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1

Implications of transferring PCLS?

“Under the simplified regime in place post-A-Day, the general limit for the PCLS when benefits are drawn is 25% of the value of the benefits or 25% of the available lifetime allowance, whichever is lower.”

“One of the main reasons for a client wishing to transfer out of their existing defined benefit scheme and into a defined contribution (DC) scheme is to access their PCLS earlier than would otherwise be the case and/or to choose from a wider range of income and lump sum options either now or at a future date.”

“There is a strong possibility that those individuals seeking to maximise the amount of their PCLS would receive a higher tax-free lump sum following their transfer into a money purchase arrangement. This is because, as stated previously in Defined benefit schemes and safeguarded benefits, the commutation factors used by private sector DB schemes when calculating PCLS are not very generous. If the member chooses to postpone taking their PCLS, they may well receive an even greater amount of PCLS as their fund will have potentially grown by the time they seek to take their tax-free lump sum.”

2

Bridging Pensions; Implications of transferring?

“When the member reaches their normal pension age a higher pension is paid until SPA is reached”

“A bridging pension would not be available via a money purchase scheme. However, where the member is seeking to take their retirement income before they reach their SPA, then they can, should they wish, enter into flexi-access drawdown and take a higher level of withdrawals for those years leading up to their SPA, whereupon they reduce their income withdrawals to reflect the receipt of their State Pension.”

3

Early retirement; Implications of transferring?

“Having transferred the member’s pension to a money purchase scheme the member may find that they have an improved position if they were to retire early when compared with doing so under their existing DB scheme. This will depend on the early retirement factors being applied by their existing scheme, and the age at which they seek to retire early.”

4

Ill health early retirement: Implications of transferring?

“Having transferred the member’s pension to a money purchase scheme, the pension available to the individual when retiring early due to ill-health will be determined by the age at which they take their pension, the size of the pension fund and the income/lump sum option selected.
A money purchase scheme member who satisfies the ill-health early retirement rule is usually eligible for an impaired life annuity because of the seriousness of their medical condition. Whether it makes sense to buy an annuity (after drawing the PCLS) depends on the member’s personal circumstances.

If the need for secure lifetime income is the priority, then there may be no alternative. If a beneficiary’s annuity is also to be purchased, then the overall rate may not be much better than a standard annuity. The higher mortality of the member will be reflected in a higher price for the beneficiary’s annuity.

For many, flexi-access drawdown may be a better option because:

it offers unrestricted income; and
any remaining fund on death before age 75 can be passed on free of income tax (and usually inheritance tax (IHT)).
However, if the member lives for longer than anticipated, the drawdown fund will run out.

5

Income Options?

“There are four methods of retirement income provision from the receiving money purchase scheme:

1. Scheme pension, which is the only route for DB schemes, but is an option for all other types of pension arrangement.
2. Lifetime annuity, payable by an insurance company.
3. Drawdown pension, which includes capped drawdown and flexi-access drawdown.
4. UFPLS, taking part or all of the pension fund as a lump sum.”

6

Scheme Pensions?

“DB arrangements can only provide income benefits in the form of scheme pensions.

Money purchase arrangements have the option of offering scheme pensions, but are not required to do so. A money purchase arrangement is only allowed to pay a scheme pension if the member was given the option to select a lifetime annuity as an alternative and rejected it. Few money purchase arrangements offer a scheme pension, as they are not considered mainstream.

Small self-administered schemes (SSASs) and some self-invested personal pension (SIPP) schemes with typically “few members, such as family SIPPs, offer scheme pensions, although those offering are becoming fewer in number. The main attraction is the potential to reduce the lifetime allowance applied to the value of the funds backing a scheme pension. This application can work when the scheme pension is paid directly from a SSAS or SIPP, but this is seen as complex and costly. Therefore, these are seen as only relevant for high net worth individuals who have significant money purchase funds and issues with the lifetime allowance.”

7

Lifetime Annuity?

“Annuity rates are based on the life expectancy of the annuitant, and traditionally a key factor was gender. Following the European Court of Justice Test-Achats case, with effect from 21 December 2012 all insurance contracts were required to calculate benefits and premiums without reference to gender. Included in this ruling are lifetime annuities”

“In particular, it may be suitable for individuals who:

have a low appetite for risk;
have low, or no, capacity for loss;
need a guaranteed income (for themselves and/or their survivors);
have no desire to manage the investment of their pension fund in retirement;
have a longer life expectancy based on family history; and/or
have a medical condition that will allow them to be underwritten and receive an enhanced annuity rate.”

8

Lifetime Annuity v Scheme Pension:

Refer page 126-127.

9

Drawdown?

“From 6 April 2015 there are two forms of drawdown:

Flexi-access drawdown

Only option available to a member wishing to commence drawdown from 6 April 2015.

(Note: a previous option was flexible drawdown. Anyone in flexible drawdown had their pension automatically converted to a flexi-access drawdown pension on 5 April 2015.)

Capped drawdown

Only available to members who were already in capped drawdown on 5 April 2015.

Both of these drawdown options allow the member to make use of short-term annuities.”

10

What are Short term annuities?

“Short-term annuities are also sometimes referred to as temporary annuities. They work as follows:

After drawing the PCLS, the bulk of the member’s pension fund is (or remains) invested in their chosen funds, but a portion is used to buy a temporary annuity in the name of the member.
Income must be paid at least yearly.
The short-term annuity must be payable by an insurance company. Since 6 April 2015 there has been no requirement for the pension provider to provide an open market option.
There is no restriction on the level of income. Short-term annuities purchased before 6 April 2015 were subject to a maximum initial income cap calculated on the same basis as drawdown pension. The cap remains in place unless the member”

“opts for flexi-access treatment.
Income reviews on pre-6 April 2015 capped short-term annuities follow the same pattern as drawdown pension, i.e. after every three years from commencement (every year from age 75), but with an interim adjustment to the maximum payment level if a new annuity is purchased or part of an arrangement is designated for this form of drawdown income.

The annuity cannot be payable for a term of more than five years.
It can be arranged on an annuity certain basis for its full term (i.e. guaranteed), but otherwise cannot incorporate any death benefits.
It may be transferred to another insurance company.

For short-term annuities purchased since 6 April 2015, the income may decrease. However, older short-term annuities are subject to the same restrictions as pre-6 April 2015 lifetime annuities subject to any maximum income limit.

At current rates, a large part of the fund must be crystallised to buy the annuity. The cost may be very similar to the sum total of gross income payments, which puts pressure on managing the portfolio. As the market is underdeveloped – and likely to remain so in a world of flexi-access – rates are unlikely to be competitive.

11

Flexi-access Drawdown: Benefits and Drawbacks

Refer page 132

12

Capped Drawdown:

“Capped drawdown ceased to be available for most new crystallisations from 6 April 2015, when it was replaced by flexi-access drawdown. However, a member with capped drawdown started before that date can continue to take capped drawdown. The existing review process (every three years to the pension year in which the member reaches their 75th birthday and annually thereafter) remains and the 150% limit of the basis amount also continues. If a withdrawal that results in the cap being exceeded is made, the capped drawdown fund is automatically converted to a flexi-access drawdown fund, thereby avoiding it being an unauthorised payment and the associated tax charge.

In any event, the member can elect for any new drawdown to be on a flexi-access basis, or for their capped drawdown to be converted to flexi-access drawdown, and then designate new funds under flexi-access. While the latter option would dispense with the administrative issues (and cost) surrounding reviews, it may not be the wisest course of action, because capped drawdown does not trigger the MPAA, so potentially allowing £10,000-plus annual contributions to be made to money purchase arrangements.

“While capped drawdown is in use, further uncrystallised funds within the same arrangement can be designated to capped drawdown. It is theoretically possible to top up existing arrangements in capped drawdown, so the member can continue to benefit from its features. Any further uncrystallised funds that the member has can be designated into their existing capped drawdown pension arrangement provided the arrangement was set up to allow for the designation of additional funds.”

13

Capped Drawdown setting the income maximum:

“Capped withdrawals are subject to a maximum level but no minimum, so were sometimes previously used to draw PCLS in isolation (as flexi-access can be used now). The maximum level was changed under the Finance Act 2014 to 150% of a basis amount. This is calculated from a set of drawdown tables produced for HMRC by GAD based on 15-year gilt yields (unless the withdrawal is for a dependant aged under 23, in which case 5-year gilt yields are used).

The latest version of these tables is dated 2011. Following the principle of gender equality established in the European Court of Justice Test-Achats case, since 21 December 2012 only male rates have been used.

The calculation for the maximum withdrawal level (other than for dependants under age 23) was (and for reviews still is) as follows:

Calculate the attained age in complete years at the date the drawdown pension fund option becomes effective (the initial ‘reference date’).
“Obtain the gross redemption yield on UK gilts (15 years) from the FTSE Actuaries Government Securities Yield Indices (published daily in the Financial Times) for the 15th of the month preceding the month in which the withdrawal option becomes effective.

If the 15th is not a working day, use the working day immediately preceding the 15th. For example, if the calculation was to be effective from 23 August 2016, the yield referred to will be that of Friday 15 July 2016, published on the Financial Times website on 16 July 2016.

If the yield is not an exact multiple of 0.25%, round it down to the next 0.25%. No rounding is necessary for exact multiples. Prior to 18 January 2017, the 15-year gilt yields contained in the GAD tables only went as low as 2%, however, from 18 January 2017 this has been extended to include gilt yields as low as 0%, though this extension to the GAD table only came into use from 1 July 2017.

“Using the age from step 1 and yield from step 3, look up the relevant basis amount per £1,000 in the GAD table 1 for males (table 2 for females is now obsolete, following the removal of gender in calculations). To calculate the basis amount, multiply the relevant basis amount by the available fund and then divide by £1,000.
To determine the maximum withdrawal, apply 150% to the basis amount. The result may be rounded to the nearest penny”

14

Capped Drawdown: Review Procedure

“The maximum income level under capped drawdown must be recalculated at least every three years after the initial reference date and prior to age 75. This three-year period is called a reference period. The new reference period must start on the same date in the year as the original reference period. For example, for a drawdown plan that started on 1 November 2014, the next reference period will start on 1 November 2017. There are, however, certain events that can cause the reference period to change, and other events that will trigger the recalculation of the maximum drawdown pension but will not change the reference period.

When the scheme administrator calculates the maximum drawdown pension at review, it uses the method outlined in example 4.5. When initially setting income, the value on that date is used, but on review the scheme administrator can carry out the calculation on any day in the 60-day period ending on the first day of the new review period. So, if the next review date is 1 November 2017, the scheme administrator can do the calculation in the period from 3 September 2017 to 1 November 2017.

“If the scheme administrator selects a date within the 60-day window, this is known as the nominated date. The age, fund value and gilt yield that apply at the nominated date are used to calculate the maximum drawdown pension for the next reference period. On attaining age 75, the review is moved to an annual basis, starting with the first plan anniversary after age 75.

To ease administration, from age 75 onwards where the member has different arrangements with different anniversary dates, it will be possible – subject to the scheme administrator’s agreement – to align all the arrangements under the same pension year. Note that the anniversary date of an arrangement can only be changed once.”

15

Capped Drawdown, Benefits and Drawbacks:

Refer page 135

16

Third way plans including variable and fixed term annuities:

“Third-way plans/annuities are contracts that offer income guarantees and/or capital guarantees. Some also provide lock-in guarantees that will lock in growth at various time intervals, e.g. on the plan anniversary.”

“The term ‘third-way’ was developed to distinguish them from annuities and drawdown, but it is important to note that, despite the name, they are not lifetime annuities but rather an investment option for a drawdown plan.”

“Variable annuities
Variable annuities are unit-linked investment products that usually guarantee to provide a set level of income over a guaranteed period of time based on a percentage of the fund value at the start of the contract. At the end of the guaranteed period, if the fund value is less than the starting fund value the income will remain at the guaranteed level, but if the fund value has increased then the income payable will increase. Guaranteed death benefits may also be included.”

“Fixed-term annuities
Fixed-term annuities pay a set level of income for a set period. The fund value at the end of that period is guaranteed. The member can then choose to continue ‘normal’ drawdown, buy an annuity or buy another fixed-term annuity.”

“The key difference is that income under the short-term annuity is dealt with under a specific element of drawdown legislation, limiting the term to a maximum of five years, whereas income paid out under the fixed-term annuity falls under the general drawdown rules.”

17

“When can a member take an UFPLS?”

“The following conditions must be met for a payment to qualify as an UFPLS:

It must be paid from uncrystallised (or unused) rights held in a money purchase pension.
The member must have reached normal minimum pension age, their protected pension age or meet the ill-health requirements.
A member aged below 75 when the payment is made must have an amount of lifetime allowance remaining that is greater than or equal to the amount of the UFPLS they wish to take.
A member aged 75 or over when the payment is made must have some lifetime allowance remaining.”

18

“When can a member not take an UFPLS?”

“A UFPLS is an uncrystallised funds pension lump sum so it cannot be taken from crystallised funds, which includes funds in a drawdown contract. In addition, an UFPLS cannot be taken from pension rights arising from a pension credit received from a pension sharing order as part of a divorce, where the relevant pension was already in payment (a disqualifying pension credit).

It is also not possible for a beneficiary to receive death benefits in the form of an UFPLS. This is because any uncrystallised benefits remaining when the member dies will crystallise automatically upon their death. As a result, death benefits can only be paid in the form of a lump sum or continuing income.

However, uncrystallised funds cannot provide an UFPLS where the member has:

primary protection and/or enhanced protection where the protection of the lump-sum rights is for more than £375,000;
scheme specific tax-free cash protection that entitles them to a PCLS of more than 25% of the value of the fund; or
a lifetime allowance enhancement factor and the available portion of the member’s lump-sum allowance is less than 25% of the proposed UFPLS.
“The restriction regarding the lifetime allowance enhancement factor is to ensure that the member cannot have an UFPLS that would give them a higher tax-free amount than they would be entitled to as a PCLS.”

19

UFPLS: “Impact of the MPAA and LTA”

“Drawing an UFPLS triggers the MPAA. The entire lump sum (not just the 25% tax-free element) is treated as a BCE 6 if drawn when under age 75. Any amount paid in excess of the individual’s remaining lifetime allowance is not an UFPLS and is treated as a lifetime allowance excess lump sum, attracting tax at 55%”

20

Phased Retirement

“Phased retirement is available under pension legislation that is ‘enabling’. In other words, although lawful, they are subject to scheme rules and what facilities pension providers are prepared to offer at a realistic cost.

Even so, there are certain restrictions:

It is unusual for a private sector defined benefit scheme to allow the phased introduction of benefits.
If an individual is entitled to a PCLS that exceeds 25% under the A-Day (6 April 2006) transitional protection rules, that transitional protection will be lost if all the benefits from the scheme are not taken simultaneously.
If an individual has a protected pension age because they worked in a ‘special occupation’ before A-Day, they will lose that protection if all the benefits are not taken simultaneously from the scheme.”

“The traditional version of phased retirement relied on a combination of multiple arrangements and lifetime annuities”

“The option offers a secure income, but unused funds continue to enjoy active management and investment flexibility. However, annuity rates are at a historic low and fixed once the annuity is purchased, and if conventional lifetime annuities are used the option does not allow any flexibility of income other than by changing the rate of phasing. Even then, the existing annuity income will generally be fixed.”






21

Inheritance Tax Trap:

“The only IHT danger point is that HMRC may seek to charge IHT on the pension if the member was in serious ill-health at the time of the transfer and death occurs within two years of a transfer.

This is because HMRC consider transfers of benefits from one scheme to another to be a transfer of value for IHT purposes. This is down to the fact that the member could direct that the transfer is made to an arrangement where the estate would be entitled to the death benefit. In practice, however, HMRC will only treat this as being a transfer of value for IHT which has more than a nominal value where the member is in serious ill-health when making the transfer and subsequently dies within two years of making the transfer.”

22

Comparison of Pension options;

Reference page 148

23

Death Benefits

“Nominee

This is any individual nominated by the member (other than a dependant) to receive the benefits from the pension plan upon the member’s death. If there is no nomination made before death (either to an individual or a charity) and there are no dependants, the scheme administrator can make the nomination on behalf of the scheme member.

Successor

This is any individual nominated by a dependant or a nominee to continue to receive the dependant’s/nominee’s flexi-access drawdown plan upon the dependant’s/nominee’s death. It can also be anyone nominated to continue to receive the income from a previous successor’s flexi-access drawdown plan. If a nominee or successor fails to nominate someone to continue to receive the income from their flexi-access drawdown plan, then the scheme administrator can do so on their behalf.

Dependants, nominees and successors can use their uncrystallised/drawdown funds to take the entire pension as a lump-sum, take income withdrawals, or purchase a lifetime annuity. Dependants also have the option of purchasing a scheme pension.”

Excerpt From: Neil Dickey BSc (Hons) Chartered Financial Planner FPFS. “AF7: 2018-19 Study text.” The Chartered Insurance Institute, 2018-07. iBooks.
This material may be protected by copyright.

24

Scheme pension:

“There are four types of benefits potentially payable when a member dies while in receipt of a scheme pension:

1. dependant’s pension;
2. guarantee periods;
3. pension/annuity protection lump sums;
4. and lump sums.”

25

Scheme pension, Dependant's pension:

“HMRC definitions of dependant:

The spouse or civil partner of the member at the date of the member’s death is considered a dependant. Additionally, if the rules of the pension scheme so provide, the BCE 5D test can be extended to apply not only at the date of the member’s death, but when the member first became entitled to a pension under the pension scheme.
A person who was not married or in a civil partnership with the member at the date of the member’s death, and is not the member’s child, is a dependant if the scheme administrator agrees that the person meets the following criteria at the date of the member’s death:
the person was financially dependent on the member;
the person’s financial relationship with the member was one of mutual dependence; or
the person was dependent on the member because of physical or mental impairment.
A child of the member is a dependant if the child has:
not reached the age of 23; or
reached age 23 and, in the opinion of the scheme administrator, was at the date of the member’s death dependent on the member because of physical or mental impairment.

26

Scheme pension; Dependant's pension, conditions:

“dependant’s pension paid as a scheme pension has certain conditions attached to it:

It must not be subject to any guarantee period.
It cannot have pension/annuity protection.
It cannot be surrendered or assigned except under a pension sharing order.
It can be transferred in payment.
It cannot provide any further benefit on the dependant’s death.
It is non-commutable other than on grounds of triviality.”

27

Scheme Pension Death Benefits continued:

“A dependant’s pension can be paid immediately on the death of the member of the scheme pension, or only from the end of the guarantee period, if applicable.

Where a scheme pension is paid to a widow/widower or surviving civil partner of the deceased, it can, depending on the scheme rules, cease on their remarriage or their entering into a new civil partnership.
Where a scheme pension is payable to a child of the deceased, the income must cease on them attaining age 23, unless there are physical or mental health grounds for them still being deemed a dependant.”

“On death before the member reaches age 75, there are no restrictions on the size of dependant’s benefits. However, if the member dies on or after their 75th birthday while receiving a scheme pension, the aggregate of dependant’s benefits cannot exceed the member’s scheme pension. Any excess dependant’s scheme pension is treated as an unauthorised payment and taxed accordingly.

The member’s scheme pension at the date of death is calculated as:

the member’s actual (and prospective) scheme pensions payable under the scheme in the year to the date of death; plus”

“5% of any PCLS (tax-free lump sum) drawn by the member.
If the member dies within twelve months of the start of their pension, the actual pension is taken as the expected pension for the full year.”

“However, the payment of a scheme pension to a dependant still does not result in the benefit value being assessed against the late member’s remaining lifetime allowance.”

28

Scheme Pension Death Benefits part 3:

“4C1B Guarantee periods
Scheme pension payments have not been impacted by the April 2015 pension freedoms. This means they can still only be guaranteed for a maximum of 10-years. Also, the guaranteed payments are taxable as income under PAYE for the recipient(s) and cannot be commuted. This is irrespective of the age of the member when they die.

4C1C Scheme pension/annuity protection
This form of death benefit was previously more commonly known as ‘capital protection’ in the annuity market. Rather confusingly, where the benefit comes from a DB scheme pension, this benefit is known as ‘pension protection’, but when it comes from a money purchase scheme pension, it is known as ‘annuity protection’.”

“The maximum lump sum payment on death is the deemed original pension cost (for a scheme pension this is calculated on the 20x basis), less gross income payments made to the date of death.
The lump sum will be tax free where the member died before reaching the age of 75, and where the member died having reached the age of 75 the lump sum will be taxable. Where the payment is made directly to the beneficiary, it will be taxable as the recipient’s pension income under PAYE. A payment made to an individual who is receiving the payment in their capacity as a trustee or personal representative will be subject to the special lump sum death benefits charge of 45%.
Pensions that started in the period 6 April 2006 until 5 April 2011 would have had an upper age restriction of 75 on the death benefits. While the age 75 restriction has now been removed, this does not help those individuals who started benefits with the restriction, as the terms and conditions when the pension started will still apply.”

29

What are the Death Benefits from a Lifetime Annuity?

“There are three main benefits potentially payable when a member dies while in receipt of an income payable as a lifetime annuity:
survivor’s annuity;
guarantee periods; and
pension/annuity protection lump sums (also known as value protection).
Most, but not all, annuities will only pay death benefits that are selected by the member at the outset of the annuity contract. This is because most annuities contain mortality cross-subsidies”

“Dependant’s pension
A dependant’s lifetime annuity has certain conditions to fulfil. It:
must not be subject to any guarantee period;
cannot have pension/annuity protection;
cannot currently be surrendered or assigned, except under a pension sharing order;
can be transferred in payment;
cannot provide any further benefit on the dependant’s death; and
is non-commutable, other than on grounds of triviality.
A dependant’s lifetime annuity can be paid immediately on the death of the individual in receipt of the lifetime annuity, or only from the end of the guarantee period if applicable.”

“There are no rules limiting the level of a dependant’s lifetime annuity being greater than the level of income that was paid to the deceased member immediately prior to their death. However, the majority of annuity offices will limit the maximum dependant’s income to 100% of the member’s pension.

With the changes introduced under the Finance Act 2015, it is possible for a lifetime annuity to be written to provide death benefits to a nominee of the member as well as a dependant of the member, with no requirement for them to be financially dependent upon them.”

“Guarantee periods
Since 6 April 2015, lifetime annuity payments may be guaranteed for any period at the discretion of the annuity provider and are no longer restricted to the previous limit of up to ten years.
Some annuity providers offer a guarantee period of up to 30 years. This can effectively offer a ‘money back guarantee’, where regardless of when the annuitant dies, the original purchase price should be returned as a combination of income and guarantee period.”

“Annuity protection
This form of death benefit was previously more commonly known as capital protection (also known as value protection). It is a lump sum payment made from the annuity office calculated as the original annuity purchase price, less the sum of the gross income payments made to the late member until their date of death. This is payable irrespective of whether the member dies before or after reaching age 75, but is taxable if death occurs on or after that age.”

30

How are Lifetime Annuity Death Benefits taxed?

“Taxation of annuity death benefits – lump sum payments
A lump sum payment may be made on death where the annuitant selected either a guarantee period and the income instalments have been commuted, or as a result of annuity protection.
If the annuitant dies before reaching age 75, and the payment is made within the two-year relevant period following their death, the payment is not taxable.

If the annuitant dies when they are aged 75 or older, or if they die before age 75 but the lump sum payment was not paid within the two-year relevant period, then the lump sum will be taxed as the recipient’s pension income under PAYE. Where the payment is made to an individual who is receiving the payment in their capacity as a trustee or personal representative, it will be subject to the special lump sum death benefits charge of 45%.”

“Taxation of annuity death benefits – income payments
There is no liability to income tax in respect of an annuity income paid to a beneficiary of a deceased member of a registered pension scheme if all of the following conditions are met:
It is paid in respect of a deceased member who died before reaching age 75.
The deceased member died on or after 3 December 2014, when in receipt of a member’s lifetime annuity.
The first income payment made under the dependant/beneficiary’s annuity, or under a term certain guarantee, was made on or after 6 April 2015.”