additional rate relief via self-assessment or adjustment to their tax code.

Question 28

How are benefits from a DB taxed?

Answer 28

The pension in payment is taxed as earned income.

Question 29

How do contracted out DBs work?

Answer 29

Members didn't accrue entitled to Additional State Pension Benefits (like SERPS or S2P) for their period of pensionable service. The scheme had to instead provide a Guaranteed Minimum Pension (GMP), which was broadly the same amount as they would have earned under SERPS. Only applicable to those contracted out between 6 Arpil 1978 and 5 April 1997.

Question 30

Statutory escalation of benefits in payment for a member who reached SPA pre-1988 GMP?

Answer 30

No escalation has to be provided. State pays the increases to the GMP, they will be fully in line with CPI.

Question 31

Statutory escalation of benefits in payment for a member who reached SPA with GMP accrued between 1988 and 1997?

Answer 31

Scheme pays increases to GMP in line with CPI to a max of 3% p.a. Excess in any year is paid by the state.

Question 32

Statutory escalation of benefits in payment for a member who reached SPA before 6 April 2016 with no GMP accrual pre 6 April 1997?

Answer 32

No requirement for statutory increases.

Question 33

Pension for service after 5 April 1997 but before 6 April 2005?

Answer 33

Must escalate in payment with CPI up to max of 5% p.a.

Question 34

Pension for service after 5 April 2005?

Answer 34

Must escalate in line with CPI to a max of 2.5% p.a.

Question 35

What is a pension increase exchange?

Answer 35

Member is offered the option of giving up future guaranteed increases to their pension in return for a higher initial pension with no future increases other than statutory increases.

Question 36

What are the benefits of pension increase exhcnage?

Answer 36

1. Escalating pensions are expensive to provide and increasing longevity means the cost in rising. 2. Cost of increases is an unknown liability to you get rid of this here. 3. Less risk for employer. 4. Employer doesn't suffer a lareg one-off cost in offering the pension increase exchange. Only additional cost is a higher initial pension.

Question 37

What are the benefits of pension increase exchange for the member?

Answer 37

1. Higher initial income 2. Higher entitlement to PCLS if the scheme calculates the entitlement as the maximum permitted under HMRC rules. 3. Lower life expectancy means a higher initial pension might be preferable.

Question 38

What are the drawbacks of pension increase exchange?

Answer 38

1. Over time they may be worse off than if they selected an escalating pension. 2. The value of member's benefits for testing against LTA will be higher. 3. Where the exchange is offered at retirement, the calculation of the pension input for the final year may exceed the annual allowance. 4. Higher initial pension may affect entitlement to State benefits.

Question 39

What are The Pension Regulators principles for pension increase exchange offers?

Answer 39

1. Clear, fair, and not misleading. 2. Open and transparent. 3. Manage conflicts of interest. 4. Trustee consultation. 5. Independent financial advice.

Question 40

What is TPR's Voluntary Code of Good Practice?

Answer 40

1. No cash incentives. 2. Advice. 3. Communications. 4. Records. 5. Sufficient Time. 6. Members who are over age 80. 7. Roles and Responsibilities

Question 41

How is PCLS in a DB calculated?

Answer 41

Determined by the rules of the scheme. It may be an accrual rate or it could be commuted.

Question 42

What is the notional value of a member's benefits if the PCLS and pension are provided separately?

Answer 42

The pensiom figure is mutlipled by a factor of 20 and the PCLS is added to this. The resulting total is the notional value of the member's benefits and the max PCLS cannot exceed 25% of this figure.

Question 43

What is the formula for the maximum PCLS payable by a DB scheme?

Answer 43

PCLS= 20 x pre-commutation pension x C ------------------------------------------------------ (20 + (3 x C))

Question 44

How to calculate residual pension?

Answer 44

Residual = Pre-commutation pension - (max PCLS/Commutation factor)

Question 45

What happens to benefits for soemone who retires early?

Answer 45

They are reduced by an early retirement factor e.g. 1/60th x final pensionable remuneration for each year of service up to the date of early retirement.

Question 46

What is the formula for calculating the reduced pension?

Answer 46

Years in service/accrual rate x final pensionable remuneration = pension Years before retirement x 12 x early retirement factor x pension = early retirement pension

Question 47

How does early retirement due to ill-health work in DB schemes?

Answer 47

Decided by rules of the scheme. Can be: 1.Based on service to the date of ill-health early retirement but without an early retirement penalty. 2. Based on prospective service to the scheme's NRD and salary at date of ill-health early retirement, no penalty. 3. Somewhere in between. If serious ill-health, the whole pension could be commuted as a lump sum.

Question 48

What are the rules for a serious ill-health lump sum?

Answer 48

1. Before age 75 it is a BCE. Commuted lump sum is tax-free as long as the value doesn't exceed the member's LTA. Excess is taxed at income via PAYE. 2. Can be paid after 75 so long as some LTA remains when benefits were tested at age 75. Taxable as recipient's income. 3. Only applies to benefits yet to br crystallised.

Question 49

What is Income Protection Insurance?

Answer 49

Provides employees with an income if they can't work due to incapacity. They will still have pensionable earnings as a result and can continue to be members of the scheme.

Question 50

How are benefits paid out on death?

Answer 50

Member can nominate, but ultimately at the discretion of trustees.

Question 51

Rules on lump sum death benefit for a DB?

Answer 51

Call a defined benefits lump sum death benefit - no limit on the su, bit if dead before 75, excess of their remaining LTA is taxed at recipient's pension income via PAYE.

Question 52

What are the rules for a spouse's, civil partner's and or dependant's pension?

Answer 52

Unlimited. But some rules: 1. A % of the member's pension based on prospective service to the scheme's NRD OR 2. % of the pension accrued to DoD 3. A fixed % of pensionable remuneration regardless of service

Question 53

Death Benefit rules following retirement?

Answer 53

Benefits are paid for a speicifed number of years - guaranteed period. E.g. if the guaranteed period is 10 years and member died 6 year into retirement, the scheme would pay to dependant's for another 4 years - usually at a fixed %

Question 54

What is a scheme valuation?

Answer 54

Pensions Act 2004 requires DB schemes to undertake an actuarial scheme valuation yearly. It projects the scheme's benefits and liabilities towards retirement.

Question 55

What is a statutory funding objective?

Answer 55

Must be set for all private sector DB schemes. Trustees must ensure that the scheme funding meets the scheme's technical provisions (the amount of assets needed to cover the scheme's future liabilities). Scheme assets are valued at market value.

Question 56

What is a Section 143 valuation?

Answer 56

Instructed when a scheme enters the PPF. It establishes whether scheme assets are sufficient to cover the PPF level of compensation.

Question 57

What is the IAS 19?

Answer 57

International Account Standards 19 (IAS 19) - gie directions on the accounting treatment of DB assets and liabilities. Aim is to make the cost to the company of running the pension more transparent. Both assets and liabilities must be shown on the balance sheet.

Question 58

Deficits in scheme technical provisions:

Answer 58

If found to be in a deficit, the trustees must develop a recovery plan to achieve full funding of the technical provisions - must be submitted to the TPR.

Question 59

Developments affecting DB pension schemes:

Answer 59

1. Strengthening the Pension Regulator's powers 2. Defined Benefit Funding Code of Practice consultation 3. Consolidation - into superfund entities for improved funding, economies of scale, and better governance.

Question 60

What were the scheme funding measures in the Pensions Schemes Act 2021?

Answer 60

1. Trustees need to agree with employer on long-term funding and investment strategy (FIS) 2. Following consultation, trustees will prepare a written statement of strategy (must be signed by their chair)

Question 61

Who is no eligible to be a scheme trustee?

Answer 61

1. Minors 2. People certified as insane 3. Anyone disqualified under the Pensions Act 1995 (e.d. bankrup or a disqualified company director) 4. Someone prohibited by the TPR

Question 62

What are the trustees' responsibilities?

Answer 62

1. Maintain the scheme in the best interests of members and be impartial 2. Act within provisions of a trust deed 3. Meet trustee knowledge requirements and inform TPR of certain notifiable events 4. Hold and invest assets to acheieve best financial return consistent with security 5. Know and understand the scheme

Question 63

What are the trustees' powers?

Answer 63

1. Hold scheme assets, subject to specific powers conferred on them by the deed and rules of the scheme, and apply these assets 2. Detrmine all questions and matters of doubt 3. Carry out transactions in connection with the scheme

Question 64

What % of trustees must be member nominated?

Answer 64

At least 1/3

Question 65

What is the role of the scheme actuary?

Answer 65

Appointed by trustees - but cannot be a trustee. It will: 1. Prepare the periodic actuarial valuation 2. Advise on funding principles, calculation of technical provisions, schedule of contributions, recovery plans etc. 3. Certify that the calculation of technical provisions is made according to scheme funding regulations

Question 66

What is a scheme auditor?

Answer 66

Appointed by trustees, must hold a practising certificate, and be a registered auditor. Cannot be a member, employee of trustees, a related employed, or trustee connected to trustees.

Question 67

What is a scheme administrator?

Answer 67

Required by the Finance Act 2004. They: 1. Register a pension with HMRC 2. Operate tax relief on contributions 3. Report events to HMRC 4. Make returns of info to HMRC 5. Provide info to scheme members and ohers regarding LTA, benefits, and transfers

Question 68

What happens when an employee leaves the scheme with under 2 years service?

Answer 68

They may be entitled to a return of their own contributions - known as the short service refund. Not obilgatory. The scheme can offer a preserved pension instead. If they complete at least 3 months of service, they must be given the option of a CETV.

Question 69

What happens if a refund of a DB occurs?

Answer 69

The tax treatment: 1. First £20,000 of any refund is taxed at 20% AND 2. Excess is taxed at 50%

Question 70

What is a preserved pension?

Answer 70

Member is entitled to a preserved pension if: 1. The scheme rules permit 2. They complete more than 2 years of service At least 2 years of service mean a minimun level of preerved benefit - called short servie benefit. Member is then called a deferred member.

Question 71

What is a CETV

Answer 71

Member may wih to transfer benefits to a new pension arrangement as an alternative to a preserved pension. It is a cash lump sum that is then invested into a new arrangement. Must be offered to an early leaver with at least 3 monhts of service. Cash equivalent of guaranteed benefits being given up.

Question 72

Define Flexible Benefits

Answer 72

DC benefits, cash balance benefits, and any benefit that is calculated by reference to a fund.

Question 73

Define Safeguarded Benefits

Answer 73

Benefits that are neither DC nor cash balance. Benefits in a DB scheme are safeguarded benefits.

Question 74

What is a statutory right to transfer?

Answer 74

Trustees cannot refuse to transfer the benefits as long as the conditions are met.

Question 75

What conditions need to be met for a transfer of safeguarded benefits?

Answer 75

1. Benefits are uncrystallised AND 2. The member has ceased accrual within the scheme AND 3. MEmber has applied for and received a statement of entitlement AND 4. Member has made an application to transfer the benefits at least one year before they reach the scheme's normal retirement age 5. All benefits are transferred.

Question 76

Can safeguarded benefits be transferred within one year of retirement?

Answer 76

Yes, as long as the other requirements are met, but it is not a statutory right - trustees can refuse.

Question 77

What is the limit requiring indpendent advice to transfer?

Answer 77

If safeguarded benefits are valued in excessof £30,000, members must receive independent advice.

Question 78

What is APTA?

Answer 78

Appropriate pension transfer analysis (APTA). Using a TVC (transfer value comparator) to consider the benefits that will potentially be given up in the ceding scheme and the potential benefit provided following the transfer. It is a way to assess the merits of the ceding vs receiving scheme. Not a report or written document but a process - it will result in a number of findings.

Question 79

What is the TVC?

Answer 79

Transfer Value Comparator. It compares the transfer value offered by the ceding scheme with the estimated value needed today to buy the future income benefits under the ceding arrangment using a lifetime annuity. COBS 19.1.3A requires that when the client passed normal retirement age, the firm must provide a TVC using the reitement age assumed in the CETV.

Question 80

What are the 7 main Public Sector Schemes?

Answer 80

1. Local Government Pension Scheme 2. NHS Pension Scheme 3. Teachers' Pension Scheme 4. Armed Forces Pension Scheme 5. Civil Service Pension Scheme 6. Police Pension Scheme 7. Fire-fighters pension scheme Police and fire-fir=ghter schemes are run by local authorities.

Question 81

What are the main features of public sector schemes?

Answer 81

1. Pensions in payment are fully inflation protected. 2. Treatment of members in early retirement is usually superior to that offered by a private sector scheme. 3. They belong to the Transfer Club - members can transfer without loss to another public sector scheme

Question 82

How is the Local Government Pension Scheme funded?

Answer 82

It is funded - contributions are invested into a fund, which builds to provide benefits for the member on retirement or death. The other six public sector schemes are unfunded.

Question 83

How are unfunded schemes paid?

Answer 83

They are guaranteed by statutre and the govenment will pay the benefits as they fall due. But the Teachers and NHS pensions are notionally funded - contributions are paid but not invested - invested in government securities instead. These have generally lower returns so contributions are artificially high - it doesn't affect the guaranteed benefits provided by the scheme.

Question 84

How are benefits provided in public sector schemes?

Answer 84

All public schemes have been moved from a final salary to a career average basis - applies to new members and future accrual of existing members.