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   Members reduced benefits    Money purchase scheme    Mortality drag
   Minimum funding requirement    Mortality profit    Mortality

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Members reduced benefits
Under section 31 of the Welfare Reform and Pensions Act 1999 (WRPA 99) there are provisions for the reduction of a members pension rights as a result of the creation of a pension debit due to a pension sharing order.

The effect of a pension debit is to reduce the value of a members retirement benefits, determined from the provider as the CETV Method or alternatively an adjusted CETV from a pensions expert if the court requires expert evidence to be provided during ancillary relief proceedings, by the percentage ascertained by the court order or as agreed by the parties through their solicitors. If the order or agreement is in terms of a specified amount, then the reduction will be by the percentage the amount represents of the value of the retirement benefits.

Where the members pension rights are accrued through a money purchase scheme such as a personal pension, retirement annuity policies (RAPs) or stakeholder pensions the pension debit will be applied to the pension fund value, usually being the cash equivalent transfer value (CETV), as a once and for all percentage reduction. The provider will implement this percentage value in the name of the former spouse if dual membership is permitted as an internal transfer or as an external transfer to another pension arrangement if an internal transfer is not allowed. There will be no further impact on the remaining members pension rights.

The calculation of a members reduced benefits for an employers final salary pension is more complex than the money purchase scheme and will involve the pension arrangement provider recording the pension debit as a negative deferred pension, to be applied at some time in the future at the scheme members normal pension age (NPA) or an alternative age if early retirement is selected.

Minimum funding requirement
Under section 56 to 61 of the Pensions Act 1995 the minimum funding requirement (MFR) was introduced to help occupational pension schemes such as a final salary pension to offer the members more security.

MFR does not apply to occupational money purchase schemes in general unless that scheme also provides other salary related benefits that are subject to MFR. On the discontinuance of the scheme, MFR is designed to ensure that the scheme will have sufficient assets to secure all pensions in payment to pensioners as well as pay a cash equivalent transfer value (CETV) for all active members and deferred members not yet in receipt of a pension income.

The minimum funding requirement was effective from 6 April 1997 and the scheme trustees must put in place a scheme that covers the next five years from the date of the actuarial valuation showing that the contributions made are sufficient for the scheme to be 100.0% funded. There is a transitional period of 5 years that ends on 5 April 2002. Where the valuation shows the scheme to be below 90.0% funded to the MFR level the schedule must show that the scheme will be at least 90.0% funded by one year after the transitional period, or 5 April 2003.

Where the valuation shows funding of 90.0% to 100.0% the transitional period is extended by 5 April 2007. In certain circumstances a seriously underfunded scheme can apply to the Occupational Pension Regulatory Authority (OPRA) to have these time limits further extended.

Money purchase scheme
Where a scheme member can contribute to a pension fund and the benefits at retirement age are uncertain, as they depend on the size of the funds under management, but the contributions are known then this is referred to as a defined contribution scheme. A defined contribution can be made to a money purchase scheme and could be operated by an employer as an occupational money purchase scheme, a group personal pension (GPP) or simply set-up by a person as an individual policy such as stakeholder pensions.

Since 6 April 2006, Pension Simplification changes have established a Lifetime Allowance for the size of an individual's money purchase scheme fund to £1.5 million in 2006 rising to £1.8 million in 2010. At retirement a tax free lump sum of 25% can be taken with the remaining fund being used to purchase an annuity or placed within an income drawdown arrangement.

At retirement the individual can use the money purchase fund to buy an annuity and has the option to use an open market option to search for the highest pension annuity. Once you have purchased an annuity it cannot be changed, so learn more about annuities, compare annuity rates and before making a decision at retirement, secure a personalised pension annuities quote offering guaranteed rates.

The Annual Allowance for contributions is set at £215,000 for 2006 rising to £255,000 in 2010. Tax relief on contributions is limited to contributions of £3,600 per annum or 100% of relevant earnings if greater. Any investment growth or loss in the value of the fund for all money purchase schemes, whether private pensions or occupational pensions, are not included in the annual allowance. For all money purchase schemes the retirement benefits can be taken between 50 to 75 years of age until 2010 when the minimum is to be raised to 55 years of age.

Prior to A-Day the amount of retirement benefits from a money purchase scheme were unlimited but the members contributions were limited and pensionable earnings subject to the earnings cap. The contributions were based on the members age from 17.5% up to 40.0% with a tax free cash of 25.0% taken before the balance is used to purchase a pension income. A free standing additional voluntary contribution (FSAVC) scheme linked to an occupational pension regime limited the member's contributions to 15.0% of pensionable earnings.

The expected age an individual can live to is reflected in mortality tables that are based on the population as a whole. The use of mortality tables is important to life companies offering pension annuity and purchase life annuity incomes. A persons mortality depends on their current age, therefore a 50 year old male can be expected to live to age 83 whereas a 70 year old male is expected to live to 87 years of age.

Some annuitants live beyond these life expectancies and as a result, receive more money from the annuity income than the original pension fund plus interest. This is particularly the case where the annuitant has a with profit annuity as the bonuses declared depend on equity performance and returns are greater than a conventional annuity in the long term. Other annuitants die early and receive only a fraction back from their original pension fund capital and creating a mortality profit for the insurance company.

At retirement the individual can use a pension fund to buy an annuity and has the option to use an open market option to search for the highest pension annuity. Once you have purchased an annuity it cannot be changed, so learn more about annuities, compare annuity rates and before making a decision at retirement, secure a personalised annuity quote offering guaranteed rates.

This means that an individual with poor health and lower life expectancy will find an annuity unattractive. Life companies offer an enhanced annuity or impaired life annuity for people with shorter life expectancies such as smokers, people that are overweight, of a certain occupation or even living in a particular location in the UK.

Where a family with an elderly relative that now requires 24 hour care after suffering an illness, their age, mortality and medical condition would usually enhance the rate paid by an immediate needs annuity. This means the long term care costs for a nursing home could be met with a reduced lump sum from the estate.

Mortality profit
Annuity providers make a profit from the fact that some members die sooner than expected. By deferring buying a pension annuity or even a purchase life annuity the individual is not able to share in the profit available from current annuity rates and this is known as mortality risk.

The resulting mortality profit will in part be used to enhance
annuity rates or for with profit annuities the bonuses declared. Delaying the purchase of an annuity means the individual forgoing potential profits and the longer the delay the greater will be the loss in potential profits.

Mortality drag
Annuity rates are based on the life expectancy of the member, whether they buy a purchase life annuity or a pension annuity. Those that live longer than others will over time receive their original pension fund value plus interest. Some members will die without receiving even their original fund value. This results in a mortality profit of which surviving annuitants will benefit with higher annuity as a result of a cross subsidy.

If the pension scheme member at
retirement age chooses drawdown rather than an annuity, the member will not benefit from the mortality profit and thereby creating a mortality risk. To compensate for this loss of mortality subsidy, pension drawdown will have to achieve an extra investment return. This also applies to anyone that chooses to delay purchasing an annuity in the hope that the rates will improve in the future, resulting in a cost of delay.

The Financial Services Authority (FSA) estimate that at age 60 the extra return required is 1% but by 75 it could be as high as 4%. This will result in a mortality drag and is effectively a loss against the investment return as a result of the member deferring the purchase of an annuity.

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