Topic 10 Flashcards
Defined-benefit pension scheme
An occupational pension scheme where the final benefits are defined, usually as a fraction of final (or near final) salary or career average earnings for every year of membership in the scheme. Eg, a 1/60th scheme would provide a benefit of 1/60th final salary for every year of membership. The employer is responsible for ensuring the promised benefits are provided, so carries all the risk.
Defined-contribution pension scheme
A pension scheme where the individual has their own pension pot, either as part of an occupational scheme or a personal pension. Contributions from the individual and perhaps their employer are invested, and at retirement the individual’s pot is used to provide the benefits. The final benefits are not guaranteed, and so the risk lies with the individual.
Pensions annual allowance
The annual limit for pension contributions for claiming income tax relief. Individuals can contribute the lower of their earned income or the annual allowance and relief income tax relief. An employer can also contribute, but if the total from both sources exceeds the annual allowance the individual will be subject to a tax charge on the surplus.
Tapered annual allowance
If an individual has ‘adjusted’ income above a certain figure, their annual allowance is tapered (reduced) by £1 for every £2 above the stated figure. The adjusted annual allowance cannot fall below a stated figure.
Money purchase annual allowance (MPPA)
If an individual draws benefits from their defined contribution (personal pension, etc) pension using flexi‑access drawdown or takes an uncrystallised funds pension lump sum (UFPLS), they can continue to fund their pension, but their Annual Allowance is reduced significantly.
Flexi-access drawdown
When taking personal pension benefits, the plan holder can take the tax-free pension commencement lump sum and leave the rest of the fund invested. Technically the remaining fund becomes a drawdown account. They then withdraw income from the fund (drawdown) as and when they want, with each payment being taxable as income. There is no requirement to take income at all or to take a regular amount – the income element is totally flexible.
Uncrystallised funds pension lump sum (UFPLS)
When wishing to take pension benefits, the individual does not move the account into drawdown by taking the tax-free pension commencement lump sum. Instead they take a series of lump sums as and when they want, with 25% of each withdrawal being tax free and the balance being taxed as income.
What tax reliefs and allowances are available?
Any individual who is a UK resident (or is non‑resident but has UK earnings) and
is under the age of 75 can receive income tax relief at their highest marginal
rate on annual contributions to occupational and private pension schemes, up
to a maximum threshold
ANNUAL ALLOWANCE REDUCTION
Omar has adjusted income of £300,000. Let’s assume the current
rate of tapering for higher earners means that for every £2 of
adjusted income over a threshold of £260,000 the annual allowance
is reduced by £1. Say the annual allowance before the taper is
applied is £40,000.
Omar’s annual allowance is £40,000 – (£300,000 – £260,000 ÷ 2) =
£20,000
AA
n individual can carry forward any unused annual allowance from the
previous three tax years to the current tax year
Taxes
Within a pension fund there is no capital gains tax on gains and no income tax
on savings or dividend income.
When and how can benefits be taken?
Benefits can generally be taken from normal minimum pension age, which is
currently age 55 (expected to rise to 57 in 2028). When benefits are drawn the
scheme member can usually take up to 25 per cent of the fund as a tax‑free
cash sum, referred to as a pension commencement lump sum (PCLS)
Defined‑benefit scheme
Defined‑benefit scheme – the balance over and above any tax‑free cash
must be used to provide an income, typically as a scheme pension direct
from the pension fund
Defined‑contribution scheme
Defined‑contribution scheme – the balance once tax‑free cash has been
taken can be used to provide income in the form of an annuity or flexible
access drawdown (FAD).
DEFINED‑BENEFIT SCHEME
A scheme in which the pension benefits the individual will receive are
specified from the outset. Also referred to as a final salary scheme
DEFINED‑CONTRIBUTION SCHEME
A scheme in which an agreed level of contributions is paid but the benefits
that the individual ultimately receives depend on the performance of the
investments into which the contributions are paid. Also referred to as a
money‑purchase scheme
Collective defined-contribution pension schemes
There is a demand for a third type of scheme, which can provide more
predictability for scheme members than defined contribution, without the
cost volatility for employers associated with defined benefit. The Pension
Schemes Act 2021 provides a framework for the UK’s operation and regulation
of collective money‑purchase schemes (commonly known as collective
defined‑contribution pensions). The new collective defined‑contribution
(CDC) pension will see both the employer and employee pay into a joint fund,
with pensions paid out from this shared pot.
he benefits of the new scheme
include that it offers predictable costs for the employer and is more resilient
against economic shocks. The Royal Mail and Communication Workers Union
will be the UK’s first CDC scheme and a case study will be done on how UK
workers receive the new scheme and how successful these schemes can be in
practice
Additional voluntary contributions
AVCs are additional contributions to an occupational scheme. Sometimes,
such contributions purchase additional years’ service in a final salary scheme.
However, most AVCs operate as money‑purchase arrangements and the employee
will only have a limited choice of funds.
The employer will usually cover some or all of the administration and fund
management costs. Contributions to AVCs are deducted from gross salary and
the employee therefore receives full tax relief at the same time
Free‑standing additional voluntary contributions
As an alternative to an AVC, an individual might choose to contribute to
an FSAVCs money‑purchase fund provided by a separate pension provider.
FSAVCs are available from a range of financial institutions, including insurance
companies, banks and building societies.
Contributions to FSAVCs are made from taxed income. Tax relief at the basic
rate of 20 per cent is claimed by the pension provider and added to the
individual’s pension fund. Higher‑ and additional‑rate taxpayers need to claim
additional relief separately through their income tax self‑assessmentTheir drawback
is that they tend to be more expensive than AVCs because the employer is not
bearing the costs. Once personal/stakeholder pensions became available to all
employees in April 2006, FSAVCs became much less popular
Workplace pensions
The criteria for auto‑enrolment are that the employee:
is not already in a pension at work;
is aged 22 or over;
is under state pension ageearns more than £10,000;
works in the UKAn employee can choose to opt out of the scheme, but only after they have
automatically been made a member.
Since April 2019 a minimum of 8 per cent of an employee’s earnings have to
be paid into the scheme, made up of an employer contribution of 3 per cent,
an employee contribution of 4 per cent and tax relief of 1 per cent.
at has been employed by Telephonics plc for just over 35 years
and has been a member of the company’s 1/60th pension scheme
for the whole of that period. His salary is now £81,000 and he is
due to retire next month. What will his pension entitlement be?
a) £54,000.
b) £28,350.
c) £47,250.
d) £81,000
The correct answer is c) £47,250. Answer a) is not correct because £54,000
represents 40/60ths of his final salary, which is what Pat could have
earned under the scheme had he worked for Telephonics for 40 years, not
35. Answer b) is not correct because £28,350 represents 35 per cent of his
final salary, not 35/60ths. Answer d) is not correct because, although he
can pay in to his pension a maximum of 100 per cent of his UK earnings,
his pensionable service does not justify that level of pension.
What is a personal pension?
All forms of non‑occupational pensions are arranged on a defined‑contribution
basis. Personal pensions are individual arrangements provided by financial
services companies such as life assurance companies, banks and building
societies. Contributions receive basic‑rate tax relief at source, even for
non‑taxpayers. A higher‑ or additional‑rate taxpayer needs to claim additional
relief separately through self‑assessment
What is a self‑invested personal pension (SIPP)?
A SIPP is a personal pension arrangement that gives access to a wider range of
investment options than would be available through a conventional personal
pension. For example, it may be possible to hold a direct shareholding or
commercial property within a SIPP. While access to a wide range of investments
is permitted, a SIPP will also allow a scheme member to use the provider’s
range of conventional pension funds.
A SIPP may appeal to someone who has the confidence to make their own
investment decisions
number of ways in which benefits can be taken
There are a number of ways in which benefits can be taken from a
defined‑contribution pension such as a personal/stakeholder pension. While
a defined‑contribution pension fund remains invested, it is referred to as
‘uncrystallised’; once benefits are taken, in full or in part, the portion of the
fund providing retirement benefits is referred to as ‘crystallised’.
Annuity purchase
Annuity purchase involves the payment of a lump sum from the pension fund
in exchange for an income.
The benefit of an annuity is certainty: the annuity provider promises a
guaranteed rate of income – an annuity rate – based on the annuitant’s
circumstances. It is not necessary to buy the annuity from the company used
during the accumulation phase: pension providers must inform their clients
that they can ‘shop around’ for the most appropriate benefits structures and/
or higher annuity rates. This is known as the open‑market option.
Once an annuity has been purchased, investment risk is removed but there is
no longer any prospect of further investment growth
Flexi‑access drawdown
Flexi‑access drawdown (FAD) involves drawing the pension fund, after any
pension commencement lump sum has been taken, and reinvesting it into a
fund to provide income. The fund remains invested so there is potential forurther growth but there is also the risk that the fund value might fall and,
consequently, income levels may not be maintained.
The withdrawals can be structured however the member wishes: as smaller,
regular payments to provide an income, or as larger, perhaps one‑off payments.
As any payment beyond the pension commencement lump sum is taxable,
care must be taken not to trigger a large tax charge
Uncrystallised funds pension lump sum
Opting for a UFPLS means the pension fund remains invested. Unlike FAD,
none of the fund is drawn or reinvested and no PCLS is drawn. The member is
able to use their pension fund to draw a series of lump sum payments from
the fund to meet their income/capital needs
UFPLS
The pension fund is not moved into a drawdown account.
No PCLS is drawn.
The member simply draws lump sums from their pension
as they require, with the balance remaining in the pension
fund.
25 per cent of each payment is tax‑free with the balance
subject to income tax.
When a UFPLS is taken, the MPAA is triggered.
Defined-benefit schemes
If a member dies before retirement age, referred to as death in service, a lump
sum death benefit is usually available. This can be a multiple of earnings
or a fixed sum. Additionally, there might be a spouse’s and/or dependant’s
pension, paid from the scheme to the spouse, civil partner or dependants of
the deceased. This can be a proportion of the member’s pension rights.
On death after retirement, a defined‑benefit scheme may:
continue to pay the pension income for a period of time, a ‘guaranteed
period’; or
pay a spouse’s/dependant’s pension as a proportion of the pension that
was being paid to the member
Defined-contribution schemes
On death before crystallisation, the pension fund can be used to provide
income and/or lump sum benefits.
On death after retirement, there are a range of ways in which a
defined‑contribution scheme will be able to provide benefits to the spouse/
civil partner or dependants of the deceased:
continuing scheme pension;
lifetime annuity continuing for an agreed period post‑death;
lifetime annuity paying an annuity protection lump sum – this would be the
balance of the funds used to buy the annuity as compared with how much
had already been paid out as income at date of death; or
continuing drawdown income
Marta is 37 and pays 3 per cent of her salary into a pension
scheme each month. The benefit that she will receive at
retirement depends solely on the investment performance of
the fund. Marta’s pension scheme is:
a) a defined‑benefit personal pension.
b) a final‑salary occupational pension.
c) a defined‑benefit occupational pension.
d) a defined‑contribution occupational or personal pension
d) Marta’s scheme is a defined‑contribution scheme, which could be
either an occupational or a personal pension
Explain what is meant by the term ‘lifetime allowance’.
The lifetime allowance is the total amount that an individual may hold in
retirement benefits at the point where the benefits are crystallised without
incurring a tax charge
What rate of tax relief is applied to contributions to an
individual’s pension plan?
a) Basic, higher or additional rate depending upon the
contributor’s marginal rate of tax.
b) Always basic rate.
c) Always higher rate.
d) Basic, higher or additional rate depending upon the pension
provider’s own rules
a) Basic, higher or additional rate depending upon the contributor’s
marginal rate of tax
Contributions to AVCs are deducted from gross income. True
or false?
True.
Which of the following statements is correct?
An individual may be auto‑enrolled in a workplace pension
scheme providing they:
a) were born in and are currently working in the UK.
b) are aged between 18 and 55.
c) earn in excess of £10,000 a year.
d) are not liable to higher‑rate tax.
c) Individuals must earn in excess of £10,000 per year to be auto‑enrolled
into a workplace pension scheme
Since April 2015 personal pension providers have been obliged
to allow scheme members to access their retirement benefits in the form of an uncrystallised funds lump sum if the member
wishes to do so. True or false?
False. Pension providers are not obliged to offer this facility, although
scheme members are free to move to a different provider if they wish to
access their funds in this way
Which of the following in relation to stakeholder pensions
is correct?
a) Charges must not exceed 2 per cent of the fund.
b) There must not be any entry or exit charges.
c) The minimum monthly contribution is £50.
d) The maximum contribution is £3,600 per annum in all cases
b) There must not be any entry or exit charges.
John is using an uncrystallised funds lump sum to provide his
pension benefits. The amount of each payment he takes that
is free of tax is:
a) 50 per cent.
b) 100 per cent.
c) 25 per cent.
d) Nil
c) 25 per cent of each UFPLS payment is tax‑free
What previous form of income drawdown was converted to
flexi‑access drawdown from 6 April 2015?
Flexible drawdown arrangements were all converted to FAD on 6 April
2015.
Nicky is 60 years old and has a low appetite for risk. She is
considering options for taking benefits from her pension fund
and would like to be able to receive a guaranteed income, with her
pension fund no longer exposed to any investment risk. Which
method of providing retirement benefits should Nicky take?
An annuity provides a guaranteed income and there is no investment risk,
so this would be a suitable option for Nicky
Alisha is just in the higher-rate tax band. She has a personal pension plan valued at £40,000 and wants to take all of it as one lump sum on her sixtieth birthday next month. How much of the withdrawal will be tax free?
Question 1 options:
a)
It will all be taxable.
b)
£30,000.
c)
£20,000.
d)
£10,000.
D
25% of the pension can be taken as a tax-free lump sum (£40,000 x 25% = £10,000).
Which statement best describes the uncrystallised funds pension lump sum option on a personal pension?
Question 2 options:
a)
The whole fund must be taken, with 25% as a tax-free lump sum.
b)
Each withdrawal will be tax free.
c)
Each withdrawal is taxed as income in the owner’s hands.
d)
25% of each withdrawal is tax free, with the balance taxed as income.
D
Which of the following is true regarding the NEST scheme?
Question 3 options:
a)
Benefits can be taken from age 55.
b)
Contributions can only be made into the default fund.
c)
The minimum contribution per employee is 10% of earnings.
d)
It cannot run alongside an existing occupational scheme.
A
In order to qualify for auto-enrolment, an employee must:
Question 4 options:
a)
be under age 60.
b)
earn more than £5,000.
c)
opt-in to the scheme.
d)
be aged at least 22.
D
Ali has been a member of his company’s 1/50th defined-benefit pension for 20 years and is about to retire. His pensionable salary is £30,000. What will Ali’s pension be?
Question 5 options:
a)
£10,000.
b)
£12,000.
c)
£15,000.
d)
£30,000
B
Which method of providing a personal pension income is free from investment risk?
Question 6 options:
a)
Flexi-access drawdown.
b)
Purchasing an annuity.
c)
Taking regular withdrawals using the uncrystallised funds pension lump sum option.
d)
Taking the 25% pension commencement lump sum and leaving the balance in the fund.
B
Which type of pension scheme is most likely to allow an individual to hold a direct investment in commercial property?
Question 7 options:
a)
A stakeholder pension.
b)
A personal pension.
c)
A self-invested personal pension.
d)
A defined-contribution occupational pension.
C
Caroline is 38 and earns £25,000 a year as a department manager for a large firm. What is the maximum contribution that could be paid into her personal pension to give her maximum tax relief and avoid any tax penalties?
Question 8 options:
a)
£25,000 from Caroline only.
b)
Up to £25,000 between Caroline and her employer.
c)
£25,000 from Caroline and £15,000 from her employer.
d)
£40,000 from Caroline only
C
Caroline can pay in an amount up to her salary, and her employer can top it up to the annual allowance amount.
The ‘direct pay’ arrangement is where a personal scheme member pays the contributions directly to the pension provider.
Question 9 options:
a) True
b) False
Falce
It is where the employer collects the employee’s contribution from their pay and passes it on to the pension provider.
When does the Money Purchase Annual Allowance apply to pension contributions? If the plan holder:
Question 10 options:
a)
takes benefits before the scheme retirement date.
b)
takes benefits through the uncrystallised funds pension lump sum option.
c)
earns more than the income threshold.
d)
uses the fund to purchase an annuity.
B
