Chapter 5 - Defined benefit schemes

Question 1

When does current legislation permit a member of a defined benefit pension scheme to take their benefits from the scheme?

a.From age 50 but the member must retire.

b.From age 55 without retiring.

c.From age 55 but the member must retire.

d.From age 50 without retiring.

Answer 1

b.From age 55 without retiring.

It is possible to take benefits from the normal minimum pension age, currently 55

• benefits are accrued in the usual way up to the date of early retirement, e.g. 1/60th × final
  pensionable remuneration for each year of service up to the date of early retirement; and
• this is reduced by an early retirement factor, e.g. the pension is reduced by ½% in respect
  of every month between the date of early retirement and the date of normal retirement

Chapter reference 5C2

Question 2

A higher rate taxpayer was a member of her employer’s defined benefit scheme for 18 months before leaving having made personal contributions of £28,000. What net payment will she receive if she takes a refund of contributions?

a.£20,800.

b.£16,800.

c.£22,400.

d.£20,000.

Answer 2

d.£20,000.

The first £20,000 of the refund is taxed at 20% and the excess is taxed at 50%.

Therefore, client will receive:
£20,000 less 20% + £8,000 less 50% = £16,000 + £4,000 = £20,000.

Chapter reference 5F1

Question 3

If a defined benefit scheme has 600 members and the scheme has six trustees, how many of the trustees must be member nominated?

a.Four.

b.Three.

c.Two.

d.One.

Answer 3

c.Two.

At least one-third of trustees (or at least one-third of the directors of a trustee company) of an occupational pension scheme must be member nominated.

Chapter reference 5E1C

Question 4

What does the Transfer Club allow members of public sector schemes to do?

a.Transfer their benefits to any other type of defined benefit or defined contribution scheme on an enhanced basis.

b.Transfer their benefits to any other defined benefit scheme without loss.

c.Transfer their benefits to any type of defined contribution scheme on an enhanced basis.

d.Transfer their benefits to another member of the Transfer Club on special terms so they receive a broadly equivalent service credit.

Answer 4

d.Transfer their benefits to another member of the Transfer Club on special terms so they receive a broadly equivalent service credit.

The Transfer Club allows pension
benefits to be transferred between Club schemes on special terms. This means that when a member transfers to another Club scheme, they will receive a broadly equivalent service credit in the new scheme, regardless of any increase in salary on moving.

Chapter reference 5H2A

Question 5

COBS 19.1.6G states that a transfer of safeguarded benefits from a defined benefit scheme should only be recommended if it is:

a.likely to be in the client’s best interests, and the starting point is that the transfer will be suitable.

b.in the client’s best interests, and the starting point is that the transfer may or may not be suitable.

c.in the client’s best interests, and the starting point is that the transfer will not be suitable.

d.likely to be in the client’s best interests, and the starting point is that the transfer may or may not be suitable.

Answer 5

c.in the client’s best interests, and the starting point is that the transfer will not be suitable.

Under the rules a transfer should only be recommended if it is in the client’s best interests.
The firm should start from the assumption that the transfer will not be suitable. The rule requiring firms to make a personal recommendation when advising on the transfer of safeguarded benefits is found in COBS 19.1.1C

Chapter reference 5G1

Question 6

Which change to the assumptions used to calculate a cash equivalent transfer value would cause it to REDUCE?

a.A decision by the trustees to ignore scheme underfunding.

b.A reduction in the discount rate.

c.An increase in the annuity rate.

d.An increase in the revaluation rate.

Answer 6

c.An increase in the annuity rate.

The calculation of a CETV is very sensitive to the assumptions used. the lower the annuity rate or the discount factor, the higher the transfer value.

Conversely, the higher the annuity rate or the discount factor, the lower the transfer value.

When we consider the revaluation rate the opposite is true, so the lower the revaluation rate the lower the transfer value and the higher the revaluation rate the higher the transfer value.

Chapter reference 5F3

Question 7

Pension increase exchange is where a member of a defined benefit scheme gives up:

a.their new State pension entitlement in return for a higher initial occupational pension.

b.their basic State pension entitlement in return for a higher initial occupational pension.

c.both non-statutory and statutory increases to their pension in return for a higher initial pension.

d.non-statutory increases to their pension in return for a higher initial pension.

Answer 7

d.non-statutory increases to their pension in return for a higher initial pension.

Many defined benefit schemes now offer a pension increase exchange (PIE) where the member is offered the option of giving up future guaranteed increases to their pension in return for a higher initial pension with no future increases other than statutory increases.

Chapter reference 5C1B

Question 8

Maja was a member of a defined benefit scheme between January 1998 and November 2004. The scheme pays the statutory minimum level of escalation once benefits come into payment. When Maja retires in August 2024, she can expect her pension to:

a.increase in line with CPI to a maximum of 2.5%.

b.increase in line with CPI to a maximum of 5%.

c.remain level in payment.

d.increase fully in line with CPI.

Answer 8

b.increase in line with CPI to a maximum of 5%.

Statutory escalation of benefits in payment: member
reaches SPA on or after 6 April 2016

Pension for service after 5 April 1997 but before 6 April 2005 - Must escalate in payment in line with CPI to a maximum of 5% p.a

Chapter reference 5C1A

Question 9

Stuart was a member of a defined benefit scheme between 1985 and 1995 but only accrued Guaranteed Minimum Pension [GMP] benefits. If he started drawing his pension at the scheme’s normal pension age of 65 in September 2015, what increases to his pension is the scheme responsible for paying?

a.CPI increases to a maximum of 3% on all of his GMP benefits.

b.CPI increases to a maximum of 3% on the GMP accrued between 6 April 1988 and his date of leaving.

c.CPI increases to a maximum of 3% on the GMP accrued prior to 6 April 1988.

d.Full CPI increases on all his GMP benefits.

Answer 9

b.CPI increases to a maximum of 3% on the GMP accrued between 6 April 1988 and his date of leaving.

Statutory escalation of benefits in payment: member reached SPA before 6 April 2016

GMP accrued between 1988 and 1997 - The scheme is responsible for paying increases to the GMP in line with increases in the CPI to a maximum of 3% p.a. Where CPI exceeds 3% in any year the additional escalation up to full CPI escalation is paid by the State.

Non-GMP accrual prior to 6 April 1997 - No requirement for any statutory increases.

Chapter reference 5C1A

Question 10

A member joined a defined benefit scheme in 1999. If the scheme provides statutory increases to pensions in payment, these will increase in line with:

a.RPI to a maximum of 5% p.a. in respect of pre 6 April 2009 accrual and 2.5% p.a. thereafter.

b.RPI to a maximum of 5% p.a. in respect of pre 6 April 2005 accrual and 2.5% p.a. thereafter.

c.CPI to a maximum of 5% p.a. in respect of pre 6 April 2009 accrual and 2.5% p.a. thereafter.

d.CPI to a maximum of 5% p.a. in respect of pre 6 April 2005 accrual and 2.5% p.a. thereafter.

Answer 10

d.CPI to a maximum of 5% p.a. in respect of pre 6 April 2005 accrual and 2.5% p.a. thereafter.

No matter when you reach SPA, this will be true:

Pension for service after 5 April 1997 but before 6
April 2005 - Must escalate in payment in line with CPI to a maximum of 5% p.a.

Pension for service after 5 April 2005 - Must escalate in payment in line with CPI to a maximum of 2.5% p.a.

Chapter reference 5C1A

Question 11

Describe how tax relief is awarded on employees’ contributions to a defined benefit scheme under the:

a. Net pay method.
b. Relief at source method

Answer 11

a. The net pay method: contributions are deducted from the employee’s salary before tax is deducted. Hence tax relief will be obtained at source at the employee’s marginal rate.

b. The relief at source method: contributions are paid net of basic rate tax. Members will have to reclaim any higher or additional rate relief via selfassessment or adjustment to their tax code

Question 12

State five factors that influence the cost of providing the benefits under a defined benefit scheme.

Answer 12

The cost of benefits under a defined benefit scheme is influenced by the (any five of):

• level of the members’ final pensionable remuneration in future;
• investment returns achieved by the underlying pension fund;
• annuity rates available at retirement;
• cost of providing guaranteed benefits to members who leave the scheme before the normal pension age;
• number of deaths before the scheme’s normal pension age; and
• profile of the scheme membership, e.g. the age and marital status.

Question 13

Sarah is about to retire at the age of 65, which is the normal pension age of her company’s defined benefit pension scheme. Sarah has pensionable service of 26 years. The scheme has an accrual rate of 1/60ths for pension and Sarah’s final pensionable remuneration is £45,000.

Calculate Sarah’s pension entitlement at the scheme’s normal pension age.

Answer 13

(1/60) x years in the scheme x final pensionable remuneration

Sarah’s pension entitlement will be:

26/60ths × £45,000 = £19,500 p.a

Question 14

Fred joined his company’s defined benefit scheme in 1980. Prior to 6 April 2016, the scheme was contracted out. He is about to retire at the scheme’s normal pension age of 65. The scheme provides statutory escalation to the pension once in payment.
Explain how the scheme must increase the benefits once they are in payment.

Answer 14

The different elements of Fred’s final salary scheme benefits must escalate in payment as follows:

• the scheme does not have to provide any escalation in respect of the pre-1988 GMP;
• in respect of the post-1988 GMP, the scheme is responsible for increasing the pension in payment in line with CPI to a maximum of 3% p.a.
• there is no statutory requirement for the excess benefits accrued before 6 April 1997 to escalate in payment;
• benefits accrued in respect of service after 5 April 1997 but before 5 April 2005 will escalate in payment in line with CPI to a maximum of 5% p.a. The scheme is
  responsible for providing these increases
• benefits accrued in respect of service after 5 April 2005 will escalate in payment in line with CPI to a maximum of 2.5% p.a.

Question 15

Philip started working for his current company on 1 November 2002. He joined the defined benefit scheme on 1 November 2004. The scheme provides benefits on a 1/80ths basis. Philip will reach the scheme’s normal pension age on 1 November 2024, with final pensionable remuneration of £90,000. Calculate Philip’s pension entitlement from the scheme at the scheme’s normal pension age.

Answer 15

Philip’s pension from the scheme at the scheme’s normal pension age will be:

20/80ths × £90,000 = £22,500.

Question 16

Jack, who was a member of his company’s defined benefit scheme, died recently. The scheme provides a lump-sum death benefit of 3 × final pensionable remuneration and a spouse’s pension of 50% of the member’s pension, based on prospective service to the scheme’s normal pension age.

Jack joined the scheme on 1 December 2000 and would have reached the scheme’s normal minimum pension age of 65 on 1 December 2025. His final pensionable remuneration was £36,000 and the scheme provides benefits on a 1/60ths basis.

Calculate the death in service lump sum and spouse’s pension payable following Jack’s death.

Answer 16

Jack’s death in service benefits will be:

• a lump sum of 3 × £36,000 = £108,000

and

• a spouse’s pension of 50% × 25/60ths × £36,000 = £7,500 per annum

Question 17

What circumstances prevent a registered auditor who holds a practising certificate from acting as a scheme auditor?

Answer 17

A registered auditor who holds a practising certificate is unable to act as scheme auditor if they are:

• a member of the scheme;
• an employee of the trustees;
• an employer in relation to the scheme
• a trustee or connected with the trustees

Question 18

Trevor left his employer’s defined benefit scheme after 18 months and he was offered a return of his personal contributions. His personal contributions were
£28,000.

How much will Trevor receive?

Answer 18

The first £20,000 of the refund is taxed at 20% and the excess is taxed at 50%. Therefore, Trevor will receive:

£20,000 less 20% + £8,000 less 50% = £16,000 + £4,000 = £20,000.

Question 19

Calvin left his company’s defined benefit scheme on 1 June 2024. He started working for the company on 1 June 2016 and joined the scheme on 1 June 2017. The
scheme is a 1/80ths scheme and Calvin’s pensionable remuneration at the date of exit was £40,000.

Calculate Calvin’s preserved pension on 1 June 2024

Answer 19

Calvin’s preserved pension is 7/80ths × £40,000 = £3,500.

Question 20

Outline the four steps involved in the calculation of a cash equivalent transfer value.

Answer 20

The four steps involved in the calculation of a cash equivalent transfer value are:

1. calculate the preserved pension at the date of exit;
2. revalue the preserved pension to the scheme’s normal pension age;
3. convert the preserved pension at the scheme’s normal pension age into a capital lump sum; and
4. discount the lump sum back to the date of calculation.

Question 21

What are an early leaver’s current statutory rights and options under a private sector defined benefit scheme?

Answer 21

An early leaver with under three months’ qualifying service normally has no rights except to a refund of personal contributions, less tax. An early leaver with more than three months’ but less than two years’ qualifying service must be offered:

• a refund of personal contributions, less tax; or
• a cash equivalent transfer value.

The member may also be offered preserved benefits instead of the transfer value, but most employers do not give this option.

An early leaver with two or more years of qualifying service must be offered:

• a preserved pension payable at the scheme’s normal retirement age
• a cash equivalent transfer value

Question 22

Multi choice

Which of the following courses of action would have an immediate effect on the deficit of a defined benefit scheme?

a. Increasing employer contributions.
b. Changing a scheme’s investment strategy away from equities towards bonds.
c. Transferring existing company assets into the scheme.
d. Increasing employee contributions.
e. Reducing future benefit accrual.

Answer 22

Correct:
a. Increasing employer contributions.
c. Transferring existing company assets into the scheme.
d. Increasing employee contributions.

Incorrect:
b. No: this may limit the extent to which the deficit can increase if market conditions are poor, but this would not have an immediate effect.
e. No: this will not have an immediate effect, but it will reduce ongoing costs, which
may make the recovery plan more affordable

Chapter reference 5D3A

Question 23

A defined benefit scheme’s technical provisions provide an estimate of the:

a. Current market value of the assets held by the scheme.
b. Amount of assets required to pay accrued pensions when they are due to be paid in future.
c. Amount by which the scheme’s current assets exceed the scheme’s liabilities.
d. Future projected value of the scheme’s assets over and above the future projected value of the scheme’s liabilities.

Answer 23

b. Amount of assets required to pay accrued pensions when they are due to be paid in future.

A statutory funding objective must be set for all private sector defined benefit schemes. Under this objective, the scheme trustees must ensure that the scheme funding meets the scheme’s technical provisions. These are the amount of assets needed to cover the scheme’s future liabilities as they fall due. The scheme assets are valued at market value.

Question 24

Which of the following changes in assumptions would cause a cash equivalent transfer value to increase?

a. An increase in revaluation rates.
b. An increase in annuity rates.
c. An increase in discount rates.

Answer 24

a. An increase in revaluation rates

Question 25

Craig is just about to retire from his company’s defined benefit scheme, which has an accrual rate of 60ths. His final remuneration was £27,000 and he has completed 40 years’ service in the scheme. He has accrued a full pre commutation pension of £18,000 p.a. His scheme provides the maximum PCLS under HMRC rules (i.e. 25% of the value of the benefits). The scheme provides PCLS by commutation and the commutation factor is 15:1. Craig’s maximum PCLS will be: a. £40,500. b. £83,077. c. £90,000. d. £124,615.

Answer 25

The correct answer is b. Craig’s maximum PCLS is calculated according to the formula: PCLS = (20 × pre-commutation pension × C) / (20 + 3 × C) Where C = the commutation factor used by the scheme. Craig’s maximum PCLS therefore is: (20 × £18,000 × 15)/ (20 + 3 × 15) = £5,400,000 / 65 = £83,077

Question 26

Trustees are required to report a delay in paying contributions by the employer to TPR once the delay is more than: a. 30 days. b. 45 days. c. 60 days. d. 90 days.

Answer 26

a. 30 days

Question 27

How often must a scheme's actuary calculate the 'funding rate of a defined benefit scheme?

Answer 27

At least every 3 years

Question 28

Steve is about to retire at the normal pension age of his company's defined benefit scheme which is 65. Steve has 20 years of pensionable service, and his final pensionable remuneration is £30,000. If the scheme has an accrual rate of 1/60th of final salary what is Steve's pension entitlement?

Answer 28

Steve's entitlement is 20/60 x £30,000 = £10,000

Question 29

Stan retired in 2018. He had been a member of his former company's defined benefit scheme since 1982 which prior to 2016 had been contracted out. If the scheme provides statutory rates of escalation, how will Stan's benefits be increased now they are in payment?

Answer 29

The different elements escalate as follows: * Pre-1988 schemes do not have to provide escalation (Government pays increase to GMP in payment) * GMP accrued between 1988 and 1997 - scheme is responsible for paying increase in line with CP| to a maximum of 3% (if CP| more than 3% State pays) Non-GMP accrual pre-1997 - no requirement for statutory increase * Pension for service after 5 April 1997 but before 6 April 2005 - escalates in line with CPI to a maximum of 5% (LPI) * For service after 5 April 2005 - escalates in line with CPI to a maximum of 2.5%

Question 30

Independent advice must be taken on a transfer from a defined benefit scheme if the Cash equivalent transfer value (CETV) exceeds what amount?

Answer 30

£30,000

Question 31

Which public sector scheme members have the right to transfer their benefits to access flexible benefits?

Answer 31

Members of funded public sector schemes, such as The Local Government Pension Scheme (LGPS)

Question 32

Brian has just reached his normal retirement age of 63 and is about to take benefits from his defined benefit scheme. From the information below, calculate the reduced annual pension Brian will receive on the basis that he takes the maximum pension commencement lump sum. 1/60th final salary accrual rate 3/80ths PCLS definition 15:1 commutation factor £30,000 final pensionable remuneration 24 years of pensionable service A. £1,800 B. £9,000 C. £10,200 D. £12,000

Answer 32

C. £10,200 Brian's entitlements are as follows: Maximum pension entitlement = 24/60 x £30,000 = £12,000 or Maximum Pension Commencement Lump Sum (PCLS) entitlement = 3/80 x 24 x £30,000 = £27,000 (plus a reduced pension). As the commutation factor is 15:1, the maximum pension is reduced by £1 for each £15 of tax-free cash taken. So, if Brian takes the maximum tax-free cash, his pension is reduced by (£27,000/15 =£1,800). Therefore, his reduced pension is £12,000 - £1,800 = £10,200. Chapter reference 5C1C

Question 33

For someone in a defined benefit (DB) scheme who reaches State pension age after 6 April 2016, what will happen to any contracted-out entitlement built up before that date? A. It is treated the same as the member's ordinary rights under the DB scheme. B. A 'rebate derived amount would have been applied to the starting amount. C. There will be changes to requisite benefits once the State pension is received. D. It remains as it was prior to the end of contracting out with the associated rights and employer obligations unchanged.

Answer 33

B. A 'rebate derived amount would have been applied to the starting amount. Someone in a defined benefit scheme, reaching State pension age (SPA) after 6 April 2016, who has built up contracted-out entitlements, will have had a 'rebate derived amount applied to their starting amount calculation. Under their defined benefits scheme, the contracted-out element will still need to be identified separately as statutory escalation rates still apply, but these rates have changed since contracting-out was abolished and the new State Pension was introduced on 6 April 2016. There is no impact on requisite benefits. Chapter reference 5C1A

Question 34

Elizabeth is due to retire from her final salary defined benefit pension scheme after 22 years' service at the normal scheme pension age of 65. Her final salary is £38,000 and the scheme is a 1/80ths scheme. What pension can Elizabeth expect to receive?

Answer 34

Answer Elizabeth can expect to receive an annual pension of £10,450 Detailed explanation Elizabeth's pension is based on the scheme's accrual rate, her final pensionable salary and her length of service in the scheme. 22 ÷ 80 x £38,000 = £10,450 per annum CII R04 Study Text Chapter 5, Section B4

Question 35

Andy's defined benefit scheme is based on a 1/60th of final salary accrual with cash of 3/80 per year of pensionable service. Part of Andy's pension can be commuted for a pension commencement lump sum (PCLS) using a commutation factor of 11:1. Assume Andy retires after 30 years of pensionable service and a final salary of £40,000. Calculate the amount of pension that Andy will be entitled to and the amount of PCLS that Andy may take and the ensuing residual pension.

Answer 35

Answer Andy would be entitled to a full pension of £20,000, or a reduced pension of £15,909.09 with PCLS of £45,000. Detailed explanation Using the 1/60th accrual rate, we can determine that Andy would be entitled to a full pension of: 1/60 × 30 x £40,000 = £20,000 Using the 3/80th accrual rate we can determine Andy's maximum lump sum would be: 3/80 × 30 x £40,000 = £45,000 The commutation factor means that for every £1 of PCLS taken, Andy's pension is reduced by £11, therefore: £45,000 ÷ 11 = £4,090.91 So, if Andy took the maximum PCLS he would have a reduced pension of: £20,000 - £4,090.91 = £15,909.09 CIl R04 Study Text Chapter 5, Section C1C

Question 36

Sally has just reached normal retirement age of 65 under her defined benefit pension scheme, she has a pre-commutation pension of £40,000, which has been based on her final remuneration of £120,000 and the commutation factor is 15:1. Calculate her maximum PCLS and residual pension.

Answer 36

Answer Sally's maximum PCLS will be £184,615 and her residual pension will be £27,692. Detailed explanation HMRC allow a maximum PCLS of 25% of the value of benefits, with pension benefits being valued using a factor of 20:1 and PCLS benefits taken at face value. However, where PCLS is provided by commutation, the residual pension depends on the amount of PCLS and the commutation factor. The formula is: PCLS = (Pre-commutation pension x C) / (1 + (0.15 x C)) NB: Remember C is the commutation factor (£40,000 × 15)/(1 + (0.15 × 15)) = £600,000/3.25 = £184,615 So, then we can complete the commutation factor calculation to determine Sally's residual pension: £40,000 - (£184,615 ÷ 15) = £27,692 CII R04 Study Text Chapter 5, Section C1C

Question 37

Duncan is due to leave his defined benefit scheme 5 years early at the age of 60 after completing 25 years' service. The scheme operates on a 1/60th of final salary accrual rate for pensions with a reduction of 0.5% for each month the member retires before the normal scheme retirement age of 65. Duncan's final pensionable remuneration is £75,000. Calculate the early retirement pension Duncan could expect to receive.

Answer 37

Answer Duncan would receive an early retirement pension of £21,875 Detailed explanation We would complete the normal calculation for Duncan's pension based on the 1/60th accrual rate: 25 × 1/60 x £75,000 = £31,250 However, as Duncan is retiring 5 years early, we need to apply the early retirement factor of 0.5% for every month: 5 × 12 × 0.5% = 30% We calculate the reduction to be applied: £31,250 x 30% = £9,375 Then apply the reduction to the full pension calculated above: £31,250 - £9,375 = £21,875 CII R04 Study Text Chapter 5, Section C2

Question 38

Duncan is due to leave his defined benefit scheme 5 years early at the age of 60 after completing 25 years' service. The scheme operates on a 1/60th of final salary accrual rate for pensions with a reduction of 0.5% for each month the member retires before the normal scheme retirement age of 65. Duncan's final pensionable remuneration is £75,000. Duncan (from above) is also entitled to a PCLS, this has an accrual rate of 3/80ths, with a commutation factor of 15:1, the early retirement factor of 0.5% for every month also applies. Calculate Duncan's PCLS and reduced pension should he take the full PCLS.

Answer 38

Answer Dúncan's maximum PCLS is £49,218.75 with a residual pension of £18,593.75 Detailed explanation As above, the first step is to calculate Duncan's full entitlement using the 3/80th accrual rate: 25 × 3/80 x £75,000 = £70,312.5 Next, reduce by the early retirement factor of 0.5% for every month, (we know this to be 30% from above): £70,312.5 × 30% = E21,093.75 So, deduct this early retirement reduction from the maximum PCLS: £70,312.5 - £21,093.75 = £49,218.75 Next, we need to use the commutation factor to calculate by how much Duncan's pension would reduce in line with him taking maximum PCLS: £49,218.75 ÷ 15= £3,281.25 Then finally deduct this from his early retirement pension calculated in the earlier question: £21,875 - £3,281.25 = £18,593.75 CIl R04 Study Text Chapter 5, Section C2

Question 39

David died whilst still a member of his defined benefit scheme. He had been a member for 15 years but wasn't due to retire for another 10 years. The scheme provides death in service benefits of 4 x final remuneration and a 50% spouse's pension based on David's pension accrued to date of death, with a pension accrual rate of 1/60ths of final salary. David's final pensionable remuneration was £64,000. What death in service lump sum and spouse's pension could his widow expect to receive?

Answer 39

Answer His widow could expect to receive a death in service lump sum of £256,000 and a spouse's pension of £8,000 Detailed explanation David's lump sum death in service is simply 4 x final remuneration: £64,000 × 4 = £256,000 The spouse's pension is half David's entitlement, so calculate David's entitlement first: 15 × 1/60 x £64,000 = £16,000 Then we know that David's widow can expect to receive half of this: £16,000 × 50% = £8,000 CII R04 Study Text Chapter 5, Section C4A

Question 40

John was a member of a defined benefit scheme and left after completing 23 months' scheme membership. John's annual salary throughout the period was £120,000 and he was required to make an annual contribution equal to 6% of his salary deducted monthly from his pay. Calculate the net amount that he will receive if he opts for a refund of contributions.

Answer 40

Answer John would be entitled to a net refund of £11,040. Detailed explanation As an early leaver with less than 2 years' service, John may be entitled to a refund of his own personal contributions. So, we can calculate his contributions as: £120,000 × 6% = £7,200 annual contribution £7,200 ÷ 12 × 23 = £13,800 The first £20,000 of any refund is taxed at 20%: £13,800 × 20% = £2,760 So, John could expect a net return of: £13,800 - £2,760 = £11,040 NB. The tax liability lies with the scheme administrator who can deduct the tax from the refund. CIl R04 Study Text Chapter 5, Section F1

Question 41

Yvonne left her company's defined benefit scheme after 7 years' service. The scheme is a 1/80ths scheme final salary and her pensionable remuneration on lea was £48,000. Calculate Yvonne's preserved pension.

Answer 41

Answer Preserved pension of £4,200 Detailed explanation Yvonne had completed 7 years' service and so the calculation is: 7 × 1/80 x £48,000 = £4,200 Yvonne would be regarded as a deferred member with a short service benefit. CII R04 Study Text Chapter 5, Section F2

Question 42

David will shortly reach age 65 and will be taking the benefits from a previous employer's defined benefit pension scheme. He has been offered a pre-commutation pension of £35,000 and maximum PCLS of £170,000. The scheme commutation rate is 18:1. He has also been offered pension increase exchange (PIE) which would increase his starting income by 25%. David intends to take a PCLS of £100,000. Calculate the pension income David would receive in the first year of payment if he: (a) does not accept the offer of PIE (b) does accept the offer of PIE

Answer 42

Answer (a) £29,444.44 (b) £38,194.44 Detailed explanation Many defined benefit schemes now offer a pension increase exchange (PIE) where the member is offered the option of giving up future guaranteed increases to their pension in return for a higher initial pension with no future increases other than statutory increases. (a) Pension after PCLS £100,000 ÷ 18 = £5,555.56 pension to be commuted £35,000 - £5,555.56 = £29,444.44 pension after PCLS (b) Pension after pension increase exchange £35,000 × 1.25 = £43,750 £43,750 - £5,555.56 = £38,194.44 CII R04 Study Text Chapter 5 Section C1B

Question 43

Eric has recently accepted an offer of new employment. His new employer offers a career average defined benefit pension scheme with the facility to make additional voluntary contributions on a defined contribution basis. In relation to his defined benefit scheme, Eric should be aware that his entitlement will be determined by A. the scheme’s accrual rate, Eric’s length of service and his final salary. B. the scheme’s accrual rate, Eric’s date of retirement and his average earnings. C. the scheme’s accrual rate, Eric’s length of service and his average earnings. D. Eric’s date of retirement, his length of service and his final salary.

Answer 43

C. the scheme’s accrual rate, Eric’s length of service and his average earnings. A career average revalued earnings (CARE) scheme defines the pension payable with regard to accrual rate, length of service and career average earnings. - Chapter 5, Section A1C, Learning Outcome 4

Question 44

Bill is a defined benefit transfer specialist working for Quality Financial Advice Ltd. As a part of training and competence monitoring, one of his cases has been selected for a post-sale review. Bill should be aware that in order for his case to be assessed as compliant he is required to have provided the client with each of the following except A. a triage service. B. a personalised charges communication. C. the transfer value comparator. D. a suitability report.

Answer 44

A. a triage service. Advisers may opt to use a triage service; however, it is not a compulsory part of the pension transfer advice process. All of the other steps are compulsory. - Chapter 5, Section G4, Learning Outcome 4

Question 45

Following 18 months of membership Neil is leaving, his firm’s defined benefit pension scheme. At the point of leaving, he had contributed £24,000 gross; a figure matched by his employer. Neil, a higher rate taxpayer, may be offered a net refund of A. £14,400 B. £18,000 C. £28,800 D. £36,000

Answer 45

B. £18,000 As Neil is leaving his firm’s defined benefit pension scheme with less than 2 years’ service, he may be entitled (if the scheme allows) to a refund of his contributions. The tax position of the refund is: First £20,000 taxed at 20% with remaining contributions taxed at 50%. Hence, Neil’s net refund will be (£20,000 x 80%) + (£4,000 x 50%) = £18,000. Neil would not receive a payment in respect of any of the contributions from his employer. - Chapter 5, Section F1, Learning Outcome 4

Question 46

Sarah is retiring after 20 years’ service in a 1/60th defined benefit pension scheme. Her final pensionable salary is £48,000. Sarah can commute part of her pension for a pension commencement lump sum (PCLS) of 3/80th of final pensionable salary for each year of service. The commutation factor is 12:1. Should Sarah take all of her PCLS entitlement, her reduced pension will be A. £12,000 p.a. B. £13,000 p.a. C. £15,000 p.a. D. £16,000 p.a.

Answer 46

B. £13,000 p.a. Sarah’s entitlements are as follows: Maximum pension entitlement = 20 x 1/60 x £48,000 = £16,000 or Maximum PCLS entitlement = 20 x 3/80 x £48,000 = £36,000 (plus a reduced pension). As the commutation factor is 12:1, the maximum pension is reduced by £1 for each £12 of PCLS taken. So, if Sarah takes the maximum PCLS, her pension is reduced by (£36,000/12 =£3,000). Therefore, her reduced pension is £16,000 - £3,000 = £13,000. - Chapter 5, Section C1C, Learning Outcome 4

Question 47

Joshua is about to take benefits from his employer’s defined benefit pension scheme. The employer is in the process of carrying out a pension increase exchange exercise whereby he can increase his starting pension in exchange for reduced annual indexation. Joshua should be aware that A. the employer will suffer a large one-off cost in offering the pension increase. B. if he lives longer than average then he may be better off as a result of accepting the exchange. C. his pension commencement lump sum entitlement will be lower if he accepts the exchange. D. he can only exchange escalation in excess of the statutory minimum.

Answer 47

D. he can only exchange escalation in excess of the statutory minimum. Pension increase exchange can only be applied to non-statutory increases. The employer will not suffer a large one-off cost as the only additional cost is the higher initial pension. In future years, the ongoing income may well be less than the escalating equivalent pension. If Joshua lives longer than average, then he could be worse off as his payments may be less than if he had accepted the original pension. However, his PCLS entitlement may be higher as a result of the exchange, since where it is paid by commutation, a higher starting pension will result in a higher lump sum entitlement. - Chapter 5, Section C1B, Learning Outcome 4

Question 48

Which of the following is a funded public sector defined benefit scheme? A. The local government pension scheme (LGPS). B. The teacher’s pension scheme. C. The National Health Service (NHS) pension scheme D. The armed forces pension scheme.

Answer 48

A. The local government pension scheme (LGPS). All of the main public sector defined benefit schemes are unfunded except for the LGPS. - Chapter 5, Section H2, Learning Outcome 4

Question 49

Where a defined benefit scheme enters the Pension Protection Fund (PPF), the scheme actuary will carry out A. an IAS 19 valuation. B. a Section 143 valuation. C. a Section 179 valuation. D. a statutory valuation.

Answer 49

B. a Section 143 valuation. A Section 143 valuation is used to establish whether the scheme is sufficiently well funded to pay benefits to PPF level. - Chapter 5, Section D2B, Learning Outcome 4

Question 50

Which factor is of least concern to a member of an occupational defined benefit scheme? A. Future and current annuity rates B. Accrual rate C. Definition of pensionable remuneration D. Length of service

Answer 50

A. Future and current annuity rates Future and current annuity rates are of least concern to a member of an occupational defined benefit scheme as the amount of pension benefits they receive is guaranteed by their employer and are based on their definition of pensionable service, the scheme accrual rate and length of service. Annuity rates are not a consideration for the member; hence, the answer is a). - Chapter 5, Section C1A, Learning Outcome 4

Question 51

The role of a scheme auditor would include A. giving an opinion as to whether or not contributions have been paid in accordance with the schedule. B. providing advice about the calculation of technical provisions. C. preparing a recovery plan. D. registering the pension scheme with His Majesty's Revenue & Customs (HMRC)

Answer 51

A. giving an opinion as to whether or not contributions have been paid in accordance with the schedule. The scheme auditor’s duties would include giving an opinion as to whether or not contributions have been paid in accordance with the schedule. Calculation of technical provisions and preparation of a recovery plan would be the duty of the scheme actuary, whilst registering the scheme with HMRC would be down to the scheme administrator. - Chapter 5, Section E2B, Learning Outcome 4

Question 52

Why might an employer decide to provide death in service benefits through a separate insured scheme as opposed to through a defined benefit scheme? A. To maintain death in service benefits without draining the fund B. To treat the death in service benefits as an allowable expense C. If the employees were all below 45 D. As the defined benefit scheme is fairly large

Answer 52

A.To maintain death in service benefits without draining the fund An employer may choose to operate a separate death in service scheme (from their defined benefit scheme) as this would ensure death benefits would not drain the fund of the defined benefit scheme. This may happen particularly if deaths rates are higher than anticipated and has more of an impact on smaller companies. - Chapter 5, Section C4C, Learning Outcome 4

Question 53

Which of the following may be permitted to act as a trustee? A. Jack, who is aged 17. B. Pedro, who has been disqualified from acting as a company director. C. Frank, who has been convicted of drink driving. D. Raymond, who no longer has capacity due to a mental health condition.

Answer 53

C. Frank, who has been convicted of drink driving. A criminal record is not necessarily a barrier to acting as a trustee, other than in the case of an unspent conviction for deception or dishonesty. All of the others are ineligible as they lack the legal capacity to hold property. - Chapter 5, Section E1, Learning Outcome 4

Question 54

Sam is a member of his employer’s defined benefit pension scheme which has a normal retirement age of 65. Scheme details are: 1/60th accrual rate 24 years’ service at early retirement date Final salary of £15,000 Early retirement factor of 0.5% per month If Sam is retiring exactly 2 years earlier than the scheme’s normal retirement age, his pension will be A. £5,280 B. £5,720 C. £6,000 D. £6,500

Answer 54

A. £5,280 Sam’s maximum pension had he retired at the scheme retirement age of 65 would have been: 24 x 1/60 x £15,000 = £6,000 As he is retiring 24 months early, his pension is reduced by 0.5% for each month he retires early (0.5% x 24 = 12%). Therefore, Sam will only receive 88% of his full pension entitlement, and his early retirement pension will be £6,000 x 88% =£5,280. - Chapter 5, Section C2, Learning Outcome 4

Question 55

A pension in payment from a defined benefit scheme must escalate in line with CPI to a maximum of 2.5% for service A. before 6 April 1978. B. after 5 April 2005. C. before 5 April 1997. D. after 5 April 1997.

Answer 55

B. after 5 April 2005. A pension in payment from a defined benefit scheme must escalate in line with CPI to a maximum of 2.5% after 5 April 2005. The rate is CPI to a max of 5% for service after 5 April 1997 up to 6 April 2005. (There are different rules for pre-1997 accrual for GMP and non GMP benefits). - Chapter 5, Section C1A, Learning Outcome 4

Question 56

Sonia is a member of a defined benefit pension scheme. She has recently been offered the option of giving up future guaranteed increases to her pension in return for a higher initial pension with no future increases. This is known as pension A. inflation. B. increase exchange. C. exchange. D. inflation exchange.

Answer 56

B. increase exchange. Pension increase exchange is where a member is offered the option to give up guaranteed increases to their defined benefit pension in return for a higher initial pension with no increases (except statutory increases). - Chapter 5, Section C1B, Learning Outcome 4

Question 57

A PPF Section 179 valuation is to establish the A. future value of a defined benefit scheme. B. level of defined benefit scheme assets and liabilities. C. number of deferred members of a defined benefit scheme. D. basis of funding guidance for a defined benefit recovery plan.

Answer 57

B. level of defined benefit scheme assets and liabilities. A PPF Section 179 valuation is carried out to establish the level of a defined benefit scheme’s assets and liabilities. This is used to determine any scheme underfunding which is then used to determine the level of the scheme’s PPF levy. - Chapter 5, Section D2C, Learning Outcome 4

Question 58

Which change to the assumptions used to calculate a cash equivalent transfer value would cause it to REDUCE? a.An increase in the annuity rate. b.An increase in the revaluation rate. c.A decision by the trustees to ignore scheme underfunding. d.A reduction in the discount rate.

Answer 58

a.An increase in the annuity rate. The calculation of a CETV is very sensitive to the assumptions used. Note that the lower the annuity rate or the discount factor, the higher the transfer value. Conversely, the higher the annuity rate or the discount factor, the lower the transfer value. When we consider the revaluation rate the opposite is true, so the lower the revaluation rate the lower the transfer value and the higher the revaluation rate the higher the transfer value. Annuity rate and discount factor are counter-cyclical revaluation rate is cyclical Chapter reference 5F3

Question 59

A defined benefit scheme is changing to a career average scheme for future accrual. Which employee will typically be LEAST disadvantaged by this change? a.Callum, who is 25, who has recently finished his professional exams and hopes to see significant salary increases over the next few years. b.Malcolm, who is 61, and has moved from a managerial role to a clerical position in the run up to his retirement in four years' time. c.Judy, who is 51, and a personal assistant whose salary has just been increased following a promotion. d.Sophie, who is 35, who has recently returned to work on a part time basis following maternity leave. She hopes to return to full time employment in five years' time.

Answer 59

b.Malcolm, who is 61, and has moved from a managerial role to a clerical position in the run up to his retirement in four years' time. Career average schemes are those where the formula used to determine benefits is based on the average earnings over a member’s career and not on their earnings at or near a set age. This tends to reduce the benefits provided to the member and thus the cost to the employer of operating such a scheme. Anyone whose pay significantly increases as retirement approaches is better off in a traditional defined benefit scheme, rather than a career average scheme. However, it may work out better for a member whose salary reduces as retirement approaches (perhaps due to a reduction in hours or because of a move to a less senior position in later years). Chapter reference 5A1C

Question 60

Jane, a member of a defined benefit scheme, is entitled to a scheme pension of £20,000 per annum. Her scheme allows her to take a tax-free pension commencement lump sum (PCLS) by commutation with a commutation rate of 15:1. What would be the maximum PCLS which Jane could take from the scheme? A. £89,514.91 B. £92,307.69 C. £96,943.24 D. £101,683.46

Answer 60

B. £92,307.69 The maximum PCLS available through commutation can be calculated using the formula: (P x 20 x C) / 20 + (3 x C) Where P is the starting pension and C is the commutation rate. (£20,000 x 20 x 15) / 20 + (3 x 15), gives £6,000,000 / 65. This equals a maximum PCLS of £92,307.69. Chapter 5, Section C1C, Learning Outcome 4