Retirements Fact Finding (Money Purchase Scheme)


Money Purchase Schemes

In a money purchase scheme, often referred to as a defined contribution scheme, the scheme rules will describe how a member's benefits are to be calculated on leaving service, retirement or death. This element of the resource material will concentrate on the calculation and communication of retirement benefits for a money purchase scheme.

The case studies that you will be referred to in the examinations will include one (1) money purchase scheme:

  • The OPQ Retirement & Death Benefits Plan (which is not contracted out)

TIP: From 6 April 2012 it was no longer possible for money purchase schemes to be contracted out.

There are four (4) distinct retirement calculations and candidates will be tested on each of these in the examinations:

  1. Normal retirement (for members who are "active" or “preserved” and who retire at normal pension date)
  2. Early retirement (for members who are “active” or "preserved" and who retire before normal pension date)
  3. Ill-health retirement (for members who are “active” or “preserved” and retire before normal pension date due to ill-health)
  4. Late retirement (for members who are "active" or “preserved” and who retire after normal pension date)


Fact Finding

1. What benefits are available on retirement from a money purchase scheme?

The benefits potentially available on retirement are as follows:

  1. Tax-free cash sum
  2. Member’s pension (with or without increases)
  3. Spouse's or dependant's pension payable on the death of the member (with or without increases)

For members taking their money purchase benefits from 6 April 2015, there are additional options available as a result of the Pension Freedoms. For instance, under the OPQ Retirement & Death Benefits Plan, it is now possible to take a single Uncrystallised Funds Pension Lump Sum (UFPLS). By taking this option, the member`s entire Personal Retirement Account is exhausted, with 25% of the UFPLS being paid tax-free and the balance being taxed at the member`s marginal rate of income tax.

TIP: The OPQ Retirement & Death Benefits Plan does not test candidates on death in retirement case studies since the member’s annuity, once in payment, is the responsibility of the chosen provider and not the OPQ Retirement & Death Benefits Plan.

2. How is the tax-free cash sum calculated?

Under a money purchase scheme, the maximum tax-free cash sum is generally 25% of the value of the member's fund.

Should a member choose to not take the tax-free cash sum option or, alternatively, to take less than the maximum available, then this will leave a higher fund value with which to purchase a pension.

From 6 April 2015, it is now also possible to take a single one-off Uncrystallised Funds Pension Lump Sum (UFPLS) or a series of UFPLS`s. 25% of each lump sum is tax-free, with the balance being taxed at the member`s marginal rate of income tax. Under the OPQ Retirement & Death Benefits Plan, only the single UFPLS is available. However, members may choose to transfer to an alternative pension arrangement if they wish to take a series of UFPLS payments or, indeed, if they wish to exercise other options available following the introduction of the Pension Freedoms introduced in Budget 2014.

Since members retiring from 6 April 2012 no longer have any protected rights, it is now possible to take 25% of the value of the overall policy account as a tax-free cash sum, assuming the amount is within the member`s remaining Individual Lifetime Allowance.

3. How is a normal retirement pension calculated?

A normal retirement pension is based on the member's fund value (after exercising the tax-free cash sum option), the prevailing annuity rates and the choice of pension at normal pension date (e.g. single life / joint life or escalating / non-escalating).

The annuity factor will vary according to the member's age at retirement and the benefits to be provided. For example:

Details
Calculation
  • Member is retiring at age 65
Fund available: £30,000
  • Annuity factor for pension for member only
  • Pension increasing annually by RPI limited to 5%
£6.60 pension per annum per £100 of fund value
  • Annuity factor for pension for member plus 50% spouse’s pension on death of member
  • Pension increasing annually by RPI limited to 3%
£5.79 pension per annum per £100 of fund value
  • Amount of pension (no spouse’s pension)
[£30,000 / 100] x 6.60 = £1,980 per annum
  • Amount of pension (50% spouse’s pension)
[£30,000 / 100] x 5.79 = £1,737 per annum


With the OPQ Retirement & Death Benefits Plan, members can make use of an `Annuity Bureau` when purchasing their annuity on retirement. For this service, an ‘Annuity Bureau` charge is applied. This charge is £60.00 or, if greater, 0.05% of the value of the member`s Personal Retirement Account after the tax-free cash sum has been taken.

TIP: Another option for securing a pension under the OPQ Retirement & Death Benefits Plan is for the trustees to purchase an annuity with an insurance company (open market option).  This option must be mentioned on the examination paper.

4. How is an early / ill-health / late retirement pension calculated?

An early / ill-health / late retirement pension is calculated in exactly the same way as a normal retirement pension. However, although the key elements are the same (i.e. fund value after exercising the tax free cash sum option, annuity factors and choice of pension), the annuity factors are based on the member's age at retirement date and so will be more generous for late retirement (due to the shorter expected period of payment) and less generous for early retirement (due to the longer expected period of payment).

The annuity factor will vary according to the member`s age at retirement and the benefits to be provided. The examples below cover early and late retirement:

Details
Calculation
  • Member is retiring EARLY at age 58
Fund available: £30,000
  • Annuity factor for pension for member only
  • Pension increasing annually by RPI limited to 5%
£5.00 pension per annum per £100 of fund value
  • Annuity factor for pension for member plus 50% spouse’s pension on death of member
  • Pension increasing annually by RPI limited to 3%
£4.61 pension per annum per £100 of fund value
  • Amount of pension (no spouse’s pension)
[£30,000 / 100] x 5.00 = £1,500 per annum
  • Amount of pension (50% spouse’s pension)
[£30,000 / 100] x 4.61 = £1,383 per annum


Details
Calculation
  • Member is retiring LATE at age 71
Fund available: £30,000
  • Annuity factor for pension for member only
  • Pension increasing annually by RPI limited to 5%
£8.75 pension per annum per £100 of fund value
  • Annuity factor for pension for member plus 50% spouse’s pension on death of member
  • Pension increasing annually by RPI limited to 3%
£7.32 pension per annum per £100 of fund value
  • Amount of pension (no spouse’s pension)
[£30,000 / 100] x 8.75 = £2,625 per annum
  • Amount of pension (50% spouse’s pension)
[£30,000 / 100] x 7.32 = £2,196 per annum


5. How are retirements from preserved status handled?

Preserved benefits (often called deferred benefits) belong to members who have left the pension scheme and who have chosen to leave their benefits in the scheme to be taken when they reach retirement. For the purposes of the examinations, a preserved member will always have a date of leaving and a date of retirement.

For money purchase schemes, the fund date of leaving will remain invested until such time as the member takes his benefits but no further contributions will be paid. Benefits will be determined in exactly the same way as indicated in previous sections. 

6. How are communications with the member / trustees made?

Once the benefits have been calculated they need to be communicated to the member and / or trustees of the scheme in the form of a letter. The examinations will expect learners to write letters to include all the facts and figures that are required to be communicated.

For retirement case studies from the OPQ Retirement & Death Benefits Plan, all letters should include the following (where applicable):

1. Member’s date of retirement

2. Value of member’s Personal Retirement Account

3. Full set of options:

  1. Annuity only (stating all combinations based on escalation rates and single life / joint life options)
  2. Tax-free cash sum and annuity (stating all combinations based on escalation rates and single life / joint life options)

4. Pension details:

  1. Commencement date
  2. Frequency of payment

5. UFPLS option (stating tax-free element and taxable element)

6. Open market option

7. LTA percentage used (stating the percentages for each of the annuity / tax-free cash sum options)

8. Requirements for payment:

  1. Choice of option
  2. Member’s birth certificate
  3. Bank details

The list is not definitive and all letters must, for example, refer to any special circumstances and additional information contained in the case study