5 - DC Schemes

Question 1

DC Schemes

Personal Pension

Answer 1

This is an individual scheme, which can hold contributions from the member, employer or others, along with the tax relief.

At retirement the fund can be used to buy an annuity or for flexible drawdown.

Up to 25% can be taken as a lump sum after age 55 and benefits may be taken before age 55 in the case of ill health.

Question 2

DC Schemes

Stakeholder Pensions

Answer 2

A type of personal pension with restrictions on certain aspects (eg charges capped at 1.5% first 10 years, 1% afterwards).

They have a simplified selling process to allow a simplified “decision tree” sales process.

They must accept any contribution above a £20 one off payment, so anybody will have a DC choice available regardless of level of wealth.

FCA regulate the sale of these schemes and the scheme must be registered with TPR.

The lifestyle approach will be offered, which shifts risk approach over time as you get closer to retirement.

Question 3

DC Schemes

Group personal pensions and Group stakeholder pensions

Answer 3

This is when a series of individual personal pensions (or stakeholder pensions) get grouped together. Looks a bit like an employer scheme but actually it’s just a collection of individual schemes.

Question 4

DC Schemes

Self Invested Personal Pension (SIPP)

Answer 4

This is a type of personal pension with a wider selection of investment possibilities (eg commercial property). The member controls the investments themselves.

These schemes are allowed to borrow money in order to invest (up to 50% of the value of the fund), but they may NOT lend money to employers.

NOTE: Can borrow 50% of the net fund. If you’ve got £250k of assets and £50k of borrowing that means you’ve only got £200k net assets, so can only borrow another £50k.

Question 5

DC Schemes

Retirement Annuity Contracts

Answer 5

Also known as s226 contracts, they’re the old version of personal pensions, but many still exist.

Be aware that they may have an attractive guaranteed annuity rate (GAR) built in that is above current market levels.

On the other hand they often have poor death benefits.

Best advice may be to replicate death benefits with an assurance contract so they can keep the GAR, rather than transferring to a personal pension.

Question 6

DC Schemes

Occupational Money Purchase Scheme

Answer 6

This is just an employers pension scheme but on a money purchase basis rather than DB basis.

Question 7

DC Schemes

Executive Pension Plan

Answer 7

Essentially a one person occupational pension plan.

This is a legacy arrangement from before personal pensions were available.

It was used to provide additional pension benefits to top employees outside the main occupational pension scheme.

Question 8

DC Schemes

Small Self-Administered Pension Scheme (SSAS)

Answer 8

Small occupational scheme used by small (family) businesses, typically for fewer than 12 people.

Can invest in commercial property, borrow money and can also lend money to the employer.

Every member must be a trustee.

Funds aren’t earmarked for individual members so benefits can be adjusted between the members.

Question 9

SSAS

What are the restrictions in investing in shares in the sponsoring employer?

Answer 9

• Under 5% can be invested in any single sponsoring employer;
• Under 20% in total in sponsoring employers where there is more than one (5% in each individual employer still applies).

Question 10

SSAS

What are the restrictions in lending money to the sponsoring employer?

Answer 10

• Up to 50% of scheme net assets (always deduct borrowings from the value of benefits in the scheme);
• Be secured as a first charge against assets of equal value;
• Minimum interest rate of 1% over average base rate of the 6 main clearing banks (rounded up to nearest 0.25%);
• Not longer than 5 years, but can be rolled over once;
• Repaid by equal installments of interest and capital.

Question 11

DC Schemes

Section 32 scheme

Answer 11

A legacy arrangement pre A-day that allowed you to transfer out of an occupational pension scheme to a money purchase arrangement where you can control the funds (pick funds etc.).

Unlike personal pensions they could retain maximum benefit limits (eg over 25% lump sum), which would be lost had they transferred to a personal pension.

Question 12

DC Schemes

Targetted Money Purchase Schemes

Answer 12

This is a hybrid DB/DC scheme.

It aims to provide DB like benefits, with contributions set so as to achieve this target.

But crucially there is no guarantee to the benefits (otherwise it would be a DB scheme).

The risk therefore is shared between the employer and the employee.

Question 13

What is an in-specie contribution and what is the process?

Answer 13

An in-specie transfer is a contribution to a pension scheme in the form of assets (eg shares) rather than cash. The assets could continue to be held within a SIPP, or could be sold and re-invested in any DC scheme.

• The contribution must be specified in advance as a cash amount.
• A seperate agreement is made to settle the contribution with assets.
• If the value of the assets falls before the transfer then the member has to pay additional cash to make up their specified contribution.
• If the value of the assets rises it can be treated as an extra contribution, or the excess can be paid back to the member in cash.

Note that employers can also make in-specie contributions.

Question 14

What is the legal basis of an occupational DC scheme?

Answer 14

Occupational DC schemes can be set up on a trust basis like DB schemes, or contract basis where a third party takes over the administration.

The contract basis is typical to the group personal pension schemes. They look a lot like occupational schemes and are funded by employer (and employee) contributions, but aren’t actually run by the employer.

Alternatively a master trust basis may be used, which is where the same trust scheme is used by several employers. This can save costs and admin burden, but the employer loses some control since they don’t control any trustees. TPR has guidelines for these schemes to ensure governance is ok.

Question 15

How does the legal basis of the DC scheme affect tax relief methods?

Answer 15

Trust basis schemes are more likely to use the net pay basis of tax relieving contributions (with tax relief given via payroll).

Contract basis schemes can only use relief at source basis.

Question 16

Which regulators govern occupational DC schemes?

Answer 16

Trust based schemes are governed by TPR, contract based by the FCA.

This makes sense because a contract based pension scheme is essentially just a special tax wrapper for investments, more similar to an ISA than a DB pension scheme.

Trust based schemes have the risk that trustees fail the members (same as a DB scheme) so TPR needs to have a similar level of scrutiny on them.

Question 17

What does TPR focus on in regulation of trust based occupational DC schemes?

Answer 17

Competence of the trustees is key and TPR produces a range of standards they should adhere to. This includes a level of knowledge they are expeced to have.

They also have rules around the charges which can be charged for the default fund of an auto-enrollment scheme.

This is 0.75% charge over any “charge year” if the charge is on a simple percentage basis, or other controls (not examinable) if it’s an initial fee + ongoing basis.

Deferred member can’t be charged more than active members.

Question 18

What additional government requirements have been introduced for contact based workplace schemes and group SIPPs?

Answer 18

The government has introduced a rule that they must have an Independent Governance Committee (IGC), which performs a similar role to the board of trustees.

The committee must have at least 5 members with the majority being independant.

Question 19

What is the legal basis of a SIPP?

Answer 19

Master trust

Question 20

What happens to your occupational DC scheme pension if you leave your employer?

Answer 20

• If you joined the scheme before 1 Oct 2015 and have less than 2 years service you can get a short service refund (refund of YOUR contributions only, less 20% tax on the first £20k and 50% after that).
• This is replaced by short service benefit after 1 Oct 2015.
• Otherwise you can maintain the benefit in the same scheme; or
• If you have over 3 months service (in the pension, not employment) you can transfer to a new scheme (subject to potential charges the old scheme might levy, finding a new DC scheme that will accept your transfer and offer you attractive investment options).

Question 21

What death in service benefits can be attached to a DC scheme?

Answer 21

• Death in service benefit from uncrystallised funds - this is just paying out the value of the funds on death;
• Death in service from life cover - usually expressed as a multiple of salary and running alongside the pension scheme.

It used to be possible for an employee to take out life insurance in this way (to run alongside their occupational pension) and so receive tax relief on premiums. This is no longer possible.

Question 22

Ill Health

What options are available in the case of ill health during service?

Answer 22

• It’s possible to take benefits early in the case of ill-health, although this is dependent on the scheme rules.
• If life expectancy reduces below 12 months seious ill health early retirement can take place, with the total value of all uncrystallised funds available as a tax-free lump sum.

Question 23

What protection is available for when the member is in ill-health but not eligible for full ill-health early retirement?

Answer 23

For schemes originating before 6 Apr 2001 there is a waiver of premium option, where no further premiums are required from the member but benefits continue as if they were paid. The scheme provider (employer) effectively makes up the difference from the employee stopping contributions.

For later schemes this isn’t possible, instead a pension contribution insurance contract can be taken out. This will cover the members contributions if they are ill. It’s limited to £3,600 contributions to ensure they are tax deductible. Premiums aren’t tax deductible but the contributions will be.

Question 24

What is a Statutory Money Purchase Illustration?

Answer 24

This is a projection of a DC scheme members likely benefits on retirement, which must be produced by DC schemes annually to help members understand their level of benefits. This is much more complicated for members than DB schemes where future benefits are clearly stated.

Question 25

What are the standard assumptions made in the Statutory Money Purchase Illustration?

Answer 25

• Growth rate - Providers own reasonable rate (BEFORE DEDUCTING EXPENSES AND FEES!);
• Inflation - 2.5%;
• Earnings growth (where contributions are linked to earnings) - 2.5%;
• Annuity interest rate - set annually in Feb, based on a level annuity;
• PCLS could be assumed to be taken or not;
• Fees at maturity - 4%.

Question 26

Which types of DC pension scheme are exempt from producing an SMPI?

Answer 26

SSAS and retirement annuities

Question 27

What is the transfer process for DC schemes?

Answer 27

This is much simpler than DB schemes since you’re just moving a bunch of assets rather than converting a guaranteed income stream into something else.

Regarded by the FCA as a “pension switch” rather than a pension transfer therefore, and doesn’t require a pension transfer specialist.

Simply need to complete a ceding form for the old provider and an application form for the receiving scheme.

Question 28

Considerations around DC transfers

Answer 28

• Level of charges in the old and new schemes;
• Any potential enchashment penalties from the old scheme;
• Investment strategies of the two schemes (is the investment profile of the new scheme appropriate for the clients risk attitude);
• Potential benefits you might lose from the old scheme (waiver of premium, life cover etc.).

Question 29

What has the FCA done to protect clients for DC transfers?

Answer 29

FCA has published a template of considerations an adviser should make for a DC transfer.

• Questions about the firm, the client and the pension;
• Questions about customer needs (hard and soft facts);
• Coverage of ‘negative outcomes’, which highlights possible things that could go wrong and whether the advised choices might lead to this;
• Hard facts about the ceding and receiving scheme.

Question 30

What contributions must be made to an occupational scheme?

Answer 30

The employer MUST contribute something to an occupational scheme.

However there are no minimum levels, other than their obligations under the auto-enrollment rules.

The only real limits governing contribution levels therefore are the annual limits which restirct the total amount of employee and employer contribution.

Question 31

Which types of scheme must have independent governance committees?

Answer 31

Contract based workplace schemes

Group SIPPs

Question 32

In-specie contributions

Is the asset value the gross or net contribution to the fund?

Answer 32

If the fund uses relief at source method, the value of the asset will be the net amount of the contribution. The scheme then claims the 20% tax relief from HMRC just as it would for a cash contribution.