topic 10 - pension products

Question 1

Defined-benefit schemes

Answer 1

• can only be offered by employers
• the benefits the individual will receive are specified from the outset
• also referred to as a final salary scheme

Question 2

Defined-contribution schemes

Answer 2

• can be offered by employers or set up as individual pension arrangements
• an agreed level of contributions is paid but the benefits received depend on the performance of the investments
• also known as a money purchase scheme

Question 3

Pension fund taxation

Answer 3

• Exempt from CGT, no tax on income
• Tax relief on contributions:
• Individual under 75 – no minimum age
• UK resident or UK earnings
• No need to be a taxpayer
• Tax relief at highest marginal rate on contributions (20% at source)
• Employer can contribute

Question 4

Money purchase annual allowance (MPAA)

Answer 4

where a pension scheme member draws benefits from their pension using flexi-access drawdown income or takes an uncrystallised funds pension lump sum (UFPLS)

Question 5

lump sum allowance (LSA)

Answer 5

• is set at £268,275 and is the maximum someone can take as a tax-free lump sum
• unless they have a protected higher amount

Question 6

lump sum and death benefit allowance (LSDBA)

Answer 6

• is set at £1,073,100 and is the maximum that can be taken tax-free from a pension fund during lifetime and on death
• unless they have a protected higher amount

Question 7

When and how can benefits be taken?

Answer 7

• Generally, can be taken from normal minimum pension age, currently 55.
• Can usually only take 25% of the fund tax-free as a pension commencement lump sum (PCLS)
• Rules for taking the remainder depend on type of scheme:
  o Defined-benefit scheme
   balance over any tax-free PCLS must be used to provide an income
   typically, as a scheme pension direct from pension fund
  o Defined-contribution scheme
   Bance once any tax-free PCLS has been taken can be used to provide income in the form of an annuity or flexible access drawdown (FAD)
   Other option is to take a UFPLS. Providers not obliged to provide this

Question 8

Collective defined-contribution pension schemes

Answer 8

• Both the employer and employee pay into a joint fund, with pensions paid out from this shared pot
• Offers predictable costs for the employer and is more resilient against economic shocks

Question 9

Topping up defined-benefit schemes

Answer 9

• The following are tax-efficient pension arrangements:
  o Additional voluntary contributions (AVCs)
  o Free-standing additional voluntary contributions (FSAVCs)
  o Personal/stakeholder pension plans

Question 10

Additional voluntary contributions (AVCs)

Answer 10

• Additional contributions to an occupational scheme
• Employee will only have a limited choice of funds
• Contributions are deducted from gross salary and therefore receives full tax relief
• Either buy additional years in a final salary scheme, or a defined-contribution basis
• Employer funds some or all of the running costs

Question 11

Free-standing additional voluntary contributions (FSAVCs)

Answer 11

• Alternative to an AVC
• Provided by a separate pension provider
• Available from a range of financial institutions, including insurance companies, banks and building societies
• Contributions made from taxed income. Tax relief at basic rate of 20% is claimed by pension provider and added to pension fund
• Drawback – more expensive than AVCs because employers not bearing the costs of admin and fund management

Question 12

Workplace pensions

Answer 12

• Under auto-enrolment, employers must enrol eligible workers in a qualifying workplace pension
• An employee can opt out of a scheme but only after they have automatically been made a member
• Minimum of 8% of an employee’s earning have to be paid in. made up of 3% employer contribution, 4% employee contribution and 1% tax relief
• No upper contribution limit
• Eligible worker – working in the UK, aged between 22 and state pension age, not in an existing work pension scheme, earning over £10,000

Question 13

Personal Pensions

Answer 13

• all forms of non-occupational pensions are arranged on a defined-contribution basis
• individual arrangements provided by financial services companies (eg life assurance companies, bands and building societies)

Question 14

a self-invested personal pension (SIPP)

Answer 14

• gives access to a wide range of investment options not available through a conventional personal pension
• example – possible to hold a direct shareholding or commercial property within a SIPP

Question 15

Defined-benefit schemes

Answer 15

• A pension fund operated by or on behalf of the employer into which contributions are paid
• Investment decisions taken at scheme level
• Usually invested in a mixture of equities, gilts, corporate bonds and cash
• Individual member unable to make decisions on investment but have reassurance of the promise of a certain level of pension benefits

Question 16

defined-contribution pension

Answer 16

• uncrystallised – pension fund remains invested
• crystallised – once benefits are taken, in full or in part
• from a personal/stakeholder pension
  o uncrystallised funds pension lump sum
  o up to 25% tax-free PCLS
  o flexi-access drawdown
  o annuity

Question 17

Annuity purchase

Answer 17

• Payment of a lump sum from the pension fund in exchange for an income
• An annuity provider promises a guaranteed rate of income – an annuity rate
• Not necessary to buy annuity from the company used during the accumulation phase – open market option
• Once purchased investment risk is removed but also no longer further investment growth

Question 18

Flexi-access drawdown

Answer 18

• Involves drawing the pension fund, after any PCLS has been taken and then investing it into a fund to provide income (drawdown account)
• Can take 25% of the value as a tax-free PCLS
• Fund remains invested so potential for further growth, also risk value may fall
• Withdrawals can be structured however the member wishes
• One any benefits in excess of tax-free PCLS are drawn, the MPAA is triggered

Question 19

The money purchase annual allowance (MPAA)

Answer 19

• To limit the extent to which people can take advantage of tax relief.
• A lower annual allowance applied once an individual has started to access their funds via FAD income or UFPLS
• Instead of being able to receive tax relief on pension contributions up to the full annual allowance, they have an MPAA.
• Only applies to defined-contribution schemes

Question 20

Uncrystallised funds pension lump sum

Answer 20

• Pension fund remains invested
• None of the fund is drawn or reinvested and no PCLS is drawn.
• Able to draw a series of lump sum payments to meet their income/capital needs
• MPAA is triggered

Question 21

Death benefits of Defined-benefit schemes

Answer 21

• If a member dies before retirement
  o a lump sum death benefit is usually available.
  o Can be a multiple of earnings or a fixed sum
• On death after retirement
  o May continue to pay the pension income for a period of time or
  o Pay a spouse’s/dependant’s pension as a proportion of the pension that was being paid to the member

Question 22

Death benefits of Defined-contribution schemes

Answer 22

• On death before crystallisation
  o Pension fund can be used to provide income and/or lump sum benefits
• On death after retirement
  o Continuing scheme pension
  o Lifetime annuity continuing for an agreed period post-death
  o Lifetime annuity paying an annuity protection lump sum
  o Continuing drawdown income for inheritors

Question 23

What rate of tax relief is applied to contributions to an individual’s pension plan?

Answer 23

Basic, higher or additional rate depending upon the contributor’s marginal rate of tax