RETIREMENT Flashcards
What is the ‘Pension input period’?
- The time frame in which individual’s pension benefits can be accrued and set against the annual allowance.
- Pension benefits are increased by contributions, increases in pension rights (DB scheme) or salary increase.
What is the ‘annual allowance?’
- A limit on how much pension benefits can be accrued before a tax charge is due.
- Currently, £60,000
- Annual allowance can be carried forwards (unlike MPAA) from the past 3 years, so long as:
- used all current allowance
- UK taxpayer at time of year brought forward.
- active member of pension scheme at time of year brought forward
Describe the taper relief on the annual allowance
- Tapered for those with adjusted annual incomes, including their own and employer’s contributions over £240,000.
- For every £2 of ‘adjusted income’ over £240k, an individual’s annual allowance is reduced by £1.
- minimum of £4000.
Assessing the pension input amount set against annual allowance for DC schemes:
- DC scheme: all contributions, excluding pension credits received on divorce and contributions paid byt the individual or someone either than the individual’s employer from 75 onwards.
Assessing the pension input amount set against annual allowance for DB final salary schemes:
Notional increase in the capital value of any defined-pension rights.
- calculated by taking the value of the member’s pension benefits at the beginning of the pension input period and multiplying by 16.
- Then increased by the CPI.
- the value of pension benefits at the end of the pension input period is then taken and multiplied by 16.
- the difference between these two numbers is the amount tested against the annual allowance
What is Market value reduction?
A reduction to amount paid out when a policy holder switches or decides to take benefits earlier than otherwise stated in a with-profits pension.
This is to protect the interests of investors who remain invested in the with-profit fund.
Unit-linked pension fund
- Personal pensions are DC.
- Unit-linked policies operate like unit trusts:
Units are sold at the offer price, and bought back from the investor at the bid price.
Value of each unit = value of fund assets/number of units at issue
With the value of the fund depending on the underlying performance of investments.
- Offer a range and flexibility in funds to invest in.
- Individual choice in funds, not available on with-profit plans
Unit-linked pension example fund categories.
- Managed
- Equity
- Fixed Interest
- Property
- Overseas equities
- Guaranteed
- Charges are more specific than with-profit funds
What is a Stakeholder Pension?
- A type of personal pension
- DC = Pay money into pot over time, pot then invested into a range of assets such as stocks and shares.
- Typically lower annual charges (1.5% first 10 years, 1% thereafter)
- May offer lower minimum contribution (as little £20)
- Narrower range of funds invested in. May reduce growth.
- Funds are chosen and managed for you, unlike SIPP
Investing in pensions: With-profit fund characteristics
- Relatively conservative
- ‘Smoothing’ provides stable return.
- There is no minimum guarantee as to the value of the fund at retirement, and it is possible for the value of units to fall, although smoothing is used to reduce that risk as far as possible.
What is ‘smoothing’ in with-profit pension fund.
- The end of year process where actuaries assess how much of the fund is needed to pay current and future liabilities, costs, and guarantees provided.
- Once assessed and liabilities settled, the balance is then used to bolster reserves, which will be distributed to with-profit policyholders in periods of poor performance.
- Creating a less ‘peak and trough’ investment return (smooth)
What happens when a with-profit policy holder decides to take benefits?
- A terminal bonus may be added to units held; portion of the returns made on investments in good years is held back to subsidise or “smooth out” years of weaker investment performance.
- The retirement fund will be the value of units multiplied by the number of units held.
- If benefits are taken earlier than previously stated, the policy may be subject to an early retirement penalty or Market-rate reduction (MRV
Charges on a Unit-linked policy
- Charges are more specific than with-profit plans.
- Allocation rates: Some older contracts may be set up so the provider only allocates a proportion of the investment to buy units. The proportion = allocation rate, i.e. 50% of premiums are used to buy units during the first 12 to 24 months
- Policy fee: Monthly or annual policy fee to cover the cost of administration.
- Annual Management Charge (AMC)
What is an Annual Management Charge (AMC)?
- Policies are subject to annual charges for the management and administration of the investments within the pension fund.
- There may be a charge for taking benefits earlier than the planned retirement date. As with all registered pension schemes, personal pension funds grow free from income tax and capital gains tax.
Earliest you can access pension benefits
- Normal minimum pension age (NMPA) = 55 Years. (Going to 57 in 2028)
- You may be able to access earlier if:
- Retiring due to Ill-health (12 months to live and under age 75)
- You have Protected Pension Age (Built in policy for the ability to take before NMPA)
What is the LTA (2023/2024)?
- Life time allowance, the amount an individual can accrue in pension benefits without being subject to additional tax charges.
- £1,073,100
To be abolished in 2024, replaced by Lump sum allowance (LSA) and Lump sum death benefit allowance (LSDBA)
What is the AA (2023/2024?)
- The annual allowance is the maximum amount of pension savings an individual can make each year without an annual allowance charge applying.
- To calculate:
Amount you’ve gone over AA x your tax rate. - £60,000
What is an Benefit Crystallisation event (BCE)? and give examples.
When benefits are taken for the first time from a pension scheme. This triggers the pension fund to be assessed against the LTA.
- Buying an annuity (BCE 4)
- Starting pension drawdown (BCE 1)
- Reaching age 75 in drawdown pension (BCE 5A)
- Reaching age 75 with uncrystallised benefits (BCE 5B)
- Taking the PCLS. This does not apply if the PCLS is not paid until after age 75 – this is because BCE 5A and 5B ensure that the sum involved is already tested against the lifetime allowance.
PCLS
Pension commencement lump sum.
- Upon crystallisation of pension benefits, transfers out of a pension fund receive a 25% tax relief.
- It is possible in some policies to take the PCLS and defer pension income until a later date.
- Plan holder can take 25% of the pension pot as a tax free lump sum.
- Alternatively, an individual with a phased retirement plan can take the PCLS from a
number of segments and leave the remainder invested. - Any PCLS drawn from age 75 onwards will be restricted to 25 per cent of the lifetime allowance remaining at age 75.
What is an annuity?
- An annuity is a long-term investment made using your pension pot, which provides a regular, guaranteed income from the proceeds.
-This uses your remaining pension fund after any tax-free lump sum withdrawals.
- Good for those wanting security (Guaranteed income).
- Depending on the options chosen when purchasing your annuity, this income can go to your spouse if you die first, or your beneficiaries, so long as you are under the age of 75.
Key points of annuities.
- It’s the simplest option (but also the most final - pension pot is consumed in purchase of annuity).
Pros:
- Guaranteed income for life
- Very little management/admin.
- You can shop around for the best annuity rates to provide a greater income. (Medical conditions may increase income - less time to pay out).
- Can be organised to provide an income for a surviving spouse under a joint-life policy.
Cons:
- Should you die early, you may miss out. (Funds are locked into annuity, no flexibility on utilising pension income/fund for last few years)
Annuity Options
- Joint or Single life?
(Joint will be lower income) - Annuity income paid in advance or arrears?
(First payment can be up front, or start at a later date; advance payments result in lower income)*
*With proportion annuity will pay
any income due between the last payment and the annuitant’s death. Without
proportion = not further payments after death, higher income.
- Annuity income fixed or rising?
(Here the income can increases over time, either with a set % p.a. or index-linked to CPI or RPI). - Annuity Protection?
- Annuity guarantee?
(A guaranteed annuity pays the income during the life of the annuitant, but it will also pay the income for a guarantee period from the annuity starting, even if the annuitant dies before the end of the guarantee.)
What happens to pension fund (if to be a death benefit lump sum) in the event of death:
- Below age 75
- 75 or older
- Before 75, pension fund is inherited (transferred) tax free.
- After 75, the fund is taxed at the beneficiaries marginal income tax rate
Unit-linked investment annuities
- Not very common.
- Not for the risk adverse.
- More volatile (potential for more or less income)
- Fund buys units in a unitised fund linked to equities and the income is based on the bid value of the units.
- In some cases:
- Investor choses rate of growth.
- If funds grow at chosen rate = income same.
- If faster = increased income, if slower = lower income
With‑profits investment annuities
- Similar to Unit linked -> choose Anticipated Bonus Rate (ABR) of between 0% and 5% p.a.
- The higher the ABR, the higher the initial income but the more the danger of a reduction later.
- Each year the income is reassessed – the annuity is first reduced by the ABR and then the newly declared bonus is added, together in many cases with a one‑year temporary bonus.
-Providers usually provide a guaranteed minimum level, below which the annuity cannot fall, regardless of bonus performance.
Calculating with-profit annuity income.
- ABR = Anticipated bonus rate
- Initial income
- Bonus.
Initial income/ABR = the new base income.
Base income * bonus = New annuity rate
Example: £1000 initial, ABR of 4%, 3% bonus.
£1000/1.04 = £961.54
£961.54 * 3% = £28.85
New annuity rate = £990.38
Enhanced and impaired‑life annuities
- Annuity rates are based on life expectancy.
- Those with poor life expectancy can expect a greater income (as the duration of income is expected to be less)
-Enhanced annuities = for those whose lifestyle characterises them as having a lower life expectancy. I.e. Smokers.
- Impaired-life = Life-threatening medical conditions.
These terms may often be used interchangeably.
What are the three categories of Draw-down pensions?
- Flexi-access drawdown.
- Short term annuities.
- Pension commencement lump sum
Flexi-access drawdown
- No limit to withdrawals.
- Pension fund remains invested (unlike when purchasing an annuity)
- After tax-free lump sum has been taken (25%) remaining withdrawal enters into a DRAWDOWN account - to be invested or managed as an income.
- Withdrawals over their tax free allowance are charged at marginal income tax rate.
- Triggers MPAA (£10,000). Replaces AA.
- Flexibility lends to risk of funds running out. Advice paramount.
EXAMPLE: £200,000 fund.
£40,000 taken out, £10,000 tax free into personal account. Remaining £30,000 goes into DRAWDOWN account that can be taken ad hoc or provide an income.
MPAA
Money purchase annual allowance
- Created by Gov in light of concerns over ultra tax-efficiency of flexi-access.
Triggered by:
- Enters flexi-access drawdown + takes withdrawal greater than PCLS (25%).
- Takes UFPLS
- Takes out a flexible annuity
- MPAA is £10,000 (2023/2024)
- Unused MPAA cannot be carried forward (Unlike AA which can be carried forward max 3 years.
Short-term Annuity
Alternative to Drawdown pension.
- Short term Annuity is purchased to provide pension income.
- The remainder of the fund remains invested to hopefully continue to grow (inherent risk)
- STA’s only 5 years in duration, on expiry another can be purchased.
UFPLS
- Bypasses the drawdown account.
- Funds taken from pension go directly into account.
- Funds above the 25% tax free amount are charged at marginal income tax rate
-Doesn’t have to be entire amount, rest of the pension fund is left untouched.
- A UFPLS is a authorised transfer NOT a PCLS (PCLS must be part of an entitlement to income.)
To qualify for UFPLS:
- Transfer from Uncrystallised fund held in DC pension.
- NMPA or early due to ill-health.
Is there a PCLS for UFPLS?
- No
- UFPLS is a form of authorised payment not a PCLS.
- It’s described as a tax-free element rather than a PCLS.
- Individuals cannot take more than 25% of the UFPLS tax free.
What is allocation rate?
- In unit-linked pensions
- The amount of what you pay that is invested in your pension.
-I.e. a allocation rate of 98% means 98% is invested, and you pay a 2% charge on each deposit you make
Advantages of Drawdown Pension
- Annuity purchase can be delayed -> potentially better rates (Life expectancy less)
- More control of investments
- Further investment growth potential
- Flexibility of income.
- Allows for ready to access capital lump sums if required
Disadvantages of Drawdown pension
- Potentially high charges when administering funds and on withdrawals.
- Risk of adverse investment performance (annuity may perform better in comparison).
- Delaying to purchase annuity may not always result in more favourable rates. (Taking A. in first place would be better).
- Potential for outliving capital reserves. Needs to be managed efficiently.
- Large withdrawals may face higher or additional tax rate charges if the withdrawal pushing the individual into these brackets
Tax treatment of DC pension if member dies BEFORE age 75
For uncrystallised funds:
- Tax-free up to the deceased lifetime allowance
For crystallised fund:
- Tax‑free to any beneficiary if member died in drawdown or an
annuity protection lump sum is paid out.
For pension Income:
- Tax‑free if taken as income via drawdown
- Tax‑free if taken as income via a joint life or guaranteed term
annuity
- Option now available to any beneficiary (can leave DC to any beneficiary they nominate - beneficiary will not have to pay income tax on the pension income they inherit)
Tax treatment of DC pension if member dies AFTER age 75
For both Crystalised and uncrystallised lump sums
- Tax at beneficiary’s marginal rate of income tax
For Income:
- Taxed at beneficiary’s marginal rate of income tax
