R04 Pensions and retirement planning 2024-2025 Study Text PDF

Pensions and retirement planning R04: 2024–25 Study text RevisionMate Provided as part of an enrolment, RevisionMate offers online services to support your studies and improve your chances of exam success. Access to RevisionMate is only available...

Pensions and retirement planning R04: 2024–25 Study text RevisionMate Provided as part of an enrolment, RevisionMate offers online services to support your studies and improve your chances of exam success. Access to RevisionMate is only available until 31 August 2025. This includes: Printable PDF and ebook of the study text. Student discussion forum – share common queries and learn with your peers. For reference only Examination guide – practise your exam technique. To explore the benefits for yourself, you can access RevisionMate via your MyCII page, using your login details: ciigroup.org/login Updates and amendments to this study text This edition is based on the 2024–25 tax year and examination syllabus which will be examined from 1 September 2024 until 31 August 2025. Any changes to the exam or syllabus, and any updates to the content of this study text, will be posted online so that you have access to the latest information. You will be notified via email when an update has been published. To view updates: 1. Visit www.cii.co.uk/qualifications 2. Select the appropriate qualification 3. Select your unit from the list provided Under ‘Unit updates’, examination changes and the testing position are shown under ‘Qualifications update’; study text updates are shown under ‘Learning solutions update’. Please ensure your email address is current to receive notifications. 2 R04/July 2024 Pensions and retirement planning © The Chartered Insurance Institute 2024 All rights reserved. Material included in this publication is copyright and may not be reproduced in whole or in part including photocopying or recording, for any purpose without the written permission of the copyright holder. Such written permission must also be obtained before any part of this publication is stored in a retrieval system of any nature. No part of this publication may be copied or reproduced in a generative AI tool. This publication is supplied for study by the original purchaser only and must not be sold, lent, hired or given to anyone else. Every attempt has been made to ensure the accuracy of this publication. However, no liability can be accepted for any loss incurred in any way whatsoever by any person relying solely on the information contained within it. The publication has been produced solely for the purpose of examination and should not be taken as definitive of the legal position. Specific advice should always be obtained before undertaking any investments. Print edition ISBN: 978 1 83727 061 3 Electronic edition ISBN: 978 1 83727 062 0 This edition published in 2024 The authors Helen Savage BSc (Hons) has worked in financial services for over 30 years, initially as an actuarial trainee and technical trainer. Helen is now self-employed and works predominantly as a technical author in the area of pensions, as well as carrying out various roles for the CII. Helen was responsible for chapters 1 to 3, 5 and 6 and acted as reviewer for the remaining chapters written by Maria. Maria Shortland FPFS Chartered Financial Planner has worked in financial services for over 30 years and in various roles for the CII for over 20 years. She specialises in pensions, tax and later life financial planning. Maria wrote chapter 4 and chapters 7 to 10 and acted as reviewer for the remaining chapters written by Helen. Acknowledgement The CII thanks the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA) for their kind permission to draw on material that is available from the FCA website: www.fca.org.uk (FCA Handbook: www.handbook.fca.org.uk/handbook) and the PRA Rulebook site: www.prarulebook.co.uk and to include extracts where appropriate. Where extracts appear, they do so without amendment. The FCA and PRA hold the copyright for all such material. Use of FCA or PRA material does not indicate any endorsement by the FCA or PRA of this publication, or the material or views contained within it. For reference only Typesetting, page make-up and editorial services CII Learning Solutions. Printed and collated in Great Britain. This paper has been manufactured using raw materials harvested from certified sources or controlled wood sources.  3 Using this study text Welcome to the R04: Pensions and retirement planning study text which is designed to support the R04 syllabus, a copy of which is included in the next section. Please note that in order to create a logical and effective study path, the contents of this study text do not necessarily mirror the order of the syllabus, which forms the basis of the assessment. To assist you in your learning we have followed the syllabus with a table that indicates where each syllabus learning outcome is covered in the study text. These are also listed on the first page of each chapter. Each chapter also has stated learning objectives to help you further assess your progress in understanding the topics covered. Contained within the study text are a number of features which we hope will enhance your study: Activities: reinforce learning through Key points: act as a memory jogger at practical exercises. the end of each chapter. Be aware: draws attention to important Key terms: introduce the key concepts points or areas that may need further and specialist terms covered in each clarification or consideration. chapter. Case studies: short scenarios that will Refer to: Refer to: section/chapter that provides test your understanding of what you valuable information on or background have read in a real life context. to the topic, from either within this or another CII study text. Sections/chapters from other study texts are available for you to view and download on For reference only RevisionMate. Consider this: stimulating thought Reinforce: encourages you to revisit a around points made in the text for which point previously learned in the course to there is no absolute right or wrong embed understanding. answer. Examples: provide practical illustrations Sources/quotations: cast further light of points made in the text. on the subject from industry sources. In-text questions: to test your recall of On the Web: introduce you to topics. other information sources that help to supplement the text. At the end of every chapter there is also a set of self-test questions that you should use to check your knowledge and understanding of what you have just studied. Compare your answers with those given at the back of the book. By referring back to the learning outcomes after you have completed your study of each chapter and attempting the end of chapter self-test questions, you will be able to assess your progress and identify any areas that you may need to revisit. Not all features appear in every study text. Note Website references correct at the time of publication. For reference only  5 Examination syllabus Pensions and retirement planning Purpose At the end of this unit, candidates should be able to demonstrate an understanding of and ability to analyse: main tax and legal frameworks that govern retirement benefits under registered pension schemes; features of defined contribution and defined benefit pensions. Summary of learning outcomes Number of questions in the examination* 1. Understand the political, economic and social environment factors which provide the 5 standard format context for pensions planning 2. Understand how the HM Revenue & Customs (HMRC) tax regime applies to pensions 10 standard format planning 3. Understand the relevant aspects of pensions law and regulation to pensions planning 4 standard format 4. Understand the structure, characteristics and application of Defined Benefit (DB) 7 standard format For reference only schemes to an individual’s pension planning 5. Analyse the range of Defined Contribution (DC) scheme options as they apply to an 4 standard format/ individual’s pension planning 2 multiple response 6. Analyse the options and factors to consider for drawing pension benefits 5 standard format/ 4 multiple response 7. Explain the structure, relevance and application of State Schemes to an individual’s 4 standard format pension planning 8. Evaluate the aims and objectives of retirement planning, including the relevant 5 multiple response investment issues * The test specification has an in-built element of flexibility. It is designed to be used as a guide for study and is not a statement of actual number of questions that will appear in every exam. However, the number of questions testing each learning outcome will generally be within the range plus or minus 2 of the number indicated. Published June 2024 ©2024 The Chartered Insurance Institute. All rights reserved. R04 6 R04/July 2024 Pensions and retirement planning Important notes Method of assessment: 50 questions: 39 standard format and 11 multiple response questions. 1 hour is allowed for this examination. This syllabus will be examined from 1 September 2024 to 31 August 2025. Candidates will be examined on the basis of English law and practice in the tax year 2024/2025 unless otherwise stated. It should be assumed that all individuals are domiciled and resident in the UK unless otherwise stated. This PDF document has been designed to be accessible with screen reader technology. If for accessibility reasons you require this document in an alternative format, please contact us on [email protected] to discuss your needs. Candidates should refer to the CII website for the latest information on changes to law and practice and when they will be examined: 1. Visit www.cii.co.uk/qualifications 2. Select the appropriate qualification 3. Select your unit from the list provided 4. Select qualification update on the right hand side of the page For reference only Published June 2024 2 of 4 ©2024 The Chartered Insurance Institute. All rights reserved.  7 1. Understand the political, economic and 5.2 Explain the legal bases of DC schemes and their social environment factors which provide impact on an individual’s pension planning. the context for pensions planning 5.3 Outline the benefits on leaving, and death before 1.1 Describe the role of Government, policy direction, and after age 75. challenges and reforms. 5.4 Outline transfer issues and considerations. 1.2 Describe corporate responsibilities, their challenges and impact on pension planning. 6. Analyse the options and factors to consider for drawing pension benefits 1.3 Describe demographic trends, longevity and the ageing population. 6.1 Analyse the options to consider in drawing State Retirement Benefits. 1.4 Describe incentives, disincentives and attitudes to saving. 6.2 Analyse the options available from DB schemes for drawing pension benefits. 1.5 Explain the main pension scheme types and methods of pension provision. 6.3 Analyse the options available from DC schemes for drawing pension benefits. 2. Understand how the HM Revenue & 6.4 Analyse the suitability of phased retirement. Customs (HMRC) tax regime applies to 6.5 Explain the small pots and trivial commutation rules. pensions planning 2.1 Explain how the HMRC tax regime applies to 7. Explain the structure, relevance and pensions planning – Contributions and tax relief; application of State Schemes to an Pension scheme investment funds; Death benefits; individual’s pension planning Retirement benefits; Transitional reliefs. 7.1 Explain the structure, relevance and application of 2.2 Explain how the following are applied – Annual State Retirement Benefits, State Death Benefits allowances; Tapering of the annual allowance; and the Pension Credit framework as part of an Lifetime allowance; Lump sum allowance; Lump individual’s pension planning. sum and death benefit allowance; Overseas transfer allowance; Associated charges. 8. Evaluate the aims and objectives For reference only 2.3 Outline the tax treatment of other types of schemes. of retirement planning, including the relevant investment issues 3. Understand the relevant aspects of 8.1 Evaluate the aims and objectives of retirement pensions law and regulation to pensions planning in relation to – An individual’s aims, planning objectives and circumstances; Investments available 3.1 Explain the relevant aspects of pensions law and to meet these objectives; Alternative sources of regulation. retirement income; Regular reviews and the factors affecting them; Asset allocation factors; The main 3.2 Describe the role and duties of trustees and characteristics of self-investment. administrators of pension schemes. 4. Understand the structure, characteristics and application of Defined Benefit (DB) schemes to an individual’s pension planning 4.1 Describe the main types, attributes and benefits of DB pension provision, including the rules and operation of DB schemes. 4.2 Outline the funding methods and related issues. 4.3 Explain the role of trustees and other parties, including scheme reporting. 4.4 Describe the factors to consider and the benefits on leaving, early and normal retirement, including the main transfer issues in broad terms. 4.5 Explain the benefits available on ill health and death. 4.6 Explain eligibility and top-up options. 4.7 Describe the structure, main attributes and benefits of public sector schemes. 5. Analyse the range of Defined Contribution (DC) scheme options as they apply to an individual’s pension planning 5.1 Analyse the types of DC schemes, their main attributes and benefits. Published June 2024 3 of 4 ©2024 The Chartered Insurance Institute. All rights reserved. 8 R04/July 2024 Pensions and retirement planning Reading list Professional pensions. London: Incisive Media. Weekly. Available at The following list provides details of further www.professionalpensions.com. reading which may assist you with your studies. Examination guide Note: The examination will test the syllabus alone. If you have a current study text enrolment, the current examination guide is included The reading list is provided for guidance only and is not in itself the subject of the and is accessible via Revisionmate examination. (ciigroup.org/login). Details of how to access Revisionmate are on the first page of your The resources listed here will help you keep up-to-date with developments and study text. It is recommended that you only provide a wider coverage of syllabus topics. study from the most recent version of the examination guide. CII study texts Pensions and retirement planning. London: Exam technique/study skills CII. Study text R04. There are many modestly priced guides Books available in bookshops. You should choose A modern approach to lifetime tax one which suits your requirements. planning for private clients (with precedents). Christopher Whitehouse, Lesley King. Bristol: Jordans, 2016. eBooks For reference only The following eBooks are available via www.cii.co.uk/elibrary (CII/PFS members only): Recreating sustainable retirement: resilience, solvency and tail risk. P. Brett Hammond, et al. Oxford: Oxford University Press, 2014. Journals and magazines Financial adviser. London: FT Business. Weekly. Available online at www.ftadviser.com. Personal finance professional. London: CII. Four issues a year. Available online at www.pfp.thepfs.org (CII/PFS members only). Money management. London: FT Business. Monthly. Available online www.ftadviser.com/ brand/money-management. Money marketing. London: EMAP Publishing Limited. Weekly. Available online at www.moneymarketing.co.uk. Pensions age. London: Perspective. Monthly. Available at www.pensionsage.com. Pensions Expert. London: FT Finance. Weekly. Available at www.pensions- expert.com. Pensions insight. Newsquest Specialist Media. Monthly. Available at www.pensions- insight.co.uk. Published June 2024 4 of 4 ©2024 The Chartered Insurance Institute. All rights reserved.  9 R04 syllabus quick-reference guide Syllabus learning outcome Study text chapter and section 1. Understand the political, economic and social environment factors which provide the context for pensions planning 1.1 Describe the role of Government, policy direction, challenges and 1A reforms. 1.2 Describe corporate responsibilities, their challenges and impact 1C on pension planning. 1.3 Describe demographic trends, longevity and the ageing 1B, 10C population. 1.4 Describe incentives, disincentives and attitudes to saving. 1D, 10E 1.5 Explain the main pension scheme types and methods of pension 1E provision. 2. Understand how the HM Revenue & Customs (HMRC) tax regime applies to pensions planning 2.1 Explain how the HMRC tax regime applies to pensions planning 2A, 3A, 3B, 3C, 3D, 3E – Contributions and tax relief; Pension scheme investment funds; Death benefits; Retirement benefits; Transitional reliefs. 2.2 Explain how the following are applied – Annual allowances; 2B, 2C For reference only Tapering of the annual allowance; Lifetime allowance; Lump sum allowance; Lump sum and death benefit allowance; Overseas transfer allowance; Associated charges. 2.3 Outline the tax treatment of other types of schemes. 3F 3. Understand the relevant aspects of pensions law and regulation to pensions planning 3.1 Explain the relevant aspects of pensions law and regulation. 4A, 4B, 4C, 4D, 4E, 4F 3.2 Describe the role and duties of trustees and administrators of 5E pension schemes. 4. Understand the structure, characteristics and application of Defined Benefit (DB) schemes to an individual’s pension planning 4.1 Describe the main types, attributes and benefits of DB pension 5A, 5B provision, including the rules and operation of DB schemes. 4.2 Outline the funding methods and related issues. 5D 4.3 Explain the role of trustees and other parties, including scheme 5E reporting. 4.4 Describe the factors to consider and the benefits on leaving, 5C, 5F, 5G early and normal retirement, including the main transfer issues in broad terms. 4.5 Explain the benefits available on ill health and death. 5C 4.6 Explain eligibility and top-up options. 5A, 5B 4.7 Describe the structure, main attributes and benefits of public 5H sector schemes. 5. Analyse the range of Defined Contribution (DC) scheme options as they apply to an individual’s pension planning 5.1 Analyse the types of DC schemes, their main attributes and 6A, 6C, 6E benefits. 5.2 Explain the legal bases of DC schemes and their impact on an 6B individual’s pension planning. 5.3 Outline the benefits on leaving, and death before and after age 6C, 6D 75. 10 R04/July 2024 Pensions and retirement planning Syllabus learning outcome Study text chapter and section 5.4 Outline transfer issues and considerations. 6D 6. Analyse the options and factors to consider for drawing pension benefits 6.1 Analyse the options to consider in drawing State Retirement 10D Benefits. 6.2 Analyse the options available from DB schemes for drawing 7C pension benefits. 6.3 Analyse the options available from DC schemes for drawing 7C, 8A, 8B, 8C, 10D pension benefits. 6.4 Analyse the suitability of phased retirement. 8D 6.5 Explain the small pots and trivial commutation rules. 7B 7. Explain the structure, relevance and application of State Schemes to an individual’s pension planning 7.1 Explain the structure, relevance and application of State 9A, 9B, 9C Retirement Benefits, State Death Benefits and the Pension Credit framework as part of an individual’s pension planning. 8. Evaluate the aims and objectives of retirement planning, including the relevant investment issues 8.1 Evaluate the aims and objectives of retirement planning in 10A, 10B, 10C, 10D, 10E, relation to – An individual’s aims, objectives and circumstances; 10F Investments available to meet these objectives; Alternative sources of retirement income; Regular reviews and the factors affecting them; Asset allocation factors; The main characteristics of self-investment. For reference only  11 Exam guidance and accessibility Before you begin the study text, we would encourage you to read about how to approach the exam. Study skills While the text will give you a foundation of facts and viewpoints, your understanding of the issues raised will be richer through adopting a range of study skills. They will also make studying more interesting! We will focus here on the need for active learning in order for you to get the most out of this core text. Active learning is experiential, mindful and engaging Underline or highlight key words and phrases as you read – many of the key words have been highlighted in the text for you, so you can easily spot the sections where key terms arise; boxed text indicates extra or important information that you might want to be aware of. Make notes in the text, attach notes to the pages that you want to go back to – chapter numbers are clearly marked on the margins. Make connections to other CII units – throughout the text you may find ‘refer to’ boxes that tell you the chapters in other books that provide background to, or further information on, the area dealt with in that section of the study text. Take notice of headings and subheadings. Use the clues in the text to engage in some further reading (refer to the syllabus reading For reference only list) to increase your knowledge of a particular area and add to your notes – be proactive! Relate what you’re learning to your own work and organisation. Be critical – question what you’re reading and your understanding of it. Five steps to better reading Scan: look at the text quickly – notice the headings (they correlate with the syllabus learning outcomes), pictures, images and key words to get an overall impression. Question: read any questions related to the section you are reading to get a feel for the subjects tackled. Read: in a relaxed way – don’t worry about taking notes first time round, just get a feel for the topics and the style the book is written in. Remember: test your memory by jotting down some notes without looking at the text. Review: read the text again, this time in more depth by taking brief notes and paraphrasing. On the Web Visit here for more detail on study skills: www.open.ac.uk/skillsforstudy. Note: website reference correct at the time of publication. 12 R04/July 2024 Pensions and retirement planning Exam guidance Answering multiple-choice questions When preparing for the examination, candidates should ensure that they are aware of what typically constitutes each type of product listed in the syllabus and ascertain whether the products with which they come into contact during the normal course of their work deviate from the norm, since questions in the examination test generic product knowledge. Some questions are simply questions of fact, whereas others may be more progressive in nature, requiring reasoning to determine the correct option or, perhaps, being answerable by a process of elimination. Whatever the question, read it carefully to identify what it is really asking. Do not assume that you 'know' what it is asking, even if the question is on a topic about which you feel very confident; answer the question exactly as it is asked. Also, look out for the occasional negative question (Which of the following is not …?). Try to answer all of the questions. While there is no substitute for a good grasp of the subject matter, and you cannot expect to pass the examination purely on guesswork, you do not lose marks for giving a wrong answer! You can find more information on the specific unit in the exam guide (available on the unit page on the CII website and on RevisionMate). Important note on tax rates and allowances Tax tables giving rates of tax, tax bands, reliefs, etc. will be provided, where necessary, when you take the exam. This information will be restricted to figures and amounts only; you will still be expected to know the principles of the tax system, and how to apply these using any figures supplied. You will also need to understand the workings of the main forms of taxation and the types of exemptions, reliefs and allowances available. For reference only On the Web You can find more on preparing for your exam by visiting: https://www.cii.co.uk/learning/ qualifications/assessment-information/before-the-exam/. Note: website reference correct at the time of publication. Accessibility The CII has produced a policy and guidance document on accessibility and reasonable/ special adjustments. The purpose of this is to ensure that you have fair access to CII qualifications and assessments. On the Web The ‘Qualifications accessibility and special circumstances policy and guidance’ document can be found here: www.cii.co.uk/media/bxsjd2e2/cii-qualifications-accessibility- and-special-circumstances-policy-and-guidance.pdf. Note: website reference correct at the time of publication.  13 Contents 1: Context of pensions planning A Role of the Government 1/2 B Demographic trends 1/6 C Corporate environmental factors 1/8 D Incentives, disincentives and attitudes to saving 1/8 E Main pension scheme types 1/10 2: HMRC tax regime: contributions and allowances A Contributions and the provision of tax relief 2/3 B Annual allowance and money purchase annual allowance 2/12 C Lump sum allowance and lump sum and death benefit allowance 2/31 3: HMRC tax regime: benefits, reliefs and overseas schemes A Tax treatment of member benefits 3/2 B Tax treatment of death benefits 3/14 C Transitional reliefs 3/26 For reference only D Tax treatment of pension fund investments 3/44 E Unauthorised payments 3/44 F Tax treatment of overseas pension schemes 3/47 4: Pensions regulation A Pensions Regulator compliance requirements 4/2 B Pension protection 4/7 C Workplace pensions 4/13 D Pensions and divorce 4/23 E Employment law relevant to pensions 4/29 F Bankruptcy law and pension assets 4/33 5: Defined benefit schemes A Main types, attributes and benefits 5/2 B Rules and operation 5/6 C Normal retirement, early retirement, ill-health, death 5/9 D Funding methods and issues 5/20 E Role of trustees and others and scheme reporting 5/25 F Early leavers, transfer issues and considerations 5/28 G Advising on pension transfers 5/37 H Public sector schemes 5/45 14 R04/July 2024 Pensions and retirement planning 6: Defined contribution schemes A Main types, attributes and benefits 6/2 B Legal bases and their impact on pension planning 6/10 C Factors to consider and benefits 6/16 D Benefits on leaving and transfer 6/21 E Stakeholder pensions 6/24 7: Secured pension options A Drawing pension benefits 7/2 B Small pots and trivial commutation 7/3 C Secured pension options 7/9 8: Flexible income options A Uncrystallised funds pension lump sum (UFPLS) 8/2 B Drawdown pension 8/4 C Compliance requirements and consumer protection 8/22 D Phased retirement 8/37 9: State schemes and an individual’s pension planning For reference only A State Pension benefits: historic and current 9/2 B How the State Pension works 9/9 C Pension Credit framework 9/16 10: Retirement planning considerations A Accumulating pension savings 10/2 B Pension fund investments during accumulation 10/6 C Interpreting client information and objectives in the decumulation phase 10/19 D Determining the method and timing of accessing pension benefits 10/27 E Tax planning 10/32 F Alternative sources of retirement income 10/37 Self-test answers i Cases xiii Legislation xv Index xvii  Chapter 1 Context of 1 pensions planning Contents Syllabus learning outcomes Introduction A Role of the Government 1.1 B Demographic trends 1.3 C Corporate environmental factors 1.2 D Incentives, disincentives and attitudes to saving 1.4 E Main pension scheme types 1.5 Key points Question answers For reference only Self-test questions Learning objectives After studying this chapter, you should be able to: describe the role of Government, policy direction, challenges and proposed reforms; demonstrate the impact of demographic trends, longevity and an ageing population; explain the impact on pension provision of corporate responsibilities and challenges; show how the incentives, disincentives and attitudes to saving affect the choice to save for a pension; describe the main scheme types and methods of pension provision. Chapter 1 1/2 R04/July 2024 Pensions and retirement planning Introduction A pension is simply a method of saving for retirement. What makes it different from other methods of saving is the tax advantages offered by the Government to encourage individuals and companies to make provision for retirement. The concept of a pension as a means of providing an income in retirement and benefits on death is hardly new and the issue of pensions and pension security is an important political issue in Britain today. In this chapter we will consider the political, economic and social environment factors relating to pensions. Key terms This chapter features explanations of the following terms and concepts: Defined benefit Defined contribution Demographic trends Final salary schemes schemes schemes Income in retirement Money purchase Pensions Saving schemes State Pensions A Role of the Government A1 Role of the Government and policy direction Most people will depend on a pension to provide them with their income in retirement. Their pension may come from the State, from a workplace pension scheme or from a private For reference only pension arrangement. The Government has been involved in shaping pension provision in the UK for many years and there have been many changes to the rules and legislation applicable to pensions. We look at these rules in more detail in the later chapters of this study text. However, to give you an overview, table 1.1 describes some of the main changes made to pension legislation over the last 30 years along with some of the future changes that have been announced. Table 1.1: Developments in pension legislation over the last 30 years Greater protection The Pensions Act 1995 set up regulatory and compensation schemes to for members of ensure that greater protection was given to members of occupational pension occupational pension schemes. In particular, schemes had to meet a minimum funding requirement schemes and mandatory increases to pensions in payment were introduced. In 2001 accounting rules, called FRS17, were introduced which required companies to report pension deficits and surpluses in the year that the deficit/ surplus occurred. The Pensions Act 2004 introduced the Pension Protection Fund (PPF), which ensures members receive some protection should their employer become insolvent, leaving a defined benefit (final salary) pension scheme that is unable to provide them with a certain level of promised benefits. Support for the poorest The Government has put in place various measures to ensure that all pensioners pensioners receive a minimum level of income in retirement: the first measure was the Minimum Income Guarantee, which came into force in 1999; and then in 2003 the State Pension Credit was introduced, which is a means tested benefit that tops up the income of the poorest pensioners. Chapter 1 Context of pensions planning 1/3 Chapter 1 Table 1.1: Developments in pension legislation over the last 30 years The introduction of On 6 April 2006 (A-Day) a single pension tax regime was introduced, which a single pension tax replaced all of the previous regimes. regime This regime introduced the annual allowance and the lifetime allowance. Both have been reduced since A-Day, so a number of transitional protections were put in place. Further changes came into force on 6 April 2016, such as a tapered annual allowance for those with high earnings. On 6 April 2024 the lifetime allowance was abolished. It was replaced with new rules limiting the amount of tax-free lump sum payment a member's pension benefits can provide, both in lifetime and on death. There is no limit on the amount of funds that can be used to provide an income. Encouraging private Various measures have been introduced to encourage individuals to contribute more pension provision towards their retirement: in 2001 stakeholder pensions were introduced and employers had to offer their employees ‘access’ to one, although they were not compelled to contribute; these failed to encourage private pension provision, so automatic enrolment was introduced in October 2012; and from a company’s staging date, all eligible workers (or ‘jobholders’) who do not have access to an adequate workplace pension scheme must be automatically enrolled into a qualifying pension scheme with a required minimum level of contribution each year. Pension flexibilities On 6 April 2015 major changes to the ways in which pension benefits can be taken came into force. The flexible benefit options apply to defined contribution schemes and so some changes were made to the transfer rules to ensure that those considering a transfer out of a defined benefit scheme obtain independent advice before making the decision. For reference only A guidance service, called Pension Wise, was also introduced to provide guidance to those wishing to access their retirement savings. Changes to State Before April 2016 the State Pension was made up of the Basic State Pension Pensions and State and a number of Additional State Pensions. The Additional State Pensions were Pension age generally only available to employees and changed several times, with the final change being the introduction of the State Second Pension (S2P) in 2002. The S2P was available to certain low earners and individuals receiving certain State benefits, such as Carer’s Allowance. In April 2016 all of the previous State Pensions (apart from the State Guarantee Credit) were replaced by the new State Pension (also known as the single- tier State Pension). To be eligible to receive the full new State Pension an individual must pay (or be credited with) National Insurance contributions (NICs) for 35 years. Until 6 April 2016, when it was abolished, it had been possible to ‘contract out’ of the Additional State Pensions via a defined benefit pension scheme, meaning the member did not receive any Additional State Pension (most recently the S2P) for that period of service. Instead the scheme had to provide a certain minimum level of benefits. Until April 2010 the State Pension age (SPA) was 65 for men and 60 for women, but women’s SPA was gradually increased from 60 to 65 over an eight year period, which ended on 6 November 2018. Since December 2018, the SPA for both men and women started to rise again and reached age 66 in October 2020. Further legislation has been implemented to increase the SPA to age 67 for both men and women by 2028. In addition, the SPA must be reviewed in each parliament. It is estimated that each review could lead to a further one year increase in SPA, meaning that a 16 year old today could have a SPA of 77 or 78. A2 Challenges It has become apparent that there are a number of problems relating to the provision of an adequate retirement income in the UK, although in recent years some improvement has been seen in the amount being saved. Some of the findings can be summarised as follows. People are living longer The UK has an ageing population meaning that the proportion of people paying tax and National Insurance is falling when compared to those receiving State Pensions. This is a problem because the State Pension is funded on a pay-as-you-go basis, which means Chapter 1 1/4 R04/July 2024 Pensions and retirement planning that the National Insurance contributions of the current working population pay for today’s State Pensions. Amount of pension savings There is a shortfall between what we should be saving for our old age and what we are actually saving. Research carried out by Sunlife, found that almost 7 million people over 50 do not have any private pension provision at all: – 2.4 million (20%) of men and 4.4 million (33%) of women over 50 are relying on the State pension alone to fund their retirement. Research done by financial hardship charity Independent Age found that 41% of those aged 50 and over, who are not yet fully retired, are concerned about living in economic hardship after they stop working. Recent research by Retirement living standards outlined the financial resources needed to achieve a minimum, moderate or comfortable standard of living in retirement. The figures for those living outside of London can be summarised as follows: Minimum Moderate Comfortable Single person £14,400 a year £31,300 a year £43,100 a year Couple £22,400 a year £43,100 a year £59,000 a year The maximum new State pension is currently £221.20 per week (2024/25), which is just over £11,500 a year. A couple who are both getting the full State pension would achieve the minimum standard of living in retirement. In all other cases, some private pension provision will be needed if the above standards are to be achieved. For reference only For example, a single person with the full State pension wishing for a moderate standard of living in retirement would need a pension fund large enough to give them a net income of £19,800 per annum. Based on May 2024 annuity rates, a fund of £390,000 would be enough to provide that income gross (assuming retirement at age 65, the purchase of a single life annuity with 3% escalation). As most of this income will be subject to income tax at 20%, a gross income of £24,750 per annum is needed. Thus the actual fund required is closer to £490,000. When you consider that the average UK pension pot at age 65 is £73,568, it should be apparent that most people will be unable to achieve even a moderate standard of living in retirement, unless they have other savings and investments. On the Web Various surveys have been carried out to show the amount of income that would be needed to provide for a basic, moderate or comfortable retirement. it is worth having a look at some of these to see the different assumptions that are used when working out the figures. The Which? research can be found here: www.which.co.uk/money/pensions-and-retirement/starting-to-plan-your-retirement/ how-much-will-you-need-to-retire-atu0z9k0lw3p. The Pensions and Lifetime Savings Association’s Retirement living standards research can be found here: www.retirementlivingstandards.org.uk. Since the introduction of auto-enrolment, more people are saving into pensions, although the rising cost of living is having some impact on the amounts that people are able to contribute. The Scottish Widows Retirement Report 2023 made the following findings: two thirds of people are on track to meet a least a minimum lifestyle in retirement. one third risk falling below the threshold for a minimum retirement lifestyle. Chapter 1 Context of pensions planning 1/5 Chapter 1 In March 2024, the Office of National Statistics (ONS) published Funded occupational pension schemes in the UK: April to September 2023, the findings of which can be summarised as follows: active membership of all private sector defined benefit schemes, including those closed to new members, has fallen over recent years. In 2008 the number of active members in private sector defined benefit schemes was 2.8 million, but this had fallen to 700,000 by the end of September 2023; most members of private sector defined benefit schemes are either deferred members or pensioner members. At the end of September 2023 there were 4.33 million deferred and 4.74 million pensioner members of private sector defined benefit schemes; and membership of defined contribution occupational pension schemes has grown rapidly in the last few years as a result of automatic enrolment. Membership reached 30.14 million (which includes active membership of 11.16 million) at the end of September 2023 (compared to 22.43 million (which includes active membership of 10.60 million) at the end of 2019). This survey only covered occupational pension schemes (both private and public sector). It does not cover State pensions or personal pensions. On the Web The Scottish Widows Retirement Report looks at all the major aspects of retirement planning. If you would like to this you can do so here: www.scottishwidows.co.uk/ about_us/media_centre/reports/retirement-report. Companies are changing the type of scheme they offer Many companies are closing their defined benefit schemes (also known as final salary schemes) and replacing them with defined contribution alternatives (also known as money For reference only purchase schemes), where the risk is borne by the member and all guarantees are lost. Final salary schemes in the private sector are closing to new members at the fastest rate on record. According to The Purple Book 2023, issued by the Pension Protection Fund: 9% of schemes are open to new members - down from 10% in 2022; 52% of schemes are closed to future accrual – up from 51% in 2022; and 36% of schemes are closed to new members, but open to new benefit accrual – down from 38% in 2022. Pension scandals In the past scandals have damaged the reputation of the UK pensions industry: In the late 1980s and early 1990s many people were wrongly advised to move away from their companies’ occupational pension schemes into personal pensions. In the early 1990s Robert Maxwell illegally used funds from the Mirror Group’s pension funds, leaving workers who had saved for many years with significantly reduced pensions in retirement. Equitable Life, a well-respected pension provider, reneged on its promise to pay valuable guaranteed annuities to its members, meaning that they lost large amounts of money. Falling stock markets, gilt yields and annuity rates Falling stock markets and falling gilt yields cause annuity rates to fall. Annuity rates are based on gilt yields and reductions in gilt yields can have a significant impact on rates. This was seen between 2016 and 2021, and an all time low was reached in August 2016. However, there have been some quite significant increases in pension annuity rates over the last couple of years. Now rates are much higher than they were four of five years ago. Sharing Pensions produce an annuity rates chart. This is based on the amount of income that could be provided by a fund of £100,000 at the age of 65. The figures are based on a level annuity with no guarantee. The chart shows that: in April 2024 the fund would have provided an annual income of £7,012; and in mid-2008 the same size fund would have provided an annual income of £7,908. However, annuity rates do fluctuate and these figures show that the annuity rate of £7,012 in April 2024 is considerably higher than, for example, the £4,696 per annum it would have Chapter 1 1/6 R04/July 2024 Pensions and retirement planning achieved in August 2016. In early March 2020 15-year gilt yields reduced to an all-time low due to the combination of the COVID-19 threat to global growth and the oil price war. Since then, gilt yields have increased and annuity rates are currently close to levels last achieved in 2008. Gilt yields have increased as a result of high inflation and rising interest rates. An interest rate cut, or signs that a cut is about to happen, will likely reduce annuity rates. It is likely that interest rates will start to fall over the next few months, when it is expected that annuity rates will start to fall again. Pensions are complex The majority of people struggle to understand the different types of pension arrangement and what will be provided by the State. Too many people still believe that the State Pension will provide them with an adequate level of income in retirement. The pension flexibilities have increased the amount of choice available, but some of these options are quite difficult to understand and often financial advice is needed to recommend the best course of action for someone at or close to retirement. Question 1.1 As well as life expectancy, annuity rates are based on expected returns from which type of underlying investment? B Demographic trends The UK’s ageing population means that the proportion of people who have retired is growing while the working population is reducing. This demographic trend obviously has a huge impact on the cost of providing pensions for those in retirement because they will have to be provided for more people. For reference only The changes are significant: in 2023 there were 11 million people aged 65 or over in the UK. This is projected to increase by 10% in th the next five years and by 32% by 2043; the fastest increase is in the number of people aged 85 and over and it is projected that this will continue to increase rapidly – by 8.2% in the next five years and by 62.7% by 2043 (126,000 and 956,000 people respectively); and in 2022, there were just over 15,120 people aged 100 or over in England and Wales – the number of centenarians has more than doubled since 2002. Life expectancy has also increased, meaning that pension income will have to be provided for a much longer time. Life expectancy at birth in the UK, based on 2020–22 statistics, is currently 78.6 years for a boy and 82.6 years for a girl. However, one of the most important factors for determining the cost of providing a pension is how long someone is expected to live once they have reached a certain age, e.g. in 2020–22 a man aged 65 could expect to live for another 18.3 years and a woman aged 65 could expect to live for another 20.8 years. To see how this has changed, let us compare 1997–99 with 2018–20: Expected to live another: Man Woman Age 1997–99 2020–22 1997–99 2020–22 65 15.2 years 18.3 years 18.5 years 20.8 years (Source: Office for National Statistics.) On the Web Visit the website www.ons.gov.uk. This site will give you lots of useful statistics relating to the population as well as other economic statistics such as inflation and earnings. Chapter 1 Context of pensions planning 1/7 Chapter 1 B1 Impact of demographic trends on pension provision These two key demographic trends: the increase in the retired population as a percentage of the total population and the fact that people are living longer, have a significant impact on the cost of pension provision in the UK. Although there are several other reasons, increased life expectancy has contributed towards the recent trend away from final salary schemes. We have already seen how the growth in life expectancy has increased the cost to the Government of providing State Pensions. Impact on annuities The impact of increasing life expectancy on annuity rates can be demonstrated by looking at a male, aged 65, looking to buy a single life annuity: At the start of the 1990s he could achieve an annuity rate in excess of 15%, so a pension fund of £100,000 could provide an annual income in excess of £15,000 p.a. By 2000 the annuity rate he could achieve had reduced to around 9% and by early 2024 it had fallen again to around 7.0%, meaning that the same £100,000 pension fund would now only provide an income of around £7,000 p.a. Until April 2015 someone with a defined contribution fund usually purchased a lifetime annuity to provide their income in retirement. The number of people purchasing lifetime annuities has fallen since the introduction of the pension flexibilities. However, following recent increases in annuity rates, annuity sales have increased significantly in 2023. The number of annuity contracts purchased reached their highest level since 2016. Impact of pension flexibilities The introduction of the pension flexibilities has seen fewer retirees purchasing annuities and more using the more flexible options such as drawdown. Such individuals are relying on investment arrangements that require ongoing reviews during their lifetime (and possibly beyond if the pension arrangement is passed down to subsequent generations). For reference only These options mean that the issue of longevity has become even more important: there is a danger that someone could run out of money during retirement. Information on the probability of surviving to a certain age can be obtained from various sources. The ONS has a basic calculator on its website and this shows that a man aged 65 has a: 1 in 4 chance of reaching the age of 92; 1 in 10 chance of reaching the age of 96; and 3.1% chance of reaching the age of 100. On the Web You can find this calculator here: www.ons.gov.uk/peoplepopulationandcommunity/healthandsocialcare/ healthandlifeexpectancies/articles/lifeexpectancycalculator/2019-06-07. There are more accurate calculators available that take into account the health of an individual. These can be found by using an internet search engine. These probabilities should be taken into account when considering the risk that someone will outlive their retirement savings and the relative value of annuitising. Question 1.2 State Pensions are funded on a ‘pay as you go’ basis. What does this mean? Chapter 1 1/8 R04/July 2024 Pensions and retirement planning C Corporate environmental factors Since October 2012, all employers must comply with the requirements to auto-enrol all eligible workers (or ‘jobholders’) into a qualifying pension scheme. The main challenge facing the Government in recent years has been to find a way of increasing pension saving in the UK. As we have seen, the introduction of auto-enrolment has increased the amount that people are saving towards their retirement. The introduction of pension flexibility for defined contribution schemes may also help, because many people were put off saving into a pension by the restrictions that applied to how benefits could be taken. Another challenge is the decline of the defined benefit scheme. This has largely been due to their growing cost, mainly as a result of increased longevity and falling annuity rates. On 6 April 2016, the new State Pension was introduced and on the same date contracting out for defined benefit schemes was abolished. Both employers and members of such schemes now need to pay increased National Insurance contributions (NICs). It is expected that this will result in even more defined benefit schemes being closed. Where a defined benefit scheme is closed to new members or wound up, it is often replaced by a defined contribution alternative, such as a group personal pension plan. Under a defined contribution arrangement all guarantees are lost and the investment risk and annuity risk (if applicable) is borne by the member. This is significant because of the key differences between a defined benefit scheme and a defined contribution scheme: Defined benefit scheme Pension is a proportion of the employee’s final salary at or close to retirement. This is a valuable guarantee as it means their retirement income is unaffected by fluctuations in investment returns or annuity rates as retirement approaches. Defined contribution scheme Pension is provided from a pension fund and the employee bears both the For reference only investment risk and, if an annuity is purchased, the annuity risk. If the fund performs badly and/or annuity rates fall at or close to retirement, pension income could be significantly reduced. Another change that has affected the level of pension saving is the change in employment trends. In the past, many people worked for the same company for their entire working life: they would join the company’s pension scheme and this would provide them with an adequate income in retirement. This is no longer the case. Most people work for several employers and may also have periods of self-employment and/or unemployment. Consequently, many people have a number of ‘paid up’ or ‘preserved pensions’. It is likely that the sum of these separate arrangements will result in a far lower pension than if they had been a member of a single pension scheme for their entire working lifetime. D Incentives, disincentives and attitudes to saving There are a number of reasons why people do and do not save for their retirement. Incentives In order to encourage saving via a pension, the Government offers the following incentives: income tax relief on contributions made by individuals; contributions made by employers are treated as a business expense for corporation tax or income tax purposes; the investment profits of the fund are exempt from income tax and CGT; the ability to take part of the proceeds as a tax-free cash lump sum, known as the pension commencement lump sum; the ability for members to take benefits from defined contribution schemes when and how they wish as a result of the flexibilities introduced in April 2015; and the ability to pass defined contribution pension funds to any beneficiary that the member chooses and more favourable tax treatment of death benefits, particularly where the member (or subsequent beneficiary) dies before the age of 75. Chapter 1 Context of pensions planning 1/9 Chapter 1 Nearly all employers offer a work based pension for their employees. An employer may be prepared to pay a financial adviser to give their employees information and advice in this respect. Under HMRC rules such advice costs are not treated as a benefit in kind for the employee, provided: similar advice is offered to all employees or to certain groups of employees, – if the advice is only offered to certain groups of employees, it must be offered to all employees within the stated groups, e.g. the advice can just be offered to certain groups of employees on the grounds of age or ill-health; and the advice only covers ‘relevant pensions advice’, which covers advice on the employee’s pension arrangements, as well as more general advice relating to the use of their pension funds (which can include general and tax issues). The exemption for income tax and National Insurance purposes is £500 per tax year. If the cost exceeds £500 per employee, any excess over £500 is subject to income tax and National Insurance contributions. Since 6 April 2017 it has been possible for a member of a defined contribution scheme to take a tax-free ‘pensions advice allowance’ from their arrangement to redeem against the cost of financial advice. A payment of up to £500 can be taken in a tax year, subject to a maximum of three payments being taken over the member’s lifetime. The money must be paid directly to the financial adviser, but the retirement financial advice can be holistic and the advice does not have to be limited to advice about the arrangement the £500 has come from. The withdrawals can be taken by the member at any age. Be aware A pension is simply a method of saving for retirement. It is only the tax advantages For reference only provided by the Government that make pensions different from other forms of saving, such as ISAs, unit trusts or bank accounts. While some other savings and investment products may have taxation privileges (for example, an ISA enjoys tax-free growth) they do not have all the taxation advantages of a pension product. Disincentives Despite the taxation advantages, many people save very little, if anything, towards their retirement. This may be for one or more of the following reasons. There is a limit to the amount of the fund that can be taken as a tax-free cash lump sum. There is no limit on the amount that may be saved in a registered pension scheme, but there is a limit on the amount of individual contributions that are eligible for tax relief. Benefits cannot be taken before the minimum pension age (currently 55) unless the individual is in ill-health or has a protected pension age. Many people find pensions complex and difficult to understand and prefer simpler savings alternatives such as a bank account or an ISA. Many people feel that pensions are expensive due to the charges incurred within pension contracts and the associated advice costs. There is a general mistrust of pensions due to past scandals and bad press. Consider this… We list the limit to the amount that can be taken as a tax-free cash lump sum and the minimum age at which benefits can be taken as disincentives. Why might these restrictions actually be beneficial (hint: the aim of a pension should be to provide an income for life in retirement)? Chapter 1 1/10 R04/July 2024 Pensions and retirement planning D1 Attitudes to saving One reason for the lack of pension provision may be people’s attitude towards saving. Affordability is often cited as the main reason for not saving enough for retirement. People have many demands on their income and other needs may take priority, e.g. bringing up children, buying a house or more pressing financial needs, such as life assurance. Many people believe, incorrectly, that the State Pension will give them an adequate standard of living in retirement. For many retirement seems a long time away and so saving into a pension feels low priority. Unfortunately, the cost of providing an adequate standard of living in retirement increases with age, so the longer someone waits before starting to save, the larger the monthly contributions will need to be. Consider this… Why is it unlikely that the State will provide an individual with an adequate standard of living in retirement? Question 1.3 Outline four taxation incentives associated with a pension scheme. E Main pension scheme types We will cover the main types of pension scheme in detail later in this study text. Here will simply give you an overview of the key features of the three main types of pension scheme. E1 State Pensions For reference only An individual may be eligible for one or more State Pension. The amount of State Pension accrued by an individual over their working lifetime depends on their National Insurance contribution (NIC) record. The eligibility for State Pensions has changed for those individuals who reach State Pension age (SPA) on or after 6 April 2016. Individuals who reached their SPA before 6 April 2016 receive State Pension benefits based on the rules that existed prior to 6 April 2016. Those who reached their SPA before April 2016 may receive State Pensions as illustrated in figure 1.1. Figure 1.1: State Pensions Basic State Pension Provided to any individual with an adequate National Insurance contribution record. PLUS State Graduated and/or and/or Pension Scheme State Earnings Related State Second Available between 1961 Pension Scheme Pension (S2P) and 1975, this was the (SERPS) Replaced SERPS in first State pension This is the earnings 2002 and applies to the scheme to provide related part of the State employed, carers and employees with an pension that applied to some people with additional earnings employees between long-term disabilities related pension on top of 1978 and 2002. who have broken work the Basic State Pension. records. On 6 April 2016, the new State Pension came into force. (You may see also this called the ‘single-tier’ State Pension.) Those reaching their SPA on or after 6 April 2016 are not entitled Chapter 1 Context of pensions planning 1/11 Chapter 1 to the State Pensions outlined in figure 1.1, but will instead receive the new State Pension. However, existing benefits accrued under the earnings related parts of the State Pension will be accounted for in calculating an individual’s entitlement, to ensure that no-one is worse off under the new system. In addition, any periods when the individual was contracted out under the pre-2016 rules will be taken into account. E2 Defined benefit (or final salary) schemes Refer to Defined benefits schemes covered in detail in chapter 5 A defined benefit scheme provides benefits that are guaranteed to be a proportion of final salary at retirement, or on death (hence their other name of final salary schemes). They may be provided by both the private sector (i.e. schemes provided by private employers) and the public sector (e.g. the NHS scheme, the teachers’ scheme etc.). Defined benefit schemes tend to provide superior benefits to other types of pension scheme, in terms of both the level and range of benefits. The major advantage of this type of scheme for the employee is the guaranteed nature of the benefits. The scheme sets a normal retirement age, which is usually the age up to which employer contributions will be paid, and this will be the age at which members will usually retire. The benefits that a defined benefit scheme will provide will be based on the following three factors: pensionable service: this is usually the employee’s period of membership in the scheme; pensionable remuneration: this is the definition of salary that is used to calculate the For reference only member’s benefits; and the accrual rate: the rules of the scheme will determine the rate at which benefits accrue, e.g. 1/60th of pensionable remuneration for each year of pensionable service. As well as a pension, a defined benefit scheme will also provide a tax-free cash lump sum, known as the pension commencement lump sum (PCLS) at retirement. The rules of the scheme will determine how much tax-free cash can be accrued for each year of service. E3 Defined contribution (or money purchase) schemes Refer to Defined contribution schemes covered in detail in chapter 6 Unlike a defined benefit scheme, a defined contribution (or money purchase) scheme does not provide the member with guaranteed benefits. Instead, a fund builds up and the benefits that are ultimately provided depend on the size of the fund at that time. If the member chooses to purchase a lifetime annuity, the actual level of income will depend on the annuity rates when benefits are taken. Generally, part of the fund may be taken as a PCLS and the amount of PCLS is usually limited to 25% of the value of the fund. The value of the fund also determines the amount of death benefits paid to the member’s chosen beneficiaries on the member’s death. Be aware The term ‘money purchase’ encompasses both defined contribution and cash balance schemes. A cash balance scheme is a type of money purchase scheme, but it provides a mix between defined benefit and defined contribution, by promising a certain lump-sum payment at a specified age (which will usually be the scheme’s retirement age). A defined contribution scheme may be an occupational scheme provided by an employer for the benefit of the employees, or it may be an individual arrangement funded by the member (and sometimes by the employer as well). Chapter 1 1/12 R04/July 2024 Pensions and retirement planning You may have come across various ‘types’ of pension arrangement, e.g. personal pensions, stakeholder pensions, executive pensions, small self-administered schemes (SSASs), self- invested personal pensions (SIPPs) etc. These are all defined contribution schemes. Some defined contribution schemes are ‘hybrid’ schemes, e.g. a targeted money purchase scheme. This type of scheme is funded to provide a specific amount of benefit at retirement, typically a proportion of final salary. Since 6 April 2015 an individual is able to take as much or as little as they like from their defined contribution arrangements once they reach the normal minimum pension age, currently 55 (or earlier if the individual is in ill-health or has a protected pension age). E3A Key terminology in relation to defined contribution schemes Learning point We have chosen to use the term ‘defined contribution schemes’ as the name for these types of schemes. However, the term ‘money purchase scheme’ is also widely used in the market. You will notice as you go through this study text that the Government/ HMRC sometimes use ‘money purchase’ and not ‘defined contribution’ as their name for certain concepts, e.g. the money purchase annual allowance. Therefore, you will need to remember both these terms as you study. There are several ways in which a member of a defined contribution scheme may choose to take their income and we summarise them in this section. If one of the first three options is selected, the member can usually choose to take up to 25% of the fund as a pension commencement lump sum (PCLS). A lifetime annuity The fund is used to purchase a contract from an insurance company and this will For reference only provide the member with an income for life. The amount of income provided depends on the size of the fund and the annuity rates available. A flexible lifetime annuity is one where the annual rate of income can be reduced each year by any amount. A scheme pension The scheme administrator uses the balance of the fund to secure an income for life for the member. For a defined contribution scheme this is similar to a lifetime annuity in that the amount of income provided depends upon the size of the fund and scheme pension rates available. A drawdown pension An income is drawn directly from a defined contribution fund. There are two different forms of drawdown: Capped drawdown The amount of income that can be drawn each year is subject to limits set by the Government Actuary’s Department (GAD). Note: it is no longer possible to set up a new capped drawdown plan, though individuals who have already designated funds into one can continue in it. They have the option of changing to flexi-access drawdown. Flexi-access There are no restrictions on the amount of income that can be drawdown (FAD) drawn each year. An uncrystallised funds A lump sum taken from a defined contribution fund from which benefits are yet to be pension lump sum taken (known as an uncrystallised fund). Up to 25% of the UFPLS will be tax-free, (UFPLS) with the balance taxable as the member’s pension income via PAYE. The member can take as much or as little as they like from the fund as an UFPLS. Death benefits may be paid to a dependant of the member, to a nominee or to a successor. Chapter 1 Context of pensions planning 1/13 Chapter 1 Dependant Defined by HMRC as someone who meets one of the following: the member’s widow(er)/civil partner at the time of the member’s death; or a child of the member who is under the age of 23 at the date of the member’s death; or a child of the member who, in the opinion of the scheme administrator, was dependent on the member due to mental or physical impairment at the date of the member’s death; or a person who was not married to/in a civil partnership with the member at the date of the member’s death, but who, in the opinion of the scheme administrator, was; – financially dependent on the member, or – in a financial relationship of mutual dependence with the member, or – dependent on the member because of their physical or mental impairment. Nominee A nominee is any individual, other than a dependant, nominated by the member to receive the benefits from a pension plan upon the member’s death. If the member does not make a nomination prior to their death (either to an individual or a charity), and there are no dependants, a scheme administrator can make the nomination on behalf of the scheme member. Successor A successor is an individual nominated by a dependant or a nominee to continue to receive the dependant’s or nominee’s flexi-access drawdown (which will then become a successor’s flexi-access drawdown). A successor can also be someone nominated to continue to receive the income from a previous successor’s flexi-access drawdown. If a nominee or successor fails to nominate someone to continue to receive the income from their flexi-access drawdown, then the scheme administrator can do so on their behalf. For reference only Refer to We look at death benefits in Tax treatment of death benefits on page 3/14 and in chapters 7 and 8. In this study text we are going to use the following abbreviations to describe a number of well-used terms. Basic State Pension BSP benefit crystallisation event BCE Consumer Prices Index CPI money purchase annual allowance MPAA National Insurance contributions NICs pay as you earn PAYE pension commencement lump sum PCLS per annum p.a. Retail Prices Index RPI State Pension age SPA uncrystallised funds pension lump sum UFPLS Chapter 1 1/14 R04/July 2024 Pensions and retirement planning Key points The main ideas covered by this chapter can be summarised as follows: Role of Government The Government has been involved in shaping pension provision in the UK for many years and some of the changes it has introduced include greater protection for members of occupational pension schemes, support for the poorest pensioners, changes to State Pensions and State Pension age, encouraging private pension provision and imposing auto-enrolment, the introduction of a single pensions tax regime and pension flexibilities. Many companies are closing their defined benefit schemes and replacing them with defined contribution alternatives. There have been a number of scandals over recent years that have damaged the reputation of the UK pensions industry. Falling stock markets and falling gilt yields have decimated annuity rates and thus pension income over the past few years. Some people are not saving enough towards their retirement, although the introduction of automatic enrolment means that more people are saving ‘adequately’ for retirement. Demographic trends The UK has an ageing population; the proportion of people who have retired is growing while the working population is reducing. The fastest population increase has been in the number of people aged 85 and over. Life expectancy at birth is currently 78.6 years for a boy and 82.6 years for a girl. For reference only Annuity rates for a male aged 65 looking to buy a single life annuity have reduced from over 15% at the beginning of the 1990s to around 7.0% by early 2024. Increased life expectancy has caused significant reductions in annuity rates over recent years. Corporate environmental factors Since October 2012, all employers have to auto-enrol all eligible workers (or ‘jobholders’) into a qualifying pension scheme. Membership of defined benefit schemes is declining, due largely to increasing costs. Changing employment trends and increased job mobility have further reduced the amount of pension provision in the UK. Incentives, disincentives and attitudes to saving Various tax related incentives are offered to try to encourage people to save for their retirement, e.g. tax relief on contributions and tax-free fund growth. Some of the restrictions relating to pensions act as a disincentive towards pension saving, e.g. the limit to the amount that can be taken as a tax-free cash lump sum and lack of access to pension funds until the normal minimum pension age. Other factors such as costs, adviser charges and the complexity of pensions are also disincentives. Attitudes towards saving can also lead to a lack of pension provision; this may be due to affordability, the feeling that the ‘State will provide’ or pension saving being a low priority because retirement is many years away. Main pension scheme types Those who reached their State Pension age before 6 April 2016 may be eligible to receive one or more of the Basic State Pension, the State Graduated Pension Scheme, the State Earnings Related Pension Scheme (SERPS) and the State Second Pension (S2P). Chapter 1 Context of pensions planning 1/15 Chapter 1 Key points Those reaching their State Pension age on or after 6 April 2016 may be eligible to receive the new State Pension. A defined benefit (or final salary scheme) provides benefits that are guaranteed as a proportion of final salary at retirement (or on death) and which tend to be superior to those provided by other types of pension scheme, in terms of both the level and range of benefits. The major advantage of a defined benefit scheme for the employee is the guaranteed nature of the benefits. A defined contribution (or money purchase) scheme provides benefits based on the size of the fund and, i