R04 Chapter 7 Flashcards
1
Q
What is crystallisation?
A
The taking of an income or the provision of a lump-sum payment (in the form of PCLS, and UFPLS, or as a lump sum death benefit).
2
Q
Can you take benefits whenever you want?
A
It is not necessary to retire to take benefits but there is a minimum age at which benefits can be taken (normal retirement age). Currently 55 but the Gov has introduced legislation which will raise this to 57 from 2028.
3
Q
What are the income options for a DC scheme?
A
- Purchase a scheme pension
- Purchase a lifetime annuity
- Enter flexi-access drawdown
- USe some or all of their funds to provide and UFPLS
This applies to arrangements rather than schemes. So the rules don’t apply to DB schemes, but they do apply to AVC (additional volutnary contributions) schemes offered to members of DB schemes.
BUT DC schemes don’t have to offer flexible options. The rules of the scheme deteremine the options available.
4
Q
What is a PCLS?
A
Pension Commencement Lump Sum - most cases 25% is paid tax-free, with the balance taxable as pension income via PAY.
From 23/24 the total amount of tax-free lump sum payments a member can take from all pensions is limited to £268,275 (quarter of the allowance) unless transitional protections apply.
5
Q
What is a small pots payment?
A
Payments valued at £10,000 or less.
6
Q
What rules apply to small pots payments?
A
- Member can taken a max of 3 small pots payments from non-occupational schemes
- Member can take an unlimited number from unconnected occupational pension schemes
- £10,000 limit is per small pots payment (can be taken without reference to the value of the member’s other pension benefits)
- Can be taken once minimum pension age is reached or earlier if there’s a protected pension age or satisfies ill-health conditions
- Small pots payments from uncrystallised funds aren’t tested against member’s lifetime allowance as they are not treated as BCE’s and no lifetime allowance needs to remain to take one
- Can be paid from both crystallised and uncrystallised funds
7
Q
What is trivial commutation lump sum?
A
Can be paid in respect of benefits held in a DB scheme and, subject to certain conditions, in respect of an ‘in payment money purchase in house scheme pension on the grounds of triviality.
8
Q
What is an ‘in payment money purchase in-house scheme pension’?
A
A scheme pension payable by the scheme administrator, to which the member has become entitled under a DC arrangement.
9
Q
What benefits can be commuted on the grounds of triviality?
A
- Uncrystallised DB pension rights
- DB scheme pensions that are in payment
- In payment money purchase in-house scheme pension
10
Q
What is the period for commutation payments?
A
Any payment must be made within a 12 month commutation period. This starts when the first commutation payment is made. No earliet than the nominated date and no later than 3 months after the date. If member fails to select the nominated date, the date of the first payment becomes the nominated date.
10
Q
What are the conditions for a lump sum payment after 16 September 2016 to be considered a trivial commutation lump sum payment?
A
- Member hasn’t been paid a trivial commutation lump sum previously (from any pension scheme, except any earlier payment within the commutation period
- Lump sum is paid in respect of a DB arrangement and/or an in-payment money purchase in-house scheme pension
- Value of the member’s pension rights (DB and DC, including those previouslt crystallised for LTA purposes) on the nominated date doesn’t exceed £30,000
- Lump sum is paid when LTA is available
- Normal minimum pension age is reached or ill health conditions or protected pension age
- Lump sum extinguishes member’s entitlement to DB and in-payment money purhase in-house scheme pensions under the registered pension scheme making the payment
10
Q
What is the nominated date?
A
The date chosen by the member on which all of the pension benefits are valued.
11
Q
What benefits are valued on the nominated date?
A
All pension rights (DB and DC) that have previously been crystallised and are assessable against the LTA (including any pensions in payment on 5 April 2006) and any uncrystallised benefits.
Small pots payments prior to the nominated date aren’t included as they’re not BCEs. Any payments made on grounds of triviality before 6 April 2006 are not included.
If benefits aren’t commuted within 3 months of the nominated date, a new date can be chosen to restart the process.
12
Q
When’s the earlier a person can receive a trivial commutation lump sum?
A
Their 55th birthday (unless ill health or there’s protected pension age). This is the earlier the commutation period can start, so the nominated date cannot be earlier than 3 months before the 55th birthday.
13
Q
Can you commute mutliple times in life?
A
A person can only have one commutation period in their lifetime. If not all schemes are commuted within the period, they cannot be commuted later.
All benefits in a scheme must be commuted, but not all schemes must be commuted.
14
Q
When must a trivial commutation lump sum death benefit be paid?
A
- When a survivor commutes a survivor’s pension OR
- When a member dies within the guarantee period of a pension they are receiving and the recipient of the guarantee wishes to commute the remaining payments
In both cases the maximum that can be paid is £30,000.
Where the lump sum amount is over £30k, the excess is not a trivial commutation lump sum death benefit and is instead an unauthorised member payment and taxed accordingly.
15
Q
Is a trivial commutation lump sum death benefit a BCE?
A
No, so it’s not tested against the LTA, and it doesn’t use up the deceased member’s or the survivor’s LTA.
16
Q
What conditions must be met to commute a survivor’s pension?
A
- The pension being commuted must be paid to a dependant or niminee of the member
- The payment made must extinguish the survivor’s entitlement to both pension and lump sum death benefits under the scheme
17
Q
Who can commute a guarantee?
A
No restrictions - anyone can receive payments under a guarantee so long as they’re entitled to them after the member’s death as long as it extinguishes their entitlements under the scheme.
18
Q
How do you value benefits for commutation?
A
- Income received on 5 April 2006 - Annual income being receive on 5 April 2006 x 25, and ignore any tax free cash that was taken in connection with the pension
- Income starting on or after 6 April 2006 - Value of the BCE in monetary terms, and any associated PCLS must also be taken into account
19
Q
How do you value crystallised funds?
A
- Valuation of DC rights = the value of the fund
- Valuation of DB rights = Annual pension entitlement as at nominated date x 20, plus any PCLS paid in addition to the pension
20
Q
How can a scheme pension be paid?
A
One of 2 ways:
1. Paid directly from the scheme’s assets
2. Paid by an insurance company selected by the scheme administrator
This is the case whether the scheme is a DB scheme or an occupational defined contribution scheme.
21
Q
What are the potential benefits for a scheme paying the scheme pension directly from the scheme assets?
A
- There’s no immediate outflow of capital from the scheme (i.e. they only have to pay out the monthly income rather than the capital cost of buying this income via an insurance company)
- Funds in the scheme remain invested
- Scheme has the option to secure the income at a later date if desired, and may benefit from an increase in annuity rates or the worsening of the member’s health (smalle capital sum is needed to secure the same level of income)
- If member or dependants die sonner than expected, the scheme retains the unused funds for the benefit of all members, whereas if the income was secured with an insurance company, they would benefit from these funds
22
Q
What are the potential drawbacks of paying the scheme pension directly from the scheme assets?
A
- Payments must be made whatever the funding position of the scheme
- Member or their dependants may live longer than expected and the scheme bears the cost of these extra payments
- Scheme retains the longevity and investment risk
- Additional administration for the scheme
23
How are scheme pension payments categorised?
Regardless of how they're paid (directly from scheme assets or via an insurance company) they are considered to be secured. The format of the benefits is agreed at outset and cannot be altered, even if the member's circumstances have changed.
24
How does the name on the policy affect the payment?
If the scheme pension is secured via an insurance company it may be in the name of the member or the trustees.
If in member's name: pension payments generally pass directly from the insurer to the member.
If in the name of the trustees: Likely to go from insurer to the scheme, and then from the scheme to the member. It's possible for the insurance contract to enable the insurer to act as a trustee and pay the member directly.
25
How can a DB scheme pay benefits on retirement?
A scheme pension is the only way for a DB pension to pay benefits at retirement. To use any other retirement options (i.e. annuity or enter drawdown), the benefits must be transfered out of the scheme before retirement.
26
How is income from a scheme pension taxed?
Pension income via PAYE.
27
What are the two exceptions for pension flexibility rules for scheme pension?
Pension flexibility rules generally do not apply to scheme pensions. 2 exceptions:
1. In respect of death benefits
2. In respect of a member of a DC scheme who receives a scheme pension directly from the scheme where fewer than 11 other people are receiving a scheme pension - here the member is treated as having flexibly accessed their pension and is thus subject to MPAA rules from the date the first payment is received.
28
What are HMRC's requirements to qualify as a scheme pension?
The pension must be:
1. Paid for the life of the member
2. Paid at least annually
3. Incapable of being reduced year on year except in limited circumstances
4. Paid by the scheme administrator or by an insurance company chosen by the scheme administrator
HMRC allows a scheme pension to offer the options of a:
1. Guarantee period
2. Capital Protection Lump Sum
29
What are the 9 circumstances where HMRC allows a scheme to reduce the annual payments to a member or stop them enitrely?
1. It's being paid due to ill-health and stops or reduces
2. Reduction is applited to all scheme pensions paid under the scheme (e.g. were the scheme has to reduce pensions payable over the previous year's level on the basis of actuarial advice)
3. It's a bridging pensions that's being reduced or stopped at SPA by an amount that doesn't exceed the state retirement pension entitlement
4. Reduced while the scheme is being wound-up due to insufficient funds and assets in the pension scheme to continue to pay the pension at the existing rate
5. Rat ie being reduced to due a pension sharing order
6. Rate is reduced due to forfeiture of entitlement permitted by regulations
7. Due to a court order
8. A scheme pension from a public service pension scheme is reduced due to abatement
9. The rate is being reduced on or after 6 April 2013 due to the scheme administrator paying an annual allowance charge in relation to the member
30
When can a member take PCLS from a scheme pension?
Must be paid no earlier than 6 months before, and no later than 12 months after the date the member becomes entitled to that scheme.
To be treated as PCLS, entitlement to the lump sum must be linked to the scheme pension entitlement.
31
How is the remainder of the benefits paid after PCLS is taken in a scheme pension?
Remainded of the benefits must be paid as a lifetime income:
DB schemes - Benefits determined by the scheme rules e.g. guarantees, spouse/dependant's pensions, escalation
DC schemes - Pension bought by scheme administrator, which may allow the pensioner to choose options. Options chosen affect the starting level of the pension - the more options chosen, the lower the starting level.
32
How are benefits valued if a member of a DC scheme chooses to accept the offer of a scheme pension rather than a lifetime annuity?
Benefits are valued under BCE 2 rather than BCE 4.
33
How does phasing receipt of a DB scheme work?
Member becomes entitled to a portion of accrued benefits, deferring receipt of the balance - this can continue to grow because:
1. The member remains employed and so continues to accrue benefits
2. It is revalued in deferment
34
How does phasing receipt of a DC scheme work?
Member takes a portion of the monetary value of the scheme to secure an income. Balance is left invested and member has complete flexibility as to how to take them (i.e. they don't need to take a scheme pension, but can use an annuity or drawdown pension)
35
What are the 3 ways in which a scheme pension can provide death benefits?
1. A dependant's scheme pension
2. A guarantee period
3. A lump-sum death benefit
36
What is a dependant's scheme pension?
A scheme pension can be set up following a member's death so that an income is paid to their dependant.
Only a dependant can receive a continuing income from a scheme pension.
If the member's scheme pension was secured via an insurance company, it will paud the dependant's scheme pension based on the format that was purchased and this cannot be altered by the dependant.
37
What are the differences between a dependant's scheme pension for DB and DC schemes?
DB - Dependant has no choice about the format of the income they receive whether it comes from the scheme's assets or an insurance company.
DC - Scheme administrator must give the dependant the choice of buying a dependant's annuity rather than a dependant's scheme pension. If scheme rules permit, a DC scheme can give the dependant the choice to receive the income as a dependant's flexi access drawdown fund.
38
What are the rules for a dependant's scheme pension?
1. Doesn't have to be paid for the life of the dependant
2. Many scheme rules state the scheme will cease if the spouse remarries
3. Many scheme rules reduce the age of independence from 23 to 18 or 21
4. Doesn't have to be paid annually
5. May be reduced at any time according to scheme rules or annuity contract terms
6. If there's more than one dependant, each of them may be provided with a dependant's scheme pension
7. A scheme pension paid to a dependant, regardless of payment method, cannot give rise to any further PCLS, and cannot provide further benefit after the death of the dependant.
8. A dependant's scheme pension cannot include: a guarantee period or any form of pension protection.
9. You cannot commute a dependant's scheme pension except on the grounds of triviality.
39
What are the rules for a dependant's scheme pension if the member died before or after 75?
Before 75 - no limit on the amount that can be paid as a dependant' scheme pension.
After 75 - if died after 75 while receiving the scheme pension, HMRC imposes limites on the amount the dependant can receive.
40
What are the rules for guarantee periods for a scheme pension?
A scheme pension may be guaranteed for no more than 10 years. Often known as 'term certain'. When member dies during the guarantee period, the full pension conitnues to be paid until the guarantee period ends.
HMRC has no restrictions on who can receive payments in respect of a guarantee.
41
What 3 situations mean HMRC allow a scheme to cease payment under a guarantee?
If the recipient of the scheme:
1. Get married
2. Reaches age 18
3. Ceases to be in full time education
Schemes aren't forced to cease payments on these conditions however.
42
Is it possible to commute a continuing income under a guarantee?
Yes - possible to commute a continuing income under a guarantee for a trivial commutation lump-sum payment.
43
What are the options for lump sum death benefits?
Depends on where they arise:
DB lump-sum death benefits - only payable from a DB scheme
Pension Protection lump sum - Only payable from a scheme pension that arises from a DB scheme
Annuity protection lump sum - Only payable from a scheme pension that arises from a DC scheme
44
What is a DB lump-sum death benefit?
Paid from a DB arrangement following a member's death. E.g. a member dies during employment and the scheme pays out a multiple of their salary as a lump sum following their death e.g. 4 times their salary.
It's possible for the scheme to pay it where the member dies after crystallisation (once they are in receipt of a scheme pension). Some schemes offer a DB lump sum death benefit in place of a guarantee (it's rare).
45
What is a pension protection lump sum?
A DB scheme can pay a pension protection lump sum on the member's death. This is included at the start of the scheme and guarantees that a certain amount of the pension will be provided. If member dies before the guarantee can be paid, the balance can be paid as a lump sum. Member MUST specify that it's to be treated as a pension protection lump sum death beenfit rather than a DB lump-sum death benefit.
46
What are the restrictions on pension protection lump sums?
1. Can be paid whatever age the member dies.
2. No limit on who can be paid nor time limit for when it can be paid.
3. Maxium lump sum payment allowed under HMRC rules is: Thecrystallised amount of the scheme pension for LTA purposes MINUS the gross amount of scheme pension paid to member.
46
What are the feature of a DB lump sum death benefit?
1. Can be paid in respect of crystallised and uncrystallised funds.
2. No upper limit on the amount that can be paid.
3. It's a BCE 7 if member dies before age 75 and benefits are paid within a 2 year window. Amounts paid in excess of member's LTA are taxed as the recipient's pension income via PAYE.
It's not a BCE where death ccurs on or after member's 75th b-day and/or payment is made outside 2 year window.
4. Tax treatment depends on age of member at death.
46
Is a pension protection lump sum a BCE?
No.
47
What are the features of a pension protecion lump-sum death benefit?
1. Only paid from crystallised funds
2. Max payment permitted is cyrstlliased amount of scheme for LTA purposes MINUS the amount of the scheme paid to the member
3. Not a BCE so not tested against LTA, regardless of age at death.
4. Tax treatment depends on age at death.
48
What is an annuity protection lump sum?
Scheme pensions arising from DC schemes may only offer a lump sum death benefit by way of an annuity protection lump sum. Also available to members of any DC scheme who chose a lifetime annuity. An annuity protection lump sum isn't a BCE.
Can be paid regardless of age at death of member. HMRC set no conditions on who can be paid or any time limit.
49
What's the maximum annuity protetion lump sum death benefit that can be paid under HMRC rules?
The amount of the scheme pension or annuity which crystallised for LTA purposes
MINUS
The gross amount of scheme pension or annuity which has been paid to the member.
50
What is a lifetime annuity?
Contract bought from an insurance company. Can only be bought using DC funds. They can be uncrystallised or previously crystallised and held in a capped drawdown fund or a flexi-access drawdown fund. In return, the insurer pays the member an income.
51
What factors affect the income paid from a lifetime annuity?
1. Size of the fund used to buy the annuity
2. Annuity rates available - these depend on member's age and the options selected
52
What is a flexible lifetime annuity?
A lifetime annuity set up on or after 6 April 2015 that allows the income paid from the annuity to fall by more than the prescribed amount.
53
What is a conventional lifetime annuity?
Set-up either before 6 April 2015, or after 6 April 2015 but does not allow the income to fall by more than the 'prescribed amount'.
54
What are HMRC's requirements for a lifetime annuity purchased on or after 6 April 2015?
1. Annuity must be purchased from an insurance company
2. Annuity must be pauable for the member's life or, if later, the expiry of the guarantee period and there is no limit on how long the guarantee period can last
3. There's nothing stopping the income paid from a lifetime annuity reducing by more than the amount prescribed by HMRC.
55
What are the 3 ways that an insurance company can set up a lifetime annuity after 6 April 2015?
1. Level income or rising by a fixed amount (e.g. 2.5% each year)
2. Income that varies
3. An income that decreases by any method set out in the contract
56
How can a lifetime annuity fluctuate in payment?
1. Indexation - changes in line with RPI, market value, or an index reflecting the value of 'freely marketable assets' - but the change in income can't exceed the change in the index
2. With-profit variations - variation reflects variable bonuses added due to the annuity fund being invested in an insurance company's with-profit fund
3. Indexation/with-profit combination
4. Selected rate of growth, linked to methods 1-3 - member selects the starting level of the annuity based on an assumed annual level of growth of between 0-5%
5. Felxible withdrawals - review conducted at minimum every 5 years determines the max and min amount of income that may be drawn each year. Max amount payable is 102% of the annual rate of a level annuity that could be purchased by the member.
57
What can the member choose for a lifetime annuity?
1. Frequency of income
2. How long they want it guaranteed for
3. How much annuity protection they want
4. The level of survivor's pension income payable when they die
58
What are the 3 ways that a lifetime annuity can provide a death benefit?
1. Survivor's annuity - bought before 6 April 2015: member could include a dependant's annuity if they chose. Bought after 6 April 2015: if rules allow, member can choose that a continuing income is paid to a dependant or nominee after their death. These are typically a percentage of the member's income.
2. Guarantee period - before 6 April 2015: maximum guarantee period that could be provided under a lifetime annuity was 10 years. This limit has been removed for annuities bought after, but a limit will be imposed by the annuity contract.
3. Annuity protection
59
What are the 2 main factors affecting annuity rates offered by insurance companies?
1. Long-term bond yields
2. Longevity expectations
60
What are long-term yield bonds (these affect annuity rates alongside longevity expectations)?
The way an insurance company ensures it has enough money to pay the regular income of an annuity is by investing the funds used to purchase it in long-term bonds.
The most secure bonds are gilts. They are issued by the government and, as gilts are UK investments, have no currency risk.
Annuity rates fall as interest rates fall because gilt yields are directly correlated with interest rates.
61
What are annuitant specific factors?
Factors affecting annuity rates specific to the annuitant.
1. Age and expected longevity - insurance companies use mortality rates to establish how long an annuitant is expected to live.
New annuity contracts must use unisex/gender neutral annuity rates. Rates for men and women are 'blended' to arrive at a unisex rate.
Unisex rates don't apply for some medical conditions exclusive to one sex, or where the income is purchased for the member by the scheme, so where a DB scheme purchases an income for the member.
2. Health/lifestyle - poor health or having a certain lifestyle may mean that an individual can obtain a higher income under an impaired life or enhanced annuity.
3. Options selected.
62
What is an impaired life annuity?
Offers higher annuity rates to individuals with a lower than average life expectancy (typically less than 5 years to live) because they suffer from certain conditions.
Likely to be fully underwritten using medical records.
63
What is an enhanced annuity?
Offer higher rates to individuals with particular conditions. Underwriting is required, but is done on an automated basis using a points system rather than medical records.
64
What is an investment linked annuity?
Most commons ones are with-profit annuities and unit-linked annuities.
65
What is a with-profit annuity?
Purchase price is invested in the life office's with-profit fund. Income reflects the investment performance of the with-profit fund. But bonuses delcared won't exaclty reflect the investment returns achieved each year, as the actuary will try to produce a smooted return for the investor by holding back some returns in good years to allow reasonable bonuses in bad years.
66
How does a with-profit annuity work?
1. The returns on the with-profit fund are paid as bonuses
2. The annuitant selects an anticipated bonus rate based on the level of bonus that they feel
the underlying investments will achieve, e.g. 3%
3. The initial level of income paid reflects the anticipated bonus rate selected
4. The higher the selected anticipated bonus rate, the higher the initial income, although if
the total bonus actually declared in a given year is less than that selected, the initial
income will be reduced the following year to reflect the fall.
67
What is a unit-linked annuity?
Annuity income varies according to the return on the life office's unit-linked funds. But unlike a with-profit annuity, there is no smoothing, so there's a higher risk to the annuitant. Bad years will be bad.
68
How does a unit-linked annuity work?
1. The initial income is calculated in monetary terms and this is converted into a number of
‘notional units’;
2. The level of the initial income is based on the provider’s actuarial tables, which take into
account the annuitant’s age, their beneficiary’s age (if applicable), the size of the pension
fund and any optional benefits that have been selected (e.g. a guarantee period);
3. The value of the units at any time determines the amount of the annuity payment,
meaning that the level of income can fluctuate in line with the performance of the
underlying investments;
4. The annuitant selects an anticipated growth rate at outset.– The higher the rate selected, the higher the initial income. As the units are all given
the same value, an annuitant who selects a higher anticipated growth rate is given a
higher number of units initially;
5. Units are then encashed on a set basis to provide the income, with the number of units
encashed in line with the anticipated growth rate; and
6. If the underlying growth is in line with the anticipated growth rate, the annuitant’s income
will remain level.
This means that an annuitant who selects a higher anticipated growth rate needs a
higher return to maintain and, hopefully, increase their income.
69
What are the features of a scheme pension?
1. Level on income set at outset. Can only decrease in certain circumstances st by HMRC. Taxed as member's pension income via PAYE.
2. DB scheme rules determine PCLS avaialble. Members of a DC scheme can select up to 25%, or HMRC max if different.
3. Doesn't trigger MPAA rules unless scheme pension is paid directly from the funds of a DC pension with less than 11 other members.
4. LTA - income is assessed using BCE 2, PCLS is assessed using BCE 6.
5. Guarantee period of no more than 10 years. Continuing income under the guaranee is taxed as survivor's pension income.
6. Continuing pension only available to those qualifying as dependants. Income taxed as dependant's pension income.
7. DB scheme can provide a DB lump sum death benefit or a pensoon protection lump sum.
DC scheme can only provide an annuity protection lump sum.
DB lump sum death benefit is tax free if members dies before 75 and funds are paid in 2 years. If paid outside 2 years and/or member dies after 75, lump sum is taxed as pension income via PAYE if paid to an individual.
Pension protection and annuity protection lump sums are tax free if member dies before 75 with no LTA test. In all other cases the lump sum is taxed as pension income if paid to an individual.
70
What are the features of a lifetime annuity?
1. Income level set at outset. Conventional lifetime annuity has limited ability to decrease. Flexible can decrease a greater amount. Taxed as member's pension income.
2. Member can decide how much PCLS they take to a max 25% of fund value, or HMRC max if different.
3. Conventional lifetime annuity doesn't trigger MPAA rules. Flexible annuity does.
4. Income is assessed using BCE 4, PCLS is assessed using BCE 6.
5. Guarantee period with no time limit. If member dies before 75 the continuing income under the guarantee is paid to survivor tax free. If 75 or older at death, the continuing income is taxed as survivor's pension income.
6. Continuing pension available to any nominated survivor. If dead before 75, survivor's annuity income is paid tax free. If 75 or older at death, survivor's annuity is taxed as survivor's pension income.
7. Annuity protection lump sum is the only death benefit option. Tax free if member dies before 75 with no test against LTA. If dead after 75, lump sum is taxed as pension income via PAYE as long as it is paid to an individual.
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