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 money purchase scheme:
TIP: From 6 April 2012 it was no longer possible for money purchase schemes to be contracted out.
There are four distinct retirement calculations and learners will be tested on each of these in the examinations:
1. What benefits are available on retirement from a money purchase scheme?
The benefits potentially available on retirement are as follows:
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 learners 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 an annuity.
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 cash 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 option 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 'Lump Sum & Death Benefit Allowance' and 'Lump Sum Allowance'.
3. How is an annuity calculated at normal pension date?
An annuity at normal pension date is based on the member's fund value (after exercising the tax-free cash sum option), the prevailing annuity rates and the choice of annuity at normal pension date (e.g. either single life or joint life [which can be either escalating or 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 |
| Fund available: £30,000.00 |
| £6.60 p.a. for each £100.00 of fund value |
| £5.79 p.a. for each £100.00 of fund value |
| [£30,000.00 / 100] x 6.60 = £1,980.00 p.a. |
| [£30,000.00 / 100] x 5.79 = £1,737.00 p.a. |
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 £75.00 or, if greater, 0.065% of the value of the member`s Personal Retirement Account after the tax-free cash sum has been taken.
TIP: Another option for securing an annuity within 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 are annuities calculated for early / ill-health / late retirement?
An annuity on early / ill-health / late retirement is calculated in exactly the same way as an annuity at normal pension date. However, although the key considerations for determining the annuity are the same (i.e. the value of the fund after exercising the tax-free cash sum option and the type of annuity required), the actual annuity factor is based on the member's age when the annuity is purchased. The factor 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 |
| Fund available: £30,000.00 |
| £5.00 p.a. for each £100.00 of fund value |
| £4.61 p.a. for each £100.00 of fund value |
| [£30,000.00 / 100] x 5.00 = £1,500.00 p.a. |
| [£30,000.00 / 100] x 4.61 = £1,383.00 p.a. |
Details | Calculation |
| Fund available: £30,000.00 |
| £8.75 p.a. for each £100.00 of fund value |
| £7.32 p.a. for each £100.00 of fund value |
| [£30,000.00 / 100] x 8.75 = £2,625.00 p.a. |
| [£30,000.00 / 100] x 7.32 = £2,196.00 p.a. |
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 at the 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:
4. Annuity details:
5. UFPLS option (stating the tax-free element and the taxable element)
6. Open market option
7. Confirmation (or otherwise) that the tax-free cash sum is within the member's remaining 'Lumps Sum & Death Benefit Allowance' and 'Lump Sum Allowance'
8. Requirements for payment:
The list is not definitive and all letters must, for example, refer to any special circumstances and additional information contained in the case study
