RETIREMENT AFAR Flashcards
When can a DB pension scheme member potentially commute their entire pension entitlement and draw all of the benefits as a tax-free lump sum?
*If their life expectancy is less than 12 months
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 increases.
What is the ‘annual allowance?’
*A limit on how much pension benefits can be accrued before a tax charge is due.
*Currently, £60,000
*earnings cap: the tax relief on pension contributions is capped at the higher of £3,600 or 100% of your earnings
*Tapered AA: if adjusted income is greater than £260k your AA is reduced by £1 for every £2 over this amount
*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
‘Smoothing’ is a feature of which type of pension fund? Explain what it is?
*With-profits funds
*Provides a more stable return by spreading investment gains and losses over a period of time.
*This is achieved by holding back some returns in good years to support payouts in years when investment performance is poorer.
Financial Reporting Standard (FRS) 17 requires employers to revalue the assets and liabilities of occupational pension funds every:
*Every three years
Client wishes to defer taking their state pension - How much will it increase by?
*It will increase by 1% for every 9 weeks it is deferred.
*It has to be deferred by 9 weeks
*5.78% for 1 year
Investment assets for retirement:
How should portfolio change as retirement becomes less than 10 years away?
*Shift from assets in equities towards Fixed-interest securities such as bonds and Gilts.
*Offers some growth, but avoids risk of loss closer to retirement.
The amount of a switch depends on the individual’s attitude to risk.
Investment assets for retirement:
What should the portfolio largely consist of if retirement is greater than 10 years away?
*Equities
*There is a good chance of capital growth ahead of inflation and the money can be tied up for the long term
SSAS (Small Self-administered Scheme). What is the maximum value the SSAS can use to purchase property?
*Can use assets and borrow up to 50% of its net assets.
Why might a personal pension holder choose flexi-access drawdown rather than an annuity?
*Gilt yields are low
*Flexibility of size and frequency of withdrawals
How does the majority of defined-contribution occupational pension schemes provide pension benefits on retirement?
*Purchasing an annuity for the member
Can members of a defined-benefit scheme take benefits early?
*Yes, members can take benefits after age 55 as with DC schemes.
*The pension will be based on their years of service less a probable early retirement penalty
What is the ‘lifestyling’ investment option in personal and stakeholder pensions?
*Some schemes provide an automatic switch in which money is moved from equities to fixed‑interest investments during the last five or ten years to retirement.
How is the state pension funded?
*It is funded by the current working population’s National insurance contributions.
*It is not funded in advance - the decline in birth rates and increase in life expectancy therefore poses an issue for future funding of the state pension.
How many qualifying years must be paid for full state pension entitlement?
- 35 Years (if retiring after April 2016)
(30 years before this date)
- 10 years minimum to receive any state pension
How much is the current full state pension?
*£11,502.40 (2024/2025)
*This can be deferred, and increases by 1% for every 9 weeks delayed - it has to be deferred by at least this amount
Current and future retirement age?
Depends on your date of birth:
*Currently is 66 (2024)
For those born after 5th April 1960, it’ll rise each month, one month at a time until it reaches 67 in April 2028.
*Increasing to 68 in 2028 (affecting those born after April 1977)
Options for retirement: ISAs
*While ISA contributions do not benefit from tax relief, there is no tax payable when the funds are withdrawn.
*Funds can be taken out at any age.
* LISAs offer 25% top up on deposits of up to £4000 (£1000 bonus per year)
*if this is withdrawn before retirement age there is a 25% penalty charge - not just the removal of the bonus
*However, withdrawals and growth is tax free.
*Contribution limit into ISAs each year is £20k for Pensions, it’s £60k.
Pension provision and public perception on long-term care provision.
*Perceived that those who save for their retirement effectively are penalised should they need care as all assets are taken into account when assessing how much is paid.
*Those who have little pension provisions pay little or nothing towards care costs.
*As of October 2023, a cap on an individual’s care costs was instigated by Gov. £86,000
What is the upper and lower capital limit in terms of benefits?
*The upper capital limit - Max value of chargeable assets owned before they can receive benefit from local authority:
- Currently, £23,250
- In Oct 25, £100,000
*The lower capital limit is the threshold below which people will not have to pay anything for their care from their assets:
- Currently £14,250
- In Oct 25, £20,000
Non-state pension: Defined contribution
*Also know as ‘money-purchase’ schemes
*Occupational or individual arrangements.
*Benefits are based on the amount of money in the fund
(which will, in turn, depend on the levels of contribution and investment performance).
*Contributions are made regularly by both employer and employee - often via salary sacrifice or net-pay arrangement
(Very similar, SS more complicated but saves on NICs)
What are the statutory minimum contributions into any occupational pension scheme?
Overall, 8% of the value of the employee’s salary must be contributed.
*Employers can contribute a minimum of 3%
Non-state pension: Defined benefit schemes. Explain/describe what they are
*Alternatively called ‘final-salary’ or ‘career-average’
*Occupational scheme.
*Benefits are based on an employee’s length of service, the scheme rules and salary.
*Should not be affected by investment performance.
The Pensions Act 2015 - Two important introductions
*Allowed individual’s access to their retirement savings without the need for a ‘minimum level of secure income’
*‘guidance guarantee’ - where everyone with a defined‑contribution pension arrangement is offered free, impartial guidance so they are clear on the range of options available to them at retirement.
The Pension regulator: Statutory objectives
*to protect the benefits of members of occupational pension schemes
*to protect the benefits of members of personal pension schemes where employees
have direct payment arrangements
*to promote and to improve understanding of the good administration of occupational
pension schemes
*to reduce the risk of situations arising that may lead to compensation being payable
from the Pension Protection Fund
*to maximise employer compliance with employer duties and with certain employment
safeguards
*in relation to defined benefit scheme funding, to minimise any adverse impact on the sustainable growth of an employer
The Pension regulator: Power’s fall into three categories
- Investigating schemes to identify and monitor risks.
- Putting things right
- Imposing fines and prosecuting certain offenses
- Requiring specific action to be taken by deadlines
- Recovering unpaid contributions from an employer - Acting against avoidance
-contribution notices, requiring the employer to make good the amount of the debt either to the scheme or to the Pension Protection Fund
- Financial support directions, which require financial support to be put in place for an underfunded scheme
- restoration orders, where assets can be restored to the scheme if there has been a transaction at an undervalue involving the scheme’s assets.
When are employers required to make contributions into employee pension scheme by?
*Must be made by the 22nd day (or 19th day if paying by cheque) of the month following the deduction from the employee’s pay.
What is the Pension Protection fund?
- Established by the Pensions Act 2004
- Protects members of private sector defined‑benefit schemes whose employers become insolvent with insufficient funds in their pension scheme.
*People who have not reached the original scheme’s normal retirement date receive 90 per cent of their accrued scheme entitlement immediately before the assessment date. (If they have reached original retirement age, it is 100%)
A pension scheme may be established by 4 different methods:
- a trust
- a contract
- a board resolution (Scotland)
- a deed poll
Pensions and divorce: three ways
Pensions are taken into account in a divorce settlement. There are three ways in which the situation can be assessed:
- Earmarking
- Splitting (sharing)
- Offsetting
Pensions and divorce: Offsetting
- Transfer value is added to the total assets of the marriage
*The assets are split but the scheme member retains the fund as part of their share.
For example, a scheme member may retain their pension but their ex‑spouse/civil partner may keep other assets, such as the house or the right to a certain income (assuming that the two assets are of similar value).
*Offsetting allows a clean break, so there is no need for the two parties to keep in touch after the settlement.
Pensions and divorce: Earmarking
*Court allocates a percentage of the scheme member’s future
pension entitlement to the ex‑spouse/civil partner.
*The earmarking order can apply to pension income and/or lump‑sum benefits (a separate order would be needed for each).
*The ex‑spouse/civil partner will receive a percentage of
the income or lump sum when the member crystallises the pension - if the scheme holder delays taking their pension the ex-spouse has to wait
*For tax purposes, the scheme member is held to have received all of the pension before passing part of it on to their ex‑spouse/civil partner
Pensions and divorce: Earmarking - Disadvantages
- It does not allow a clean break between the two parties.
- The scheme member decides when to crystallise the pension.
- If the scheme member is a higher‑rate or additional‑rate taxpayer, 40 per cent or 45 per cent income tax will be payable on the pension income. The ex‑spouse/civil partner can reclaim none of this even if they do not pay tax at the higher rates.
*Income benefits may be lost on the death of the scheme member.
* Entitlement to income may cease upon remarriage or upon a new civil partnership of the ex‑spouse/civil partner.
* The ex‑spouse/civil partner has no control over investment decisions made by the scheme member.
Pensions and divorce: Sharing (splitting)
*Court ascertains the value of the fund, known as the cash equivalent transfer value (CETV), and splits it on a percentage basis between the two parties.
*The proportions will depend on the judge’s interpretation of the situation, taking into account other assets.
- Each party will have their own independent fund and can take benefits as and when they wish, without reference to each other. Future contributions will be outside the split and will belong to whoever makes them.
*The splitting arrangement creates a debit (reduction) in the scheme member’s pension fund and the member is free to build the fund up as they wish. The amount transferred to the ex‑spouse/civil partner’s fund is a ‘credit’ to their pension.
*The credit is not treated as part of the recipient’s annual allowance, but will count towards their lifetime allowance. The debit will be taken away from the ‘donor’s’ fund when calculating their lifetime allowance.
*There is one exception to this: if a pension benefit is already in payment before the divorce, it will not count towards the ex‑spouse/civil partner’s lifetime allowance. This is
because it has already been assessed against the scheme member’s lifetime allowance. Effectively, their lifetime allowance is enhanced by the amount of the transfer.
Pensions and bankruptcy
*The bankrupt’s pension falls out of their estate, and the Trustee in Bankruptcy cannot claim rights over it.
*This rule applies to registered occupational, personal, stakeholder and retirement annuity schemes. It does not apply to unregistered schemes.
*However, if the court believes excessive contributions have been made to a pension scheme to avoid the assets being included, it can order the pension provider to make a payment to the trustee.
What is the earnings cap for tax relief on pension contributions?
*earnings cap: the tax relief on pension contributions is capped at the higher of £3,600 or 100% of your earnings.
*If no income, £3600 is used.
The state pension age is due to be raised to 68 by what date?
*Between 2037 and 2039
*It is now based on you date of birth, and is raised accordingly
The new state pension. For who? How is benefit calculated? How much benefit?
*For those retiring on or after 6th April 2016
*Provides a basic income for those above state pension age
*Based on an individuals NIC - minimum 10 years to receive anything, 35 to gain full amount.
*Full state pension is currently £221.20 per week or £11,502.40 per year
Basic state pension
- For those retiring before 6th April 2016
*The current full state pension (2024) £169.50 per week with those aged 80 and over earning an additional 25p per week.
*Each year is treated differently for calculating benefits
*Enough NICs = qualifying year = 30 qualifying years for basic
*If an individual couldn’t work owing to illness or unemployment, they may have been given credits towards the state pension.
*Credits reduced the number of qualifying years required to gain the full state pension
Deferral from the basic state pension
*More favourable than the new state pension
*Deferral of taking your pension for only 5 weeks would result in a 1% increase
*10.4% per annum.
*If deferred for over a year, the amount deferred could be taken as a tax-free lump sum, plus interest.
Considerations affecting both the basic and new state
pensions
*Both are not means-tested - entitlement does not depend on earnings or savings available.
- They are paid without tax deducted but are taxable
*the recipient’s tax code is adjusted to allow for the fact that the pension has been paid.
*Married couples and civil partners can qualify for two full single person’s state pensions if both have qualified for a full pension in their own right.
*Those entitled to a UK state pension who retire and move to live abroad are able, in most countries, to receive their UK state pension.
*Annual increase in line with the ‘triple lock’
Can you still receive your UK state pension if you retire and then move abroad?
*Yes, in most countries.
*If the country is in the EEA, Switzerland, Gibraltar, or any other country with an agreement with the UK - then their pension will adjust in line with inflation, so long as they live in the UK for 6 months or more
Explain what the ‘triple lock’ is
The triple lock is the guarantee of increase for new and basic state pension.
It is based on one of the three, which ever is greatest:
- Rate of inflation measured by the CPI
- Earnings growth
- 2.5%
*Additional state pension (SERPS and SP2) payable to those who reached state pension age before 6 April 2016 is only indexed in line with CPI inflation.
Explain the State earnings‑related pension scheme (SERPS)
*Pension scheme that ran from 1978-2002 when it was replaced by the State second pension (S2P)
*Anybody who was in SERPS between 1978 and 2002 and retired
before 6 April 2016, will receive SERPS benefits together with any S2P benefits accrued since 2002.
*SERPS was means tested; earnings between lower and upper earnings limits.
- Provided additional benefits on top of the basic state pension
*Objective: boost the basic state pension by 25% of an individual’s upper band earnings over a period of their best 20 years.
Conditions and amounts - Inheriting SERPS and S2P
- S2P = Maximum 50% of your spouse or civil partner’s State Second Pension.
*SERPS = The maximum you can inherit depends on when your spouse or civil partner died (100%-50%
Cannot inherit if you remarry before state pension age
Explain the state second pension (S2P)
*Objective: provide a more generous state pension than SERPS for low and moderate earners, and for certain carers and people with a long-term illness or disability.
- S2P gave those with low earnings a better pension than SERPS.
- The greatest benefit was for those classed as low earners.
- Carers and the disabled got credits towards S2P.
The state second pension was earnings related, as with SERPS.
Contracting out of SERPS and S2P
In 1988 it became possible to contract-out of first SERPS and then S2P.
This meant that the individual agreed to forgo benefits from SERPS or S2P in return for a reduced rate, or a rebate of, National Insurance contributions.
The contributions were then redirected into their private personal pension or occupational pension scheme
Pension credit - what is it’s objective? what are the two types? Is it taxable?
Objective: increase the pension income of many older people.
Two elements:
- Guarantee Credit: tops up your weekly income to a minimum level
- Savings Credit: extra payment for those who funded their retirement through other means other than the stage pension.
*It is means tested, unlike the other pensions (Based on income and savings)
*It is not taxable
Guarantee Credit
*For those from women’s state pension age and over.
*That have a weekly income below a threshold, known as the
‘appropriate amount’.
Guarantee Credit will provide a top-up payment to bring
income up to that level.
*Some may have higher ‘appropriate amounts’ such as those with disabilities or carers
*Capital (savings) over £10k (known as capital disregard) is said to produce ‘deemed income’ of £1 a week for every £500.
Example: if the appropriate amount for a single person was £173.75, and the individual earned £160 per week and had savings of £19k, they would not receive guarantee credit.
Their income would be deemed as £160 + £18 from savings
Savings credit
Objective: reward people who made some provision for their retirement.
*Payable to individuals who reached state pension age before 6 April
2016
*Can still be applied for if state pension age was reached before this date.
*To qualify:
*are part of a couple and one of them reached state pension age before 6 April 2016;
*were already getting Savings Credit up to that date; and
* have remained eligible since then.
If eligibility stops for any reason, it is not possible to claim for Savings Credit again.
Summary of tax benefits of pensions
- Tax relief on contributions into the pension fund
- No tax due on income received by or gains made by the fund
- A certain amount of tax‑free cash on retirement (to a maximum 25 per cent of the fund value)
*Known as the pension‑commencement lump sum.
*Afterwards, pension income is taxed as earned income, and subject to the individuals marginal tax bracket rate.
What is the the pension-commencement lump sum? (PCLS)
- A maximum of 25% of the pension fund can be taken tax-free
- This is a crystallisation event, hence the ‘commencement’
- In phased retirement, the individual 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% of the life time allowance remaining at age 75.
Eligibility for UK pension schemes
- Must be under the age of 75
- Be a resident in the UK during the tax year
- Have relevant earnings in the UK chargeable to income tax for the tax year in which the contribution is made
- have been resident in the UK at some point in the five years immediately before the tax year in which the contribution was made and when they became a member of the
scheme - the contributor, or their spouse or civil partner, must have received overseas income subject to UK income tax as a Crown employee.
In the case of those who have earnings subject to UK income tax, the personal contribution on which tax relief can be claimed is limited to the greater of £3,600 or their earned income.
Those without earned income, including children, are limited to £3,600 gross.
The personal contribution on which tax relief can be claimed is limited to… for those with income? For those without income
- Tax relief on pension contributions for those earning an income is the greater of £3,600 or or their earned income.
- For those without earned income, this is limited to £3,600 gross
Rules on contributions into a pension scheme
- There is no limit to how much you can contribute, but there is a level to which you do not receive tax relief - and may incur a tax charge
- This is called the annual allowance and is £60,000 (2024)
- The annual allowance is restricted to the ‘pension input period’ each year. this runs in line with the tax year April 6 - April 5
- Should an individual’s income (including employer contributions) exceed £260,000 then a taper is applied to the annual allowance
- For every £2 over this amount, £1 is deducted from the annual allowance
What happens if a non-eligible person makes contributions into a UK pension scheme?
They can still contribute and build their retirement find but they will not receive tax relief on the contributions
What is the annual allowance charge? An when are the two incidences when it does not apply?
- The annual allowance charge is due on contributions made above an the annual allowance during the pension input period. I.e. a tax charge on pension contributions above £60,000 in one tax year.
Not due:
- The year an individual dies (pension savings are set to nil)
- When benefits are taken due to severe ill health (pension savings are set to nil)
Assessing the pension input amount against the annual allowance: Defined-benefit (Final salary) Schemes
-The notional increase in the capital value of any defined‑benefit pension rights is set against the AA.
Calculated by
1. Taking value of pension benefits at the start of the year, and multiplying by 16.
- The value is then increased by the CPI
- Taking value of pension benefits at the end of the year, and multiplying by 16.
- The difference between the two figures is the total pension input, and this is the figure that is tested against the annual allowance.
Assessing the pension input amount against the annual allowance: DEFERRED Defined-benefit (Final salary) Schemes
only annual increases in pension rights that are in excess of either what is required by the pension scheme rules that were in place on 10 October 2010 or CPI for the 12‑month period ending with a month
that falls in the pension input period count towards the annual allowance.
If benefits from a deferred defined‑benefit pension increase by an amount that is less than this, the member is treated as having no pension input.
If increases are in excess of this amount, they will be valued using a factor of 16:1 for the purpose of calculating the annual allowance.
‘Carrying Forward’ - annual allowance
- Unused annual allowance can be carried forwards 3 years
- Provided you have been a member of a registered pension scheme during that time.
- In order to carry forwards, you must use all of your current years AA first.
Tax relief on pension contributions - limits
- Tax relief is given on contributions of up to £3,600 or the value of the individual’s salary - which ever is greater.
- (Income from savings, investments, pensions and other non‑earned sources cannot be included.)
-If the individual has no earned income, £3,600 gross is the limit.
Two ways tax relief is given on contributions into pension: Personal and stakeholder pension contributions
Relief at source
- Contributions are made from net income (after income tax).
- Provider claims back basic rate tax relief from HMRC and adds it to the pot.
- Higher and additional rate taxpayers claim additional relief through self-assessment tax return.
Net pay arrangement
- Contributions are deducted from gross salary, reducing taxable income.
- this gives immediate full tax relief at the individual’s marginal rate with no further action needed.
*Personal and stake-holder contributions are paid net of basic rate tax.
*Retirement annuity contract (RAC) contributions are usually now paid net of basic‑rate tax.
Two ways tax relief is given on contributions into pension: Net pay arrangement
- Occupation scheme arrangement
- This is where the employee contribution is taken from their gross pay before tax is calculated (Thus reducing the amount of income tax paid)
- This means that the employee receives the highest amount of tax relief immediately.
Where the net pay arrangement is not available, contributions will be paid net of basic‑rate tax.
Note: that while the ‘net pay’ contribution is deductible for the purposes of income tax, it is not deductible when calculating National Insurance contributions.
Tax relief if contributions are made by a third party:
Tax relief is limited to 20 per cent at source unless the person for
whom the plan is established is a higher‑rate taxpayer.
This means that a higher‑rate taxpaying parent cannot claim 40 per cent tax relief unless the child is also a higher‑rate taxpayer, and in that case the child would receive the additional relief.
The employer and contributions in relation to tax - how is tax charged on contributions?
- Can make unlimited contributions to an employee’s pension and claim as an allowable expense (So long as they can prove is it wholly and exclusively for the purposes of trade).
-Pension contributions are therefore usually tax-deductible, so long as not disproportionate.
-Employer contributions are made gross, with tax relief claimed as an expense in the accounting year of payment.
- One of the advantages of drawing dividends is that there is no liability to employer or employee NICs on the payments. However, if there are significant contributions made to the directions pension, HMRC may challenge - Contributions large in relation to salary (small salary + big dividends)
Employer and contributions: Salary Sacrifice
Employer contributions set up under salary sacrifice are not deemed a benefit in kind, therefore:
- Income tax not due by employee
- NICs not due on pension contributions
Employees may come to an arrangement in which they forgo part of their salary in order for an additional pension contribution.
Advantage: no liability to employer and employee NICs on the contribution
HMRC is strict on this - cannot be paid into a registered
pension scheme for an employee’s spouse or family member as part of their flexible remuneration package.
However, the effects of a reduced salary on pension death benefits would need to be considered.
Annual allowance charge
- If pension contributions exceed the annual allowance within the pension input period, then a tax charge is due at their rate of income tax on the contributions over the AA.
This is regardless of who makes the contributions above the AA:
- Employer can still claim as a business expense.
- the employee will still be able to claim tax relief on their contribution, as long as it does not exceed 100 per cent of their earnings, although the tax relief will be cancelled out by the annual allowance charge.
The lifetime allowance.
- Scrapped as of 6th April 2024. It is still used to calculate available tax-free cash (LSA)
- There is a lifetime allowance (LTA), or limit, on the total value of registered pension funds held by an individual that can benefit from tax relief.
- The LTA is enhanced (protected) where a member elected for ‘transitional protection’ in respect of their pre-A-day benefits.
- Or, where an individual benefits from a pre-A-day pension credit on divorce
- The enhanced allowances were introduced to protect those who had already built up a pension fund in excess of, or likely to grow to exceed, the lifetime allowance
What is an enhanced (protected) LTA?
The enhanced allowances were introduced to protect those who had already built up a pension fund in excess of, or likely to grow to exceed, the lifetime allowance.
Factors used to determined if LTA has been exceeded
- A factor of 20:1 is used to convert each £1 of benefits from a defined‑benefit scheme to a notional capital sum. This factor will apply irrespective of the age of the member and their retirement date. (pg 206) - this is used when benefits have not been taken
- A factor of 25:1 is used to convert each £1 of benefit already in payment prior to 6th April 2006 to a notional capital sum. This higher factor assumes a tax-free sum will already have been taken.
- Where a member is in receipt of pension fund withdrawal benefits that started before 6 April 2006, it is assumed that the income being withdrawn is the maximum available for someone of that age,
Lifetime allowance charge
- Removed from 6th April 2023. was a tax charge on crystallising benefits that exceed the available LTA.
- Instead, for certain lump sums, the individual will be charged income tax at their highest rate. These lump sums include:
- Serious-ill health LS
- Uncrystallised LS death benefits
- LTA excess LS
- DB LS death benefits
At any time when an individual crystallises (takes) benefits from a registered pension scheme, there must be a check to ensure that the lifetime allowance has not been exceeded.
What must an individual do each time they looks to crystallise benefits from a registered pension scheme?
Check whether their lifetime allowance has not been exceeded.
Otherwise, a tax charge will occur on the amount in excess of the LTA. This is charged at the individuals highest rate of income tax
Crystallisation events (Name 6)
- Commencing pension fund withdrawal (drawdown)
- Purchasing a lifetime annuity
- Taking lump sum cash benefits
- Reaching the age of 75 with an uncrystallised pension
- Paying a lump sum death benefit
- Transferring to an overseas pension scheme.
Tax treatment of registered pension funds
Extremely tax efficient
- There is no CGT on gains made on investments within the pension fund.
- The is no income tax on any income generated by investments within the pension fund. If any tax has been deducted at source, it can be reclaimed by the fund.
Tax treatment of registered pension scheme
death benefits - Defined benefit schemes
For DB schemes:
- Usually provide lump sum death benefit and scheme pension
- The lump sum death benefit is usually a set amount or a multiple of the member’s salary.
For DB schemes, member under 75:
- Paid tax free if under LTA and within 2 years of death
For DB schemes, member over 75:
- Taxed as either the recipient’s income via PAYE (or 45% if to a trustee or representative)
- Isn’t tested against LTA.
A scheme pension is taxable as the recipient’s income regardless of the age at death.
A trivial commutation lump sum death benefit may be paid when the value of a dependant’s pension or remaining guaranteed instalments are £30,000 or less - non-crystallisation event but is taxed as income (regardless of when death occurred).
Tax treatment of registered pension scheme
death benefits - Defined contribution schemes
For DC schemes, member under 75:
- Paid tax free if under LTA and within 2 years of death
- If in drawdown or receiving annuity, benefits are tax free if paid within 2 years either if lump sum or as income.
For DC schemes, member over 75:
- Taxed as either the recipient’s income via PAYE (or 45% if to a trustee or representative)
- If in drawdown or receiving annuity, any lump sum is taxed as income (or at 45% if to a trustee or rep).
What is a trivial commutation lump sum death benefit
A trivial commutation lump sum death benefit is a payment made from a pension scheme when the total value of a deceased person’s pension benefits is below a certain threshold.
This type of payment allows the beneficiaries to receive the pension benefits as a one-off lump sum rather than through regular payments.
Can be made when the remaining pension is £30,000 or less.
What is the Pension-commencement Lump Sum?
Upon first taking benefits from a registered pension (i.e. crystallisation) an individual can take a maximum of 25% of the value of the pension fund as tax free cash.
This is normally to a maximum of 25% of the recipient’s available lifetime allowance.
For a member of a defined‑benefit scheme, taking the maximum PCLS needs to be considered carefully since it can reduce the amount of pension income available
What is PCLS recycling? And when is it disallowed?
- The process of an individual taking tax-free cash, and then reinvesting into their pension - receiving tax relief.
HMRC may challenge if:
- Contribution to pension greater than what it usually would be
- The recycling was planned.
- The PCLS, plus any other PCLS received in the previous 12 months, is more than £7,500.
-The increase in the annual pension contribution is more than 30 per cent of the amount received from the PCLS.
What is the Tax treatment of retirement income and
additional lump sum withdrawals?
- Income taken from registered pension is treated as earned income.
- Once PCLS has been taken, pension income is taxed at the individuals marginal rate of income tax.
- Income from state pensions - tax not deducted at source, but is taxable.
- Tax code is reduced to allow for the payment. Pension Credit payments are tax‑free.
Retirement options: What is an Annuity?
- Annuities are the most secure and reliable option at retirement - they provide a secured income for life
- It is a contract between the insurance company and individual to provide an income for life.
- Capital-protected annuities ensure that the outstanding balance (annuity less payments received before death) is returned to the beneficiaries (tax free if under 75, at their marginal tax rate if not)
- They are purchased via lump sum (usually the individuals pension fund)
Two types of annuities:
- Compulsory-purchase annuity
- Purchased-life annuity
What is a compulsory-purchase annuity?
An annuity that an individual has purchased as part of a pension arrangement.
Income from these annuities is always taxed as earned income through the PAYE system, with the pension provider effectively acting as ‘employer’.
What is a purchased-life annuity?
An annuities that the individual has chosen to
buy, outside of any pension arrangement – with investment capital or a pension tax‑free lump sum.
Income from these annuities is treated as a part return of capital (tax‑free) and, in part, interest (taxable).
Protecting pre‑A‑day pension funds - what is primary protection?
- Those with accrued rights in excess of £1.5million
- Increased the individual’s ongoing lifetime allowance in proportion to the amount by which the existing fund exceeded the 2006 limit
-E.G. if the fund on 6 April 2006 was 25 per cent over the new lifetime allowance, the ongoing lifetime allowance would be 125 per cent of the standard allowance.
Protecting pre‑A‑day pension funds - what is enhanced protection?
- For those who do not have an active membership to pension schemes before A-day - had built benefits but no longer accruing.
- So long as membership was not resumed after April 2006, all benefits coming into payment will be exempt from the lifetime allowance charge.
Other pension arrangements - Employer‑financed retirement benefits scheme (EFRBS)
Replaced Funded unapproved retirement benefits schemes (FURBS) and unfunded unapproved retirement benefits schemes (UURBS) on April 2006
*Until 5 April 2011 employee contributions were not treated as a benefit in kind and so the employee did not pay tax or NICs based on them.
- The employer cannot claim contributions as a deductible business expense until the benefits become payable.
*The fund will pay income tax at the trust rate on any income received from investments. Capital gains are also taxed, although the trustees do have an annual exempt amount (which is equal to half the individual exempt amount).
*Retirement benefits will be subject to income tax at the individual’s normal rate, but do not count as part of the member’s lifetime allowance.
*Any lump sum death benefit will form part of the individual’s estate for IHT purposes.
Pre-2011 used to have the benefit of Income tax deferral and NIC avoidance, however, now does not have these benefits. Does have the disadvantage over cash bonuses now that they have to be paid in a certain form and at retirement
Other pension arrangements - Qualifying recognised overseas pension scheme
(QROPS)
What is it?
When can it be used?
When might charges apply?
An overseas pension arrangement that can accept a transfer from a UK pension
scheme, other than the state pension, provided that the UK pension fund has not been used to provide an annuity.
- For those who intend (or have already moved) to move away from the UK.
- For International workers who have been part of a UK scheme but are returning home.
The QROPS can be set up to provide benefits on retirement, death or serious illness.
Conditions:
- Must be a recognised pension for tax purposes in both jurisdictions
- Subject to time constraints/conditions.
- Overseas transfer charge may apply
Charge applies made after March 2017 and if the applicant is not:
- A resident where QROPS receiving the transfer is based
- in the European Economic Area (EEA), Gibraltar or the UK
The QROPS they are transferring to is:
- an occupational pension scheme and they are an employee of a sponsoring employer under the scheme at that time;
- an overseas public service scheme and they are employed by an employer that
participates in that scheme at that time; or
- a pension scheme of an international organisation and they are employed by that
organisation at that time.
If none of the above apply, there is a 25 per cent tax charge on the transfer and the tax charge will be deducted before the transfer is made by the scheme administrator.
What is a Personal Pension Plan?
An additional arrangement made by an individual who wishes to contribute towards their retirement savings outside of their employer and state provision.
All PPPs are defined contributions.
PPP providers must supply an annual illustration showing the value of the fund and estimate future income (in today’s terms).
Individuals have a wide option of providers available - from banks, building societies , investment companies, friendly societies etc. and can be arranged via with profit or unit-linked investment principles
Stakeholder pensions (SHPs) AND Self-investment Personal Pensions (SIPPS) are additional options
Name two ways that a Personal Pension can legally be set up under
- Master trust
- Deed poll
The main benefit of both approaches to the plan holder is that death benefits can usually be paid free from inheritance tax
PPP set up under Master trust. How is it organised?
Organised under trust, with the provider appointing a trust company to act as scheme trustee
PPP set up under Deed poll. How is it organised?
Not organised under trust - the Deed poll appoints the pension provider as the scheme administrator
and there is no need for a trustee.
Main difference between Stakeholder pensions and personal pensions? What is the criteria that constitutes a stakeholder scheme?
4 points
Stakeholder pensions were introduced by the government as part of their stakeholder suite of products, these were designed to:
- Serve the needs of lower earners
- Simple-to-understand low-charging savings vehicles
Conditions for a stakeholder scheme:
- Max charge - cannot be higher than 1.5% for the the first 10 years, and then 1% thereafter.
- Minimum contribution cannot be higher than £20, whether a single or regular payment.
- Must offer lifestyling investment option
- The plan must accept transfers from other pension plans
What is the ‘phased-retirement’ facility offered by some personal pension providers?
Phased retirement is where an individual gradually reduces their number of working hours whilst simultaneously drawing a portion of their retirement income from their pension.
The pension plan is arranged in a number of ‘mini-policies’ each representing a proportion of the total premium and fee etc.
When the member decides to take benefit, they can chose to drawn from any number of these ‘segments’ - each with its own tax-free PCLP.
The value of the combined segments can be used to generate an income in the form of an annuity, drawdown, or to take further taxable lump sums.
Investment principle: With-profit funds
- Relatively conservative
- Uses the principle of ‘smoothing’ returns over the years.
- Contributions are allocated into units win the provider’s with-profit fund - these will grow/fall in value based on performance of underlying assets.
- At the end of the year, actuaries decided how much of the fund is needed to pay current and future liabilities, costs and guarantees
- The balance is profit, some of which is held back for ‘smoothing’, the rest is passed on as bonuses to policyholders
- When a member decides to take benefits, a terminal bonus may be added.
- The retirement value will be the value of units x how many units held.
- If benefits are taken earlier than originally stated, an early retirement penalty or Market rate reduction (MVR) may be applied.
What is the Market rate reduction? And what does it apply to?
The market rate reduction is a penalty that may be imposed if benefits are taken early from a private personal pension that is arranged under a ‘with-profits’ investment principle.
When a member decides to take benefits, a terminal bonus may also be added.
Investment principle: Unit-linked funds
- Offers a wider selection of funds compared to With-profits funds.
- Unit-linked funds operate similarly to unit trusts but pension fund legislation.
- As with unit trusts, the value of each unit is simply the value of the fund assets divided by the number of units in issue.
- As with unit trusts, units are sold at the offer price and bought back
from the investor at the bid price. A typical bid/offer spread would be 5 per cent. - Charges are more specific than with-profits funds. Other charges include:
Allocation rates
- This is where only a proportion of the investment (contribution) is used to purchase units.
- Most modern providers have an allocation rate close to 100% however.
Initial and capital units
- Different types of units may carry an additional Annual fund management charge.
Policy Fee
- Monthly or annual fee to cover admin, often included within the annual management fee.
Annual Management Fee
- Either a monetary amount or percentage of the value of the fund.
- Covers the cost of investing funds and admin for the scheme.
There may also be a charge for taking benefits earlier.
Categories of funds available for unit-linked funds
Broad categories of funds available:
-Managed
-Equity
-Fixed interest
-property
-Overseas equities
-Guarantee
What is a ‘waiver of premium’?
Is a policy option that allows for a ‘premium payment holiday’ in the event the member is unable to work through accident or illness.
Since 6 April, tax relief has not been available on waiver of premium benefits.
NOT available for pension plans taken out instead - Pension contribution insurance can be taken out instead.
Group income protection insurance - Income from claim = taxable income, can be used for pension contributions.
individual income protection insurance policy - Income from claim = Not
taxable and cannot usually be used as earnings for pension contributions.
Pension contribution insurance - contributions to continue in the event of being unable to work as a result of an accident or illness. There is no tax relief on premiums for this insurance.
ALTERNATIVE - Critical illness cover to provide pension contributions.
When is the earliest an individual can withdraw benefits from their PPP?
Under the minimum pension age - currently, aged 55.
To increase to age 57 in April 2028
In what two situations may a member take benefits from their pension before the minimum pension age?
Due to ill health where the member’s life expectancy is less than 12 months.
Special occupation (Such as professional footballers, military personnel, police):
- The member’s lifetime allowance (LTA) will be reduced by 2.5 per cent for each complete year before the normal minimum pension age that the benefit is taken.
Two ways to take benefits from your pension
- As a tax free lump sum (Pension commencement lump sum) - up to 25% of the fund value can be taken this way.
- The rest can be taken as a taxable lump sum, or used to provide an income via drawdown or annuity.
Crystallisation events
- Turning 75 with uncrystallised benefits
- Turning 75 in drawdown
- Buying an annuity
- Starting pension drawdown
- Taking PCLS
Can an individual take PCLS after age 75?
Yes, however, any PCLS drawn from age 75 onwards will be restricted to 25 per cent of the lifetime allowance remaining at age 75.
** double check **
Annuity options - capital-protected annuity?
An annuity with additional protection to ensure that the outstanding balance (annuity less payments received before death) is returned to the beneficiaries (tax free if under 75, at their marginal tax rate if not)
What are Enhanced and impaired‑life annuities?
Annuity rates are based on life expectancy. If an individual has a lower life expectancy than normal for their age, they may receive improved annuity rates.
Enhanced - higher rates for certain medical conditions or lifestyles
Impaired-life - higher rates for certain medical conditions that are life-shortening.
Often these terms are used interchangeably
Annuity options - Joint or single life?
- Joint will provide less income, can be arranged to pau a surviving partner between 50-100% of the annuitant’s initial income.
- A joint life annuity will continue to pay out until both parties have died.
Annuity options - is a guarantee required?
Continues to pay even after the annuitant dies.
The ten‑year limit on guarantee periods has been removed and guarantee
payments can now be commuted for a taxable lump sum where their value is under
£30,000.
Annuity options - Annuity income to be level or escalating?
If escalating, it is to rise based on a fixed about each year (i.e. 3%) or index-linked (increased by RPI or CPI).
Escalating annuities pay less than level annuities (can take 10 years to catch up)
Decreasing annuities are also available since April 2015.
Annuity options - Annuity income to be paid in advance or arrears?
- Payment immediately or later?
- Is income required monthly, quarterly, half‑yearly or annually? Payments
in advance result in a slightly lower income than payments in arrears. - A with proportion annuity will pay any income due between the last payment and the annuitant’s death.
- A without proportion annuity will not make a further payment if the annuitant dies between payments but will result in very slightly higher income.
Explain Unit‑linked annuities
- Not as common, not for the risk-adverse
- Pension fund buys units in a unitised fund linked to equities and income based on the bid value of the units.
- Can choose the anticipated growth rate: If the funds
grow at the chosen rate, the income will remain the same. If fund growth exceeds the chosen rate, income will increase; if it is below the chosen rate, the income will decrease.
Explain with-profits annuities
Similar organisation to unit-linked, but invested in with-profit fund:
Applicant selects bonus rate (ABR) between 0 per cent and 5 per cent pa
- 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.
If the actual bonus rate matches the chosen rate, the income will stay the same for the next year.
If the rate exceeds the chosen rate, the income will increase for the next year.
If the actual rate is below the chosen rate the income will decrease for the next year, and the base annuity rate will for the next calculation be lower.
What is the money purchase annual allowance? (MPAA)
A reduced annual allowance amount instigated by the individual going into drawdown.
- Current limit is £10,000
Stops benefits being taken then immediately reinvested into pension for further tax relief (i.e. pension recycling)
What is flexi-access drawdown? (Drawdown option)
Pension fund - PCLS -> Drawdown account (crystallised) -> take ad hoc payments, regular income, or purchase an annuity.
- No limits to how many payments can be made
- Once PCLS has been taken, the remained of their fund is invested in a drawdown fund of their choosing.
- They can then arrange regular income, further lump sums, or purchase an annuity.
All withdrawals in excess of their tax-free cash will be classed as INCOME and taxed as such.
- Triggers the MPAA.
What is a short-term annuity? (Drawdown option)
- Purchased with part of pension fund
- Income is paid directly by the insurance company rather than the scheme admin in this circumstance.
- Maximum term is 5 years, though another can be purchased.
- Remainder of funds remain invested to capitalise on potential further growth.
What is Uncrystallised funds pension lump sum (UFPLS)? (Drawdown option)
- Allows the member to take Tax free cash without the need for the drawdown component
-The rest of the funds remain invested and untouched (crystallised) - Must be: DC pension scheme, over 55 (unless ill-health) and from an uncrystallised fund
- Not called PCLS as there must be an arising entitlement to income, ie drawdown or annuity to be called this (It’s just called tax-free cash)
Not available for individuals that have:
- lump sum protection under enhanced or primary protection; or
- a lifetime allowance enhancement factor and where the available portion of the lump sum allowance (LSA) is less than 25 per cent of the proposed UFPLS.
Pros of Drawdown options at retirement
- Allows for greater control over investments
- Allows for the delay of taking an annuity, therefore allowing the investor to take advantage of more favourable Gilt yields and beneficial rates based on their age.
- Further investment growth may be achieved by leaving a proportion of funds untouched.
- Greater flexibility of income
Cons of Drawdown options at retirement
- Fund performance may decline
- There may be high fund charges on withdrawals
- Annuity rates may not increase as expected
- Requires careful management: each withdrawal runs the risk that the member runs out of funds, as people tend to underestimate their life expectancy.
- If member withdraws a large portion of their funds, they may face a higher or additional rate tax charge if this pushes them into another tax bracket (withdrawal will be added to income for tax purposes)
With annuities, those who die earlier than expected effectively save the insurance company money and this represents a gain to the fund that is to the benefit of other annuitants. This ‘mortality cross‑subsidy’ does not exist with pension fund withdrawal.
What is the ‘mortality cross-subsidy
When annuitants die early, the insurance company saves money as they do not have to pay out the remaining income (unless a guaranteed annuity).
This saving is passed on to other annuitants:
If someone lives longer than the average life expectancy, they continue to receive payments, effectively funded by the premiums of those who did not live as long.
Defined‑contribution scheme death benefits for those UNDER 75 - Income/ Crystallised / uncrystallised
Income
- Tax‑free if taken as income via drawdown
- Tax‑free if taken as income via a joint life or guaranteed term
annuity
Crystallised funds
- Tax‑free to any beneficiary if member died in drawdown or an
annuity protection lump sum is paid out
Uncrystallised funds
- Tax‑free up to the deceased’s lifetime allowance
Defined‑contribution scheme death benefits for those ABOVE 75 - Income/ Crystallised / uncrystallised
Income
-Taxed at beneficiary’s marginal rate of income tax
Crystallised and uncrystallised funds
- Taxed at beneficiary’s marginal rate of income tax
What is a SIPP and what are it’s key features?
Self Investment Personal Pension
- Personal pension scheme with enhanced agency and options for investment.
-SIPPs can borrow funds for investment purposes and can purchase commercial property - Up to the value of the fund + 50%.
- Must pay a market rent to use the building, the rent is paid to the SIPP tax‑free.
- Residential property is classed as prohibited. Any investment involving this will be subject to punitive charges
there is an unauthorised payment charge of 40 per cent on the member and a surcharge of 15 per cent on the scheme. Scheme can be shut down if 25% of the fund value is in residential property.
Punitive charges on residential property investment in SIPPs
- Residential property is prohibited.
- Unauthorised payment charge of 40% on the member
- A surcharge of 15% is applied to the scheme.
If the investment represents 25% of the fund value:
- Further charge
- Risks scheme being shut down.
Indirect investment is allowed - via real estate investment trusts
What is a Retirement Annuity contract?
Prior to 1988 - was the only option for an individual to take out a form of personal pension.
What are Free‑standing additional voluntary contributions? (FSAVC)
Prior to early 2000s
Only way to increase your pension was to make AVC (additional voluntary contributions) to their contribute their occupational scheme.
Or to contribute to a free‑standing additional voluntary contributions (FSAVC) arrangement.
- Similar structure to PPP in that they belonged to the individual and fund could be chosen.
Essentially replaced by Private personal pensions in 2006 with the pension simplifications.
Occupational pension schemes - basic points
- Does not have to state a normal retirement date, though 65 is usually used.
- Fund grows free on UK taxes.
- Pensions paid are taxed as earned income
- Tax-free cash (PCLS) can be taken.
- Contributions by employer and employee qualify for tax relief, subject to the annual allowance.
- Death benefits treated as outside of the estate for IHT - provided that the trustees or administrators retain discretion over the distribution of the benefits and distribution occurs within two years of the member’s death.
Can you contract out of a defined benefit scheme?
- After April 2006, No
- Contracting out is the process of opting out of the additional state pension, saving NICs for employer and employee
Defined-benefit schemes - Employer contributions. Tax? Who pays?
Employer contributions are treated as a deductible business expense and offset against profits in the accounts.
- Employer must make contributions to ensure that the defined pension and death benefits can be provided to scheme members.
- As wage inflation and investment performance may change, it may result in additional contributions from the employer.
- Equally, if overfunding occurs, a contribution holiday might be necessary - or the surplus may be used to increase benefits.
Employer contributions are usually paid annually, based on the level of contributions calculated by the scheme actuary. The rate of funding is reviewed every three years in a triennial review.
Defined-benefit schemes - Employee contributions
- Small number of schemes are ‘non-contributory’ (only employer pays)
- Employee contribution is usually a % of pensionable pay, usually around 5-6%
- Pensionable pay (or salary) is the scheme definition of earnings that will be taken into account when calculating contributions and benefits.
- Employee contributions are paid under the net pay arrangement, where the full amount is taken from pay but then deducted before tax is calculated.
What three factors affect the retirement benefits of a defined-benefit pension scheme?
- Length of service
- The scheme’s accrual rate - this is the rate at which benefits build up (expressed as a fraction, such as 1/60, which would represent 1/60th of the final salary for each year of membership)
For example, after 30 years (30/60) the member would retire with 50% of their final salary.
- The employee’s ‘scheme pay’ - how much of the individuals salary that goes towards benefits.
What age can you take benefits from a DB pensions?
- From 55, although a penalty would normally be charged.
- Most schemes have a retirement date of 60 or 65
Can you take a PCLS from a DB scheme?
- Yes, though this will reduce the pension you will receive.
- The old rules capped the lump sum at 1.5x final remuneration (many schemes still use this)
- Alternatively, 25% of their ‘fund’ can be taken - calculated by multiplying
Death‑in‑service benefits for DB schemes - two forms
- Lump sum
- Dependants pension
Death‑in‑service benefits for DB schemes - Lump sum - tax amounts pre and post A day?
- Pre A-Day - maximum 4x final salary tax-free.
- Post A-day - any amount is tax-free.
However, if the lump sum exceeds the individual’s Lifetime allowance, then it will be taxed at the recipients income tax rate.
Death‑in‑service benefits for DB schemes - dependants’ pension, limits?
Any pension paid to a dependant is taxed as their earned income.
- Pre A-day, Typically, most schemes provided a pension of between 50 per cent and 66.7 per cent of the member’s projected entitlement.
- Post‑A‑Day, there is no limit to the pension that can be provided for dependants
DB schemes - death after retirement. How much is provided? How long for? Tax?
Any pension paid to a dependant is taxed as their earned income.
- If a member dies whilst receiving benefit, their spouse or dependants will receive a pension from the provider
- Usually pays 50-67% of the members pension.
- Paid for the life of the beneficiary, or a specified term.
Describe defined-contribution schemes structure and process.
- both employee and employer make defined contributions - this makes it easy to budget for (unlike for DB schemes)
- Each employee has a ‘pot’ which grows with each contribution and investment performance that the pension fund is held in (Fund of funds).
- This pot is then used to (usually) purchase an annuity on behalf of the member to provide an income for life.
- Type of annuity is limited to the scheme but typically be rising with inflation
Death benefits of DC schemes (in and out of service)
- not tax status
- Annuity funded by the scheme member’s pot typically provides a spouse’s pension of 50 per cent if the member dies.
- Some schemes provide a lump-sum death-in‑service benefit. If the member dies in service, the value of their fund will be used to buy a dependant’s pension or may be returned as a lump sum.
Advantages of defined contributions schemes
-Easy for members to understand in terms of benefits and contribution rates
- Usually better value for short‑service members who leave the scheme before reaching retirement
- Able to offer a known outlay for the employer.
Disadvantages of defined contributions schemes
- there is no underlying benefit promise for members
- the employee ends up bearing the risk that the investments within the scheme will underperform, because the employer has no commitment other than to pay the agreed contributions
- ultimately, members’ benefits will be affected by the fund value on the day of retirement and, if relevant, annuity rates
- No guarantee of the level of benefits payable. The criteria for contributions are normally defined at the outset, with specific contributions for both employer and employee. These will either be a percentage of salary or a fixed monetary amount
What is an Executive pension plan (EPPs)? Who is it for?
- A defined-contribution scheme designed for small to medium sized companies
- Subject to the same rules as any occupational scheme
- Often set up as one-person schemes.
What is a small self‑administered scheme (SSAS)? Who is it for? Why is it often used?
- Particularly useful for the owner/directors of small or medium‑sized companies.
-Group defined‑contribution scheme
- 12 or fewer members
- All of whom must be trustees.
- Often set up to purchase the company premises through the scheme. This way the income and gains from owning the building will be sheltered from income, CGT, and corporation tax.
- SSAS can borrow up to the value of the fund + 50% (like SIPPs)
These loans cannot be for more than 5 years (rolled into a new loan once for an additional 5 years). - Punitive charges for prohibited investments (like SIPPs)
- the sponsoring company MUST pay market value rent to the pension fund for the use of the business premises.
-The pension scheme can invest up to a maximum of 5 per cent of the fund value in the sponsoring company’s shares.
What are group personal pension schemes?
- A similar way for an employer to set up a pension as opposed to an occupational scheme
- Employer makes arrangement with pension company, each employee has their own policy as part of a group.
- Each policy is a personal pension, so the employee can do with it what they wish
- if to be used as a qualifying workplace pension, the minimum contributions need to be satisfied.
- Payments are usually made by payroll deduction net of basic‑rate tax.
- defined contribution only
What is the main advantage of a group personal pension scheme?
- simplicity of administration and the lower costs for employer
- The advantage to the employee is in the provision of the pension itself and its portability.
What is a stakeholder pension?
A stakeholder pension is a form of personal pension that was brought in by the government as part of their ‘stakeholder’ suite.
These aimed to be low-cost and simple-to-understand to assist the lowest earners.
What does notionally funded mean?
This refers to the arrangement in which the contributions of the current workers fund the current retirees benefits
- Employers and Employees pay contribution directly to the treasury.
- The contributions are NOT invested, but instead treated as a loan (or Gilt).
- More burden on the employer as Gilts provide less growth than equities
- The government pays benefits when they fall due.
Examples include the Teachers’ Superannuation Scheme and the NHS scheme,
What is an unfunded scheme?
This is where no fund exists - the pension provision is paid directly from the public’s purse. Example: Civil Service
How to determine accural rate for a DB scheme?
Depends on individual scheme, however:
*1/60 is used for career average
*1/80 is used for final salary
Example:
- (Years of service/80) x career average
- A lump sum can be provided at 3/80 x career average.
When is it advisable to switch personal pension providers?
- Rarely, as there are often initial charges involved.
- You’re banking that the other providers fund performance will be better (no way of knowing)
- Can be beneficial when charges are lower than current provider
Three options for those leaving an employer providing a DB scheme
- Refund on contributions -> if they have been employed less than 2 years. They will not receive interest, and there may be a tax charge.
- If completed at least 3 months with scheme, the employer may offer to ‘preserve pension’ - benefits taken at normal retirement age.
- Transfer the value of their benefits to another scheme if they have been a member for at least 3 months.
Leaving a DB scheme - benefits of transferring, things to consider
- to consolidate pension benefits
- to achieve freedom from a previous employer
- for investment choice and flexibility
- to secure greater flexibility of benefits, particularly those offered by the pension freedom legislation
- a desire for personal and private arrangements
- the possibility of improved benefits
- the option to retire early.
Always important to understand the charges, penalties, and drawbacks of transferring out. For example:
A transfer to a defined‑contribution arrangement may not carry a high enough level of financial security despite other advantages it might have.
What are retained benefits, and what are the three options an individual has to transfer to?
Retained benefits are the accrued benefits built up in a previous employer’s scheme.
The individual can chose to transfer the cash equivalent pension to:
- Another occupational scheme
- A personal or stakeholder pension
- A section 32 buyout plan
How is the cash equivalent transfer value (CETV) calculated?
- Obtain the annual pension as at date of leaving employment.
- Revalue the annual pension to the scheme’s normal retirement date.
- Calculate the capital value of the revalued annual pension at the scheme’s normal retirement date.
- Discount the capital value to today’s date to arrive at the CETV.
Transfer decisions - Transferring to a new employer’s scheme. How are benefits transferred to the new scheme?
- If the new scheme is DB, it is possible to use the CETV to ‘purchase’ additional years of service or guaranteed benefits in the new scheme.
- Alternatively, the cash equivalent is transferred into the new scheme fund on a defined‑contribution basis and allocated as a separate pot within the main fund.
What is a ‘transfer club’ within DB scheme transfers
A transfer club is an arrangement under which certain schemes agree to transfer benefits from one scheme to another on a like‑for‑like basis.
- Often in the public service sector
an easy and cost‑effective method of allowing transfers without the expenses usually involved.
Trivial commutation and small pots - what is it and what are the rules?
If an individual’s pension pot is low in value, it may be converted into a cash payment in certain circumstances.
- the minimum age for doing so is 55.
Trivial commutation
- Can be taken if fund is less than £30,000
- Added to income (and taxed as such)
- Additional rules for DB schemes
Small pots
- if less than £10,000
- Up to three personal pension pots can be taken this way
- Any any number of occupational pension pots
- Benefits taken do not trigger the MPAA
- Taxed as added income
Who is in charge of ensuring that employers meet their pension obligations? And how much is the penalty for not doing so?
- The pensions regulator
- Fixed penalty of £50,000
- Additional penalties of £10,000 for each day they do not take remedial action.
NEST - what is it, what are the charges?
NEST (National employment saving trust) is a government workplace pension scheme that employers can use.
- Members are charged 0.3% of their fund each year
- 1.8% contribution charge
Alternative retirement funding - Cash ISAs
- ISAs are a relatively tax efficient savings product - Tax free wrapper
- Deposits into ISAs do not receive tax relief (unlike pensions)
- However, tax is not paid on withdrawals
- Funds within an ISA grow free of Capital gains tax, and any interest that accrues is not subject to income tax.
- The ISA allowance is £20,000, across all types of ISA
- You may only fund one of each type of ISA in each tax year.
May be attractive for their flexibility - funds can be drawn for retirement whenever the investor chooses
NOT ideal for a retirement fund - only grows with interest which often will not outpace inflation.
Good to supplement other retirement funds or for emergency funds.
What is a flexible ISA?
An ISA in which money can be taken from a cash
ISA at any point and returned in the same tax year without it reducing the current year’s allowance.
Alternative retirement funding - Stocks and shares ISAs
Stocks and shares ISAs allow a number of investments to be held in a tax‑free wrapper.
- Have the potential for real growth over time (in comparison to cash ISA) and therefore a more viable option for a retirement fund
- There is current no limit to the value held in S&S ISA
- 25% charge on total fund if withdrawn early
- can only contribute up and receive bonus until 50
They can be invested in any of the following:
— shares;
— unit trusts;
— investment trusts;
— open‑ended investment companies (OEICs);
— gilts; and
— corporate bonds.
Alternative retirement funding - LISA
Lifetime ISA - government tops up with 25% bonus for every £4 deposited
- Limit of £4000 per year, equalling a £1000 bonus
- This is included in the ISA allowance
Funds within an LISA can only be used to fund retirement or the purchase of the individual’s first property (which has to be for their own residence and below £450,000)
- If withdrawn for any other reason, a 25% charge on the ENTIRE fund is charged (not just loss of bonus)
- An individual can continue to contribute into their LISA until age 60, however, the bonus is stopped at age 50
Alternative retirement funding - Unit trusts/OEICs - Key features/ tax relief?/ charges?
Collective investments such as UT/OEIC offer diversification and professional fund management. Performance is is similar to pensions.
- Investments into UT/OEIC do not receive tax relief.
-No CGT on disposals within UT/OEIC (fund switches?)
- Individual may pay CGT on again gains when they encash their investment.
- Depending on underlying investments - equities = dividend tax. Non-equity = income tax (included in personal savings allowance
- No limits on value able to invest, no restrictions of when they can withdraw
- UT/OEIC typically have an AMC of 1-1.5%
Alternative retirement funding - Insured investment plans (endowments and IB)
Insured investment plans, such as endowments and investment bonds, can be a useful way to build up additional funds.
Endowments:
- Regular premium
- Fixed maturity date (can’t be encashed before this)
- Do not benefit from tax relief
- £3600 max premiums to be qualifying (thus reducing investment opportunity)
IB:
- Single premium, whole-of-life policy.
- Bonds can be encashed at any time, though possible income tax.
- IBs are non-qualifying
- Premiums do not receive tax relief
- Higher and additional tax payers pay 20% and 25% (basic rate satisfied)
- 5% of the original investment can be withdrawn each year without tax, this rolls over
The capital gains tax (CGT) rate for basic‑rate taxpayers combined with the annual
exempt amount may, however, mean that many investors would be better off investing in unit trusts, etc. They would not pay tax in the fund and, on retirement, the holder can cash in units to provide income within the annual exempt amount and effectively pay no tax.
Alternative retirement funding - Direct investment into fixed‑interest stocks or equities
- Higher charges than UT/OEIC
- No professional fund management
- Difficult to provide diversification (Not collective investments so unless high funds it’s difficult)
-Equities offer the potential for capital growth as well as income. There is a risk, however, of capital loss, and diversification is essential.
- Investment does not receive tax relief – income tax is payable on dividends. An investor may be liable for capital gains tax on any gain on disposal.
- Shares received through employee incentive schemes often have significant tax and National Insurance contribution advantages. There is, however, a danger that an employee building up substantial holdings in an employer’s shares will lack diversification.
Alternative retirement funding - Property (BTL/Downsizing)
Buy-to-let
- provides an income
- However, tax implications need consideration - CGT, income from rent liable into income tax.
- Stamp duty Land Tax has increased on additional residential purchases
Downsizing
- Release cash for retirement
- Buying/selling costs need to be considered
- Emotional toll on moving if not entirely wanted
Alternative retirement funding - Lifetime mortgage - what is it? advantages/disadvantages?
An interest only mortgage, an agreement that the interest will be rolled-up and repaid when sold or owner dies.
- Owner may release 20-50% of property value depending on their age - any existing mortgage would have to be paid off as part of the arrangement.
Advantages
- Owner remains in their own home
- No regular payments
- Plans guarantee that, if the loan exceeds the value of the home when the owner dies, the lender will not require the excess to be repaid. This is known as the ‘no negative equity’ guarantee.
Disadvantages
- Home is mortgaged (again)
- Reduces inheritance
- Debt rolls up quickly.
Alternative retirement funding - Home reversion plans - what is it? advantages/disadvantages?
For older homeowners, above 70, who have no outstanding mortgage.
Owner sells the property to a reversion provider in exchange for a lump sum, which
is likely to be a substantial discount from its market value.
Essentially equity release
The former owner will have a guaranteed lifetime lease on the property. Some arrangements might involve a nominal annual rent.
Upon death, the provider takes possession of the proportion
Advantages:
- The owner can remain in their own home.
- It allows cash to be raised.
- Higher cash sums are usually available than those for lifetime mortgages.
- No regular repayments are required.
Disadvantages:
- Part of house out of of the estate.
- The cash raised will not reflect the true value of the property.
- The owner no longer owns the property that might have taken them a lifetime to
buy. Many people would not like to be a tenant in their ‘own home’.
Questions to consider when reviewing a client in terms of retirement planning
- At what age does the client wish to retire?
- What income will the client need at retirement?
- Are there any capital needs at retirement?
- Should an individual take the maximum 25 per cent tax‑free cash
(pension‑commencement lump sum) from the pension arrangement? - Is it desirable to have a higher level of income in the first few years to provide
a ‘wind‑down’ period? - What level of dependant’s pension will be needed?
- Is long‑term care an important factor?
Once client needs for retirement have been established, what additional information/questions should be asked?
- How much of this pension need is already provided for?
- State pension (forecaset - gateway or BR19)
- Occupational pension
- Retained benefits from previous employment
- Personal pensions
- What is the gap between current provision and the amount needed?
- How is this shortfall to be funded?
- If the shortfall is not funded, does the client appreciate the potential impact on
their living standards?
Investment strategy - Risk - issues to consider with a client
- Does the client understand the concept of risk and reward?
- Are they aware of the relative performance of each asset type?
- How do they feel about the possibility of losing some of their capital?
- Do they understand that choosing a more secure investment will mean funding to
higher level to compensate for lower growth potential? - Do they have other pension provision or assets that they might use in retirement? If the
proposed provision is only part of the overall plan, they might be able to take more risk.
The choice of which types of asset to use depends on two key factors:
- Attitude to risk
- Time to retirement
Low attitude to risk - which assets are worth considering?
- Cash deposits
- Inflation risk
- Tend to be outperformed by bonds and equities.
- Useful for those who have built up a fund and wish to protect it near to retirement.
- Fixed‑interest securities
- Considered less risky than equities
- Good for those nearing retirement and wishing to consolidate and protect gains already made.
Advised to change portfolio away from equities to these form of investments 10 years before retirement.
Medium to high attitude to risk - which assets are worth considering?
- Property
- Growth over the medium to long term
- Rental income can ofset captial losses
- High entry costs
- CGT
- Equities
- Volitile, fluctuate over the short term
- Should be considered medium to long term investments (at least 5 years)
- Usually outperform other assets
Describe portfolio changes as individual approaches retirement
- With a long time till retirement, the investors portfolio should consist mainly of equities (though being mindful of diversification).
- Good oppurtunity for growth that outpaces of inflation, and time to have investments tied up. - As individual approaches 10 years before retirement, should shift to lower-risk investments such as bonds and Gilts.
- This does depend on the clients attitude to risk
- So may chose to move 10% of the fund over each year
- Others may chose 20% each year in the final 5 years.
- Some personal pension schemes offer an automatic switching facility – often called a lifestyling option
What is a lifestyling option? and what is it otherwise known as?
- Also known as automatic switching facility
- Lifestyling option is an automatic switching of asset allocation within personal pension schemes as an individual approaches retirement.
Explain correlation theory - what correlation is prudent for good levels of diversification?
Correlation looks at the linear relationship between two types of asset in terms of
performance, measured in numbers from +1 to –1: the extent to which asset classes tend
to rise and fall together.
- A correlation above 0 is said to be a positive correlation, getting stronger the nearer
it gets to +1. - A correlation below 0 is said to be a negative correlation, getting stronger the nearer
it gets to –1. - A correlation of +1 will be a perfect positive correlation, whilst a correlation of –1 will
be a perfect negative correlation. - A correlation of 0 would indicate no correlation between the assets. They would
move up or down independently of each other.
A netural correlation or slighlty negative correlation would be best to offer diversification - avoiding the risk if one type of asset drops, the other don’t drop too.
Advantages of investing in property through a SIPP?
- Contributions to the SIPP benefit from tax relief, which will help with the property
purchase. - The SIPP fund can be used to buy the property.
- The SIPP can borrow up to 50 per cent overall of its net fund value to assist in the
property purchase, ie assets minus any outstanding loans. - Property investment provides a regular tax‑free income to the SIPP from rent. When
the plan holder decides to take benefits the rent could be used to fund the income
from the SIPP via drawdown, leaving the property in the fund. - There is the potential for steady tax‑free total returns. Although commercial property
does not tend to grow at the same rate as equities, rental income is generally steady
and adds to the total return. - Any gain made on selling the property will be exempt from CGT.
- On the death of the SIPP holder, the property would not be subject to IHT.
Disadvantages of investing in property through a SIPP?
- The purchase of property may use up most or all of the SIPP funds and borrowing
capacity, leaving the SIPP with an undiversified portfolio. - If the property is the SIPP owner’s own business premises, a full market rent will still
have to be paid, and the SIPP provider has a responsibility to pursue the tenant for
unpaid rent, even if the tenant is the SIPP owner. - If the property forms the bulk of the SIPP fund it may have to be sold to provide
retirement benefits. This could be at a bad time in the market, which could result in
the property selling for less than its true value. - Property is illiquid – if it needs to be sold to provide benefits, it could be some time
before the funds are available. - If business partners have combined their SIPPs to buy the premises, what will happen
if one partner wants to take benefits? Is there enough liquid capital or loan capacity
in the other SIPP funds to allow a buyout? - Property transactions are expensive, with loan fees, surveys/valuations, stamp duty
land tax (in England and Northern Ireland), agent/broker fees, etc. - Loan interest paid by the SIPP is not a deductible expense because the SIPP is exempt
from tax. - If the property is untenanted for a period, loan payments will still need to be paid
from the SIPP, reducing the total return
Reviews - retirement planning with clients - What should be considered?
Pension arrangements should be reviewed on a regular basis to be agreed with the client.
The following aspects should form part of such a review
- revisiting retirement objectives
- assessing the pension plan performance to date and whether changes are needed to
the investments or funding level - noting changes in the client’s circumstances;
- if the client is within ten years of taking benefits, considering a consolidation plan,
whereby the funds are gradually moved to more cautious funds over time - revisiting the asset allocation.
Calculating the charge on withdrawals above the LTA - How much is the charge on funds take as income? As taken as a lump sum?
The lifetime allowance is no longer in affect as of April 2024. However, it may still be used to calculate the maximum amount of tax-free cash an individual can withdraw from their pension.
Taking the LTA of £1,073,000, any amount over this will be charged at a rate of:
* 25% for funds taken as income
* 55% as a lump sum
What is the minimum an individual’s annual allowance can be reduced to? (2024) and why might this happen?
- £10,000
- The annual allowance is tapered for earnings + pension contributions above £240,000
- This minimum amount may occur where an individual’s earnings combined with their contributions for the year (and assuming they have no AA to carry over from the past three years) exceed this threshold significantly
Do employers have to contribute towards a stakeholder pension?
- No
- One of the main reasons pension contributions were not increased as much as the government had hoped
Steps to calculating the annual pension benefit for a DB scheme
- Times the years of service by the accural rate
- Times this number by the final salary or career average.
- If a PCLS is being taken, times the lump sum by the commutation ratio and take this away from 2.
What is a Targeted Money Purchase Scheme/ Collective Defined contribution scheme?
- A pension scheme that combines aspects of both DB and DC arrangements.
- Provides benefits similar to a DB scheme, though not guaranteed.
- Less risky and easier to predict than DB schemes for employers
- Less longevitiy and investment risk for employees
Which pension rights cannot be included in a pension sharing order?
- The basic state pension
- Pensions already in receipt
- Certain Overseas, War, or disability pensions
- Small pensions under the rules of triviality
Explain: Purchased Life Annuities
These are bought with a lump sum and provide a guaranteed income for life or for a fixed period.
Explain: Pension Annuities
These are typically bought with the funds from a defined contribution pension pot at retirement and are designed to provide a regular income for life
most common form of annuity
Explain: Enhanced Annuities
These offer higher payments to individuals with shorter life expectancies due to health conditions or lifestyle factors.
Two types of annuity
- Compulsory purchase annuity (purchased through proceeds from DC scheme)
- Life annuity
Two types of annuity
- Compulsory purchase annuity (purchased through proceeds from DC scheme)
- Life annuity
What is the DB accural rate for public sector schemes on a final salary basis?
- 1/80
- bonus of 3/80
What is the DB accural rate for private sector schemes on a final salary basis?
- 1/60
What are ‘notionally-funded’ schemes?
Typically public sector pension schemes.
There is not a ‘fund’ whereby employers and employees contribute which is then invested.
Instead the benefit is provided by HM treasury
How much does your LTA reduce by should you retire before minimum retirement age?
2.5% each year before
When is a 1/60 and 1/80 accural used?
Defined benefit schemes
- final salary is usually 1/80
- career average is usually 1/60
How is an individual’s defined benefit entitlement assessed against the LTA?
- Their annual entitlement x 20
- Add any lump sum entitlement
