FAMR found that there is an ‘advice gap’ for retirement advice for people without significant wealth. The pension advice allowance was introduced to help tackle this.
How does the pension advice allowance work?
- From 6 April 2017 individuals were permitted to use their hybrid or defined contribution pension provisions to pay for financial advice with no adverse tax-consequences.
- Enables individuals to access up to £500 from their pot (three time in lifetime)
- Used once per tax-year
- Designed so that people can obtain advice connected with their pension at different life stages.
- Allowance can be used at any age
- Tax-advantaged funds used to fund advice
- Cannot be used against DB entitlement
What three key areas did the FAMR focus on?
- Accessibility
- measures to help consumers engage more effectively with advice. i.e. making consumers own information more easily available to them.
- Affordability
- steps to make the provision of advice and guidance to the mass-market more cost effective. Recommendations intended to allow firms to develop more stramlined services and engage with customers in a more effective way.
- Liabilities and consumer redress
- recommendations to increase the clarity and transparency the FOS deals with customer complaints
Advice requirements outlined by Section 48 of PSA 2015?
- Where thre transfer value exceeds £30,000
- Appropriate independent advice must be given
- Advice given by authorised, independent adviser
- Who has permission under FSMA 2000
- To carry out thre new regulated activity of advising on the transfer or conversion of pension benefits under regulation 53E - such persons are referred to as Pension Transfer Specialists in the COBS sourcebook
Members have statutory right to transfer the cash equivalent of their DB benefits to another pension arrangement. What does this mean and what rights do they have?
- Statutory right to cash equivalent (deferred members)
- Deferred members of DB occupational scheme have a right to transfer CE value of their scheme benefits to another arrangement
- Once a year, provided by the scheme - otherwise may be a fee
- CE value guaranteed for 3 months
- Statutory right overrides any conflicting provisions in scheme trust deed and/or rules
- Statutory right applies when member’s pensionable service ends at least one year before normal pension age and the member has acrrued rights to benefits under the scheme
- Members who remain in service after pensionable service ends only acquire a right to transfer CE of benefits attributable to post-6 April 1988 pensionable service - RARELY APPLIED
A relevant UK individiual is someone under the age of 75 who, in respect of a tax year, meets at least one of the following criteria: (4)
- Has relevant UK earnings charegable to income for that tax year;
- UK resident during the tax year
- UK resident both when they become a member of the pension scheme AND at some time during the five tax years immediately prior to the year which the contribution was made
- individual or spouse have earnings from overseas Crown employment subject to UK tax
Relevant UK earning include (6):
- Employment income: salary, wages, bonuses, overtime and commission
- Taxable profits for self employed or from partnership
- Income arising from patent rights and treated as earned income
- redundancy payment above the £30,000 tax exempt threshold
- income from a UK and/or EEA furnished holiday lettings business
- Earnings from an overseas Crown employment subject to UK tax
A relevant UK individual is eligible to receive tax relief on personal contirbutions up to a gross value of £3,600 p.a. or 100% of relevant UK earnings subject to limits imposed by the annual allowance (and lifetime allowance rules).
For the purposes of the Annual Allowance, a Defined Benefit pension input amount is calculated by: (5 Steps)
Assumptions:
- 15 years service
- 1/60 accrual
- £75,000 pensionable earnings; increasing to £78,000
- Inflation 3%
- Money purchase AVC contributions £4,680
- ‘Opening Value’:
(15/60 x £75,000) x 16
= £18,750 x 16
= £300,000
2. Increase ‘opening value’ by inflation:
£300,000 x (1 + 3%)
= £309,000
3. ‘Closing Value’:
(16/60 x £78,000) x 16
= £20,800 x 16
= £332,800
4. DB ‘Pension Input Amount’:
Closing Value – Opening Value
= £332,800 - £309,000
= £23,800
5. Add money purchase contributions:
£23,800 + £4,680
= £28,480
Total pension input amount = £28,480
Net pay method (of contributions/ tax relief)
Net pay only applies to occupational pension schemes; this is a ‘gross from gross’ method: the employer deducts gross contributions from gross pay before PAYE income tax and the employee gets tax relief immediately.
Low earners in master trust schemes used for AE have been disadvantaged through the net pay method as they do not earn enough to pay tax - therefore do not receive tax relief.
Relief at source - how does it work?
- Used by personal and stakeholder pensions (also some auto enrolement workplace pensions).
- Net from net method
- Contributions are made from income that has already had tax deducted
- If paying from employer, 80% of pension contribution deducted from salary with the remaining 20% claimed from HMRC
- Higher rate relief and additional rate relief is given by increasing the basic rate and higher rate band, if applicable) by the amount of the gross contribution when calculating the total tax due on self assessment.
Up until 6 April 2016, the state pension was made up of:
- the Basic State Pension (BSP);
- the additional earnings related schemes for employees;
- the first earnings related scheme was the State Graduated Pension scheme, which existed between April 1961 and April 1975
- the State Earning Related Pension Scheme (SERPS) replaced the State Graduated Pension scheme in 1978
- the State Second Pension (S2P) replaced SERPS on 6 April 2002; and
- the Pension Credit, which was introduced in October 2003
Those who reached their SPA before 6 April 2016, received a non-means tested pension income of £122.30 a week, if at least 30 years of NICs or credits towards them were accrued.
Once in payment BSP increased by the triple lock.
From 6 April 2016, the provision of state pensions changed for anyone who reached state pension age (SPA) after this date:
- 35 years of NICs credits will be needed to get the maximum, currently (2019/20) at £168.60 gross per week;
- Minimum entitlement requires 10 years NIC credits; and
- Those affected will receive transistional protection, the new STP will not allow one person to use anothers NIC record to boost their own STP
Who do the pension freedoms apply to and what are they entitled to?
What are flexible benefits?
The pension freedoms apply, from age 55, to persons entitled to ‘flexible benefits’. They do not apply inrespect of safeguarded benefits.
Effectively, flexible benefits are:
- money purchase benefits - these are benefits the rate or amount of which is calculated by:
- reference to a payment or payments made by the member (or any other person in respect of the member); and
- solely by reference to assets that are always sufficient to meet the liabilities
- cash balance benefits - where the member builds up a guaranteed cash sum or amount during their pensionable service which is then used to buy a pension income, and
- other benefits calculated by reference to a monetary amount available for provision of benefits to or in respect of a member
Desribe how an increase in the inflation assumption will impact a cash flow model and the suitability of a transfer? (7)
- Inflation reduces the spending power of income and therefore an increased level of spending would be required to offset. This may lead to earlier than expected depletion of fund.
- Higher investment returns may be required to offset inflation, which may lead to an inappropriate level of investment risk being taken.
- Revaluation and escalation will be increased within the defined benefit scheme
- This may result in a transfer out becoming unsuitable for the member.
Taken from April 2018 AF7 exam paper
The basis for calculating transfer values is confirmed in legislation in The Occupational Pension Schemes (Transfer Values) (Amendments) Regulations 2008. The legislation proides for two methods of calculating CETVs, these are:
- Best Estimate Method
- based on the expected cost of providing the members benefits in the scheme
- the legislation proides the basis for calculation of an initial cash equivalent, which is then adjusted if necessary to arrive at the final CETV.
- it is the trustees obligation, assisted by the scheme actuary to decide what assumptions should be used to calculate the ICE
- the resultant ICE should be the best estimate of the amount of money needed at the date of calculation to provide the scheme benefits if invested by the scheme
- Alternative Method
- where trustees wish to pay CETVs above the minimum amount
The Best Estimate method provides for the calculation of the minimum transfer value, the alternative method provides the basis for calculating the CETV at a higher amount.
Why might trustees wish to pay a higher CETV?
- Employer or trustees request it
- Scheme rules require it
- Shared cost scheme is in surplus
Reduced Transfer Values
When might trustees be able to reduce transfer values?
- To allow for underfunding in the scheme - only after an insufficiency report has been obtained
- To allow for wind-up exercises
- Priority order allowance - to retain parity in benefit security between those transferring and those remaining in the scheme
Following a request for a transfer value, trustees must proide the following documentation:
- A statement of entitlemet detailing the transfer value and the benefits this is based on
- Confirmation of whether the benefits have been reduced
- Information about potential pension scams
- Information where members may obtain guidance and advice
- Confirmation whether or not independent advice is required
- Details of the time limits applicable for the member to request a transfer
- Details of any enhancement of inducements offered
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Pension Planning17
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Defined & Safeguarded Benefit Schemes37
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Transfer Process, Requirements and Timescales21
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Defined Contribution and Flexible Benefit Schemes27
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Death Benefits23
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Enhanced and Fixed Protection18
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Primary and Individual Protection17
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Tax-free cash4
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Pension Transfers and Regulated Financial Advice27
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Questions likely to come up28
