AF7 Pre exam course

1. AF7 Pre exam course 2018/19 Audley Financial Training

2. Course Objectives • understand the background to pension transfers both from money purchase and final salary arrangements • describe a DB scheme’s main features including the benefits paid at normal, early and late retirement, ill health pension and on death • Describe the member options with an uncrystallised money purchase fund • understand the options available to someone who has left a DB scheme’s sponsoring employment • understand how a Cash Equivalent Transfer Value (CETV), is calculated, the assumptions behind the calculation and how changes in these will affect the CETV Audley Financial Training

3. understand the main principles in advising clients considering transferring their DB rights to flexible benefits • Understand the factors that must be taken into account to ensure that advice is appropriate. • Understand the factors in ensuring that income in drawdown will be sustainable • know the FCA’s current thinking on DB transfers and the compliance issues in giving advice on DB transfers Audley Financial Training

4. The exam • Four short questions (approx. 40 marks) • Two case study questions (approx. 30 marks each) • Two hours • Pass mark 60% Audley Financial Training

5. The basic question A 60 year old man has a choice A final salary pension of £20,000 OR A lump sum of £750,000 Which is better? Audley Financial Training

6. Get it wrong and…. Audley Financial Training

7. Current state of play • Until 2015 transfers from DB schemes were viewed as “here be dragons” • “Pensions freedom” changed everything. • Lifechanging amounts of money were potentially available • But the British Steel scandal showed the potential dangers. • Fears of a repeat of the 80’s/90’s misselling scandal • The FCA’s rules were out of date as these focussed on a transfer from a DB scheme being used to buy an annuity. Audley Financial Training

8. Money Purchase Transfers Audley Financial Training

9. Money Purchase: Preserved Benefits General rule is that there is no refund except under cooling off procedures. • If old and new employer offered NEST the member’s account can be transferred • GPP/PP, belongs to member can continue to contribute • OPS, member cannot contribute once left employment • Funds remain invested and can get potential growth • Individuals could end up with many separate pots Audley Financial Training

10. Problems with stranded pots • Difficult to keep track of the funds • May be no planned investment strategy • May have high charges • Occupational scheme funds may not allow benefits to be accessed flexibly Audley Financial Training

11. Why transfer MP benefits? • Consolidation of benefits, bringing MP benefits together • To get lower charges • Wish to get a better performance • To avoid trail commission • To access benefits flexibly Audley Financial Training

12. But… • May lose protected benefits such as GAR, scheme specific lump sum protection • Might be better off transferring former benefits into current arrangement • May be transfer charges Audley Financial Training

13. Overview of DB benefits and risks Audley Financial Training

14. The DB member’s tale I’m 50, I’ve been here 20years and my present salary is £48,000 That means my potential pension rights are currently £16,000 I’m a member of my employers DB scheme. I pay in 5% of my gross salary and every year I build up 1/60 of my salary as pension Audley Financial Training

15. The DB member’s tale I don’t need to take any decisions about investing my fund, the scheme does all the work In addition I get a Death in Service benefit of £144,000 and my husband would get a pension if I died before retirment Audley Financial Training

16. Her pension will be paid into her bank each month, no admin on her part Jane is about to retire with a DB pension of £30,000 a year She can take a tax free PCLS and have a reduced pension The pension will increase in payment each year and be payable for life Jane is married and if she dies before him, he will get a pension payable for life Audley Financial Training

17. Escalation • The scheme is required to increase pensions in payment of an annual basis. • In practice many schemes pay more than the legal minimum • A scheme that was contracted out could have three different elements. • Guaranteed Minimum Pension (GMP) What the scheme had to offer before April 1997 to contract out of SERPS) • Excess Benefits The pre 1997 benefits in excess of GMP • Post 1997 Benefits All benefits accrued since April 1997 Audley Financial Training

18. Escalation • GMP pre April 88 Nil • For members who reached State Pension age before 6/4/16, this is increased by CPI as part of state pension. Members who reach SPA after 6/4/16 get no increase • GMP post April 88 Increased by CPI with scheme paying first 3%, • For members who reached State Pension before 6/4/16, if CPI higher than 3% excess is paid as part of state pension. Only scheme increase is SPA after 6/4/16 • Pre April 97 excess benefits Nil • April 97 – April 05 CPI to a max of 5% • Post April 05 CPI to a max of 2.5% Audley Financial Training

19. Early leavers: DB schemes • Members who leave before two years can have a return of member’s contribution less 20% tax on the first £20,000 and 50% on the excess. • After 3 months they can have a transfer value • Members leaving after that are classed as deferred members and get a preserved pension which will be revalued to retirement • Preserved pension is normally calculated as the pension the member would have if they were retiring at that point • Default option, member needs to take no action Audley Financial Training

20. Preserved benefits revaluation GMP revalued at a fixed rate determined by date of leaving. Current rate 3.5% Audley Financial Training

21. In practice • GMP is revalued on a complete tax year basis • Non-GMP benefits are revalued on a calendar year basis • The Government issues the statutory minimum increase annualy in Section 52A orders • For someone who became a deferred member 15 years before SPA (2018) will have their preserved pension increased by 45.2% • Non GMP revaluation only became compulsory for leavers after January 1 1986 and only for benefits accrued since 1/1/85 • Non GMP revaluation on all benefits leavers after 1/1/91 Audley Financial Training

22. But early leavers can lose out • No requirement for a pre retirement death lump sum • Spouse’s pension may be limited • Inflation could be higher than revaluation Audley Financial Training

23. DB schemes, what’s not to like? Inflation may be higher than the scheme increases Benefits rely on employer being able to fund the benefits Member may die shortly after retirement Apart from the PCLS there is no capital from a DB scheme Audley Financial Training

24. Pension Protection Fund • 100% protection for • Members who are above scheme retirement age • Dependents’ pensions • Ill health pensions • 90% protection for all others including those who retired early • This is subject to a max pension cap (£39,006.) 90% of which is £35,105 which is reduced if scheme pension age before 65 Audley Financial Training

25. Pensions Protection Fund • Pensions payable from scheme pension age • But can be taken earlier with an actuarial reduction • Deferred pensions will be revalued in line with CPI but capped at 5% (2.5% post April 09) • Pensions in payment will increase by CPI to a max of 2.5% but only on benefits accrued post April 6 1997 • Spouse’s pension of 50% of member’s pension Audley Financial Training

26. Overview of flexible benefits Audley Financial Training

27. What’s this got to do with transfers? • Transferring from a DB scheme means moving into money purchase arrangements usually a SIPP/PP. • DB benefits are classed as safeguarded benefits • MP benefits are classed as flexible benefits • Transferring to a SIPP/PP gives the member additional options but exposes them to additional risks • So we need to know what these are. Audley Financial Training

28. The main options on taking benefits Lifetime Annuity 25% PCLS Flexi Access Drawdown UFPLS Audley Financial Training

29. Uncrystallised Fund Pension Lump Sum (UFPLS) • Ad hoc withdrawals from uncrystallised fund • No separate PCLS • 25% of each withdrawal is tax free, 75% is subject to income tax Audley Financial Training

30. Flexi Access Drawdown • Fund after PCLS is designated a FAD • Member can withdraw anything they want, whenever they want. • Taking income will trigger Money Purchase Annual Allowance • All withdrawals taxed as non-savings income • No new money can be paid in but uncrystallised funds can be transferred into the FAD. Audley Financial Training

31. FAD v UFPLS Uncrystallised Fund PCLS Uncrystallised fund Crystallised fund Audley Financial Training

32. Death options Cash Money outside pension regime Nominee’s annuity FAD/UC fund Income will end on nominee’s death Any funds remaining in FAD can be passed to successor Nominee’s FAD Audley Financial Training

33. Who’s who • Dependant. • Defined as previously, nominated by member or administrator • Nominee: • someone not a dependant nominated by member or administrator • Successor • Someone nominated by dependant, nominee or administrator Audley Financial Training

34. Charity Lump Sum Death Benefit • Member can nominate a charity to receive the fund on their death IF: • If it comes from a uncrystallised or drawdown fund • AND there are no dependants of the deceased member • Beneficiary can make a CLSDB on their death IF: • There are no dependants of the member • It is paid from a dependant’s or nominee’s flexi access drawdown fund • It is paid to a charity nominated by the member OR • If the member made no nomination, the beneficiary can make the nomination. Audley Financial Training

35. Fred went into FAD and nominated his wife Helen as beneficiary Fred dies age 74. Helen, designates the fund as a dependent’s FAD Her withdrawals are tax free Helen nominates her two children as successors. She dies aged 80 Withdrawals are taxable Her children decide to keep these as a successor FAD Withdrawals are taxable Audley Financial Training

36. Taxation summary • Apart from 25% PCLS (or 25% of UFPLS or small pots), benefits taken by the member are ALWAYS subject to income tax. • Dependant, nominee or successor benefits are always income tax exempt provided member or nominee/successor died before 75 and provider notified within two years of death. • Dependant, nominee or successor benefits are always subject to income tax if member or nominee/successor died after 75 or provider not notified within two years of death. • Uncrystallised and FAD funds are exempt from IHT Audley Financial Training

37. DB v FAD Income & Capital • Income will not fall • Income will last no matter how long the member lives • Income will increase each year • No need for any investment decisions or administration • Capital is restricted to PCLS • Income can run out • Increasing income may be impossible to fund • Investment decisions need to be taken plus a great deal of administration • 25% of TV may be higher than scheme PCLS • Greater amounts can be taken albeit taxable Audley Financial Training

38. DB v FAD Death and Survivor Benefits • No death benefits outside guarantee • Survivor pension may not be payable other than to a legal spouse/CP • This will always be taxable. • No one else can benefit once survivor dies • Survivor has more options on death of member • All survivor benefits are tax free if member dies before 75 • Any remaining fund after survivor dies can be passed on Audley Financial Training

39. Ensuring the advice is appropriate The cash Equivalent Transfer Audley Financial Training

40. What is a CETV? DB Fund Pays for all benefits to all members So how much of the fund “belongs” to the member? Audley Financial Training

41. Rights to request a CETV • Essentially the cash sum the scheme calculates the member is likely to need to produce equivalent benefits if they had remained in the scheme. • Deferred member has the right to request this every year until 12 months before scheme retirement age • No right to CETV at point of retirement but will usually be given Audley Financial Training

42. Calculating a CETV Calculate lump sum required to purchase an annuity that would provide the same benefits Revalue to scheme retirement age Discount back to date of calculation (what sum is needed to now to produce sum in previous step) Calculate preserved pension at date of leaving Audley Financial Training

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44. What happens if we increase the annuity rate and reduce the discount rate? Audley Financial Training

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46. However, • Transfer value may be reduced if the trustees have concerns about the scheme being underfunded. • It might be increased if trustees want to encourage members to leave • If the member gets a TV but takes no action and requests another TV some years later the TV will be different • Assumed inflation rate increased, TV increases • Assumed annuity rate and discount rate increase TV reduces • The TV is likely to increase as it gets closer to scheme retirement age. Audley Financial Training

47. At the point of retirement Audley Financial Training

48. Ensuring the advice is appropriate Assessing the situation Audley Financial Training

49. WHY? I’d like to transfer my DB pension TC Audley Financial Training

50. Why would anyone want to give up a guaranteed lifetime income , that has a reasonable level of inflation protection, that can be inherited in part by the spouse or partner and requires no admin on the part of the individual? Audley Financial Training