Topic 10: Pension Products Flashcards
(37 cards)
What is the defined-benefit pension scheme?
An occupational pension scheme where the final benefits are defined, usually as a fraction of final (or near final) salary or career average earnings for every year of membership in the scheme. Eg, a 1/60th scheme would provide a benefit of 1/60th final salary for every year of membership. The employer is responsible for ensuring the promised benefits are provided, so carries all the risk.
What is the Defined - contribution pension scheme?
A pension scheme where the individual has their own pension pot, either as part of an occupational scheme or a personal pension. Contributions from the individual and perhaps their employer are invested, and at retirement the individual’s pot is used to provide the benefits. The final benefits are not guaranteed, and so the risk lies with the individual.
What is a Pensions annual allowance?
The annual limit for pension contributions for claiming income tax relief. Individuals can contribute the lower of their earned income or the annual allowance and relief income tax relief. An employer can also contribute, but if the total from both sources exceeds the annual allowance the individual will be subject to a tax charge on the surplus.
What is a Tapered annual allowance?
If an individual has ‘adjusted’ income above a certain figure, their annual allowance is tapered (reduced) by £1 for every £2 above the stated figure. The adjusted annual allowance cannot fall below a stated figure.
What is a Money purchase annual allowance (MPPA)?
If an individual draws benefits from their defined contribution (personal pension, etc) pension using flexi‑access drawdown or takes an uncrystallised funds pension lump sum (UFPLS), they can continue to fund their pension, but their Annual Allowance is reduced significantly.
What is a Flexi-access drawdown?
When taking personal pension benefits, the plan holder can take the tax-free pension commencement lump sum and leave the rest of the fund invested. Technically the remaining fund becomes a drawdown account. They then withdraw income from the fund (drawdown) as and when they want, with each payment being taxable as income. There is no requirement to take income at all or to take a regular amount – the income element is totally flexible.
What is a Uncrystallised funds pension lump sum (UFPLS)?
When wishing to take pension benefits, the individual does not move the account into drawdown by taking the tax-free pension commencement lump sum. Instead they take a series of lump sums as and when they want, with 25% of each withdrawal being tax free and the balance being taxed as income.
What is Direct Pay Arrangement?
Relates to pensions, where the employer deducts the employee’s pension contribution from their gross salary and sends it to the pension provider.
Threshold income is calculated through the following steps:
- Calculate total net income for the tax year.
- Deduct any gross pension contributions that benefited from relief at source
(but excluding any employer contributions). - Deduct any lump sum death benefits from registered pension schemes.
- Add any reduction of employed income for pension provision through
salary sacrifice schemes and flexible remuneration arrangements made
after 8 July 2015
Adjusted income is calculated through the following 6 steps:
- Calculate total net income for the tax year.
- Add claims made for tax relief on pension savings paid before tax relief
was given. - Add pension savings made to pension schemes where tax relief was given.
- Add any tax relief claims on pension savings made to overseas pension
schemes (for non‑domicile individuals). - Add employer pension contributions.
- Deduct any lump sum death benefits received from registered pension
schemes.
What is Lifetime Allowance?
If the total value of an individual’s pension benefits exceeds the lifetime allowance at the point when benefits are taken, there is a lifetime allowance tax charge. The pension provider will deduct the tax before any benefits are issued. There are different tax rates charged depending on how the money is paid out, with lump sums attracting a higher charge than funds taken as income or withdrawals.
What is the ‘Marginal Rate’ of tax?
A person’s highest marginal rate of tax is the highest rate
that they pay on their income. For example, a person whose
taxable income falls within the higher‑rate band would pay 20
per cent on their income up to the basic‑rate threshold and 40
per cent on any income that lies above that. As they only pay higher‑rate income tax on part of their earnings, they would
only receive tax relief at the highest rate (40 per cent) on that amount of their pension contributions (eg if £5,000 of income was within the higher‑rate band, then £5,000 of pension contributions would be eligible for an additional 20 per cent tax relief). Any contribution in excess of that amount would
receive tax relief at the basic rate.
When and how can benefits be taken?
Benefits can generally be taken from normal minimum pension age, which is currently age 55 (rising to 57 in 2028). When benefits are drawn the scheme member can usually take up to 25 per cent of the fund tax free as a pension
commencement lump sum (PCLS).
The rules regarding to taking the remainder depend on the type of scheme.
When and how can benefits be taken from a Defined-benefit scheme?
The balance over and above any tax‑free PCLS
must be used to provide an income, typically as a scheme pension direct
from the pension fund
When and how can benefits be taken from Defined-contribution scheme?
The balance once any tax‑free PCLS has
been taken can be used to provide income in the form of an annuity or
flexible access drawdown (FAD). An alternative is to take a UFPLS – we cover
these options in more detail in section 10.5.3. Providers are not obliged to provide customers with the option of taking UFPLS, but customers have the option of switching providers should they wish to do this.
What is Pension commencement lump sum?
The sum (up to 25 per cent of the individual’s pension fund) that may be taken at retirement tax‑free.
What is the Collective defined-contribution pension schemes?
There is a demand for a third type of scheme, which can provide more
predictability for scheme members than defined contribution, without the
cost volatility for employers associated with defined benefit. The Pension Schemes Act 2021 provides a framework for the UK’s operation and regulation
of collective money‑purchase schemes (commonly known as collective
defined‑contribution pensions). The new collective defined‑contribution
(CDC) pension will see both the employer and employee pay into a joint fund, with pensions paid out from this shared pot. The benefits of the new scheme include that it offers predictable costs for the employer and is more resilient against economic shocks. The Royal Mail and Communication Workers Union will be the UK’s first CDC scheme and a case study will be done on how UK workers receive the new scheme and how successful these schemes can be in
practice.
Explain topping up defined-benefit schemes?
As people are now living longer and spending a longer period in retirement, employers are finding defined‑benefit schemes increasingly expensive to
run. As a result, many are reducing their commitment and transferring
responsibility for pension provision to individuals. Many people may therefore
wish to supplement their retirement income by contributing more to their
occupational schemes, or contributing to private arrangements. The following
are tax‑efficient pension arrangements:
- additional voluntary contributions (AVCs);
- free‑standing additional voluntary contributions (FSAVCs);
- personal/stakeholder pension plans.
AVCs and FSAVCs are available to employees who are members of occupational
schemes. Personal/stakeholder pensions are generally available to anyone
under the age of 75
What are additional voluntary contributions?
AVCs are additional contributions to an occupational scheme. Sometimes,
such contributions purchase additional years’ service in a final salary scheme.
However, most AVCs operate as defined‑contribution arrangements and the
employee will only have a limited choice of funds.
The employer will usually cover some or all of the administration and fund
management costs. Contributions to AVCs are deducted from gross salary and
the employee therefore receives full tax relief at the same time.
What are Free-standing additional voluntary contribution?
As an alternative to an AVC, an individual might choose to contribute to an FSAVCs defined‑contribution fund provided by a separate pension provider.
FSAVCs are available from a range of financial institutions, including insurance companies, banks and building societies.
Contributions to FSAVCs are made from taxed income. Tax relief at the basic rate of 20 per cent is claimed by the pension provider and added to the individual’s pension fund. Higher‑ and additional‑rate taxpayers need to claim additional relief separately through their income tax self‑assessment.
What are Workplace pensions?
Under auto‑enrolment, employers must enrol ‘eligible’ workers in a qualifying
workplace pension and contribute a specified minimum amount to the scheme.
Many existing occupational pensions already qualified as a suitable pension
scheme for this purpose; those employers who did not have a scheme already
could set one up, or enrol their employees in the National Employment Savings
Trust (Nest).
Explain the National Employment Savings Trust (NEST)?
As an alternative to setting up or using their own pension
scheme, employers can meet their obligations by enrolling
their employees in Nest.
Nest is a trust‑based occupational pension scheme established
to support workplace pension provisions; it can be used by an
employer either alongside or instead of its own occupational
pension scheme.
Nest offers a range of investment funds from which the
member can choose, and there are default fund selections for
members who do not wish to make their own choice. Charges
are capped. Benefits can be taken from age 55 and must be
taken no later than age 75.
What are the criteria for auto-enrolment into a workplace pension?
- is not already in a pension at work;
- is aged 22 or over;
- is under state pension age;
- earns more than £10,000;
- works in the UK
An employee can choose to opt out of the scheme, but only after they have
automatically been made a member.
A minimum of 8 per cent of an employee’s earnings have to be paid into the
scheme, made up of an employer contribution of 3 per cent, an employee
contribution of 4 per cent and tax relief of 1 per cent.
What is a Personal Pension?
All forms of non‑occupational pensions are arranged on a defined‑contribution
basis. Personal pensions are individual arrangements provided by financial
services companies such as life assurance companies, banks and building
societies. Contributions receive basic‑rate tax relief at source, even for
non‑taxpayers. A higher‑ or additional‑rate taxpayer needs to claim additional
relief separately through self‑assessment.
