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
