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September 2020 - Question 2 iv)

M

Matthew Brown

Member
Hi all - I'm looking at a question from the last SA7 paper where candidates were asked to determine a numerical work through of a pension final value for individuals based on a starting salary at 25 of 30k and a contribution rate of 5% for 40 years.

My first question is what assumptions are reasonable to make in the exam for this type of question and how best to decide on a level for each? The examiners report for example makes assumptions for:
  • Price inflation
  • Annual salary growth (relative to inflation)
  • Asset growth (relative to inflation)
  • Annuity rate at 65 = 25
Secondly I couldn't work through to the final value that they determined of £360k or £193k in real terms. They also seem to make an assumption that the payout for the pension is for 25 years when determining the annual pension? Is this a standard assumption to make too? (appreciate this may just be because I've used the wrong formula for it!)

Many thanks in advance!!
 
Hi,
I must admit that I also got a variety of different answers for this one (most of which were a bit higher than the examiners). It depends on the assumptions you make. But as the examiners said in the question:
You should make other assumptions as necessary to estimate the level of pension income at retirement and how this might
vary.
So most reasonable estimates would gain marks.

The expectation of 25 years is crucial for the value of the expected pension, and is not given in the question. But without mortality tables, you do need some rough estimate of life expectancy in order to calculate a pension from the lump sum at retirement, and I think any sensible estimate between 20 and 30 years would be awarded marks. The examiners calcs are only approximate, and indeed the conversion from lump sum 360k to annuity 14.4k using 25 years life expectancy, is 360/25 = 14.4, indicating that great deal of accuracy was not required to score marks. Sorry if this is not a precise answer, but I dont really have one here.
 
Matthew Brown said:
Hi all - I'm looking at a question from the last SA7 paper where candidates were asked to determine a numerical work through of a pension final value for individuals based on a starting salary at 25 of 30k and a contribution rate of 5% for 40 years.

My first question is what assumptions are reasonable to make in the exam for this type of question and how best to decide on a level for each? The examiners report for example makes assumptions for:
  • Price inflation
  • Annual salary growth (relative to inflation)
  • Asset growth (relative to inflation)
  • Annuity rate at 65 = 25
Secondly I couldn't work through to the final value that they determined of £360k or £193k in real terms. They also seem to make an assumption that the payout for the pension is for 25 years when determining the annual pension? Is this a standard assumption to make too? (appreciate this may just be because I've used the wrong formula for it!)
Click to expand...
Many thanks in advance!![/QUOTE]

Hi Matthew!

I, too, had some issues with this question as well.....I am glad to see i am not the only one puzzled by their figures. :)

I would like to see exactly how they got 360K.

For the annuity factor, I used 25 or close to it, because, given that interest rates are are so low, and with longevity increasing, so that a person who lives to be 65 might expect another 25 years, I went with a 1% or less annuity (around 22 years) which is close to 25 years. Although that does not factor in the probabilities which would make it lower?.
 
Hello,

I am finding it tricky to reach the £360k value of the pension pot at retirement age noted in the examiners report.

I have used the assumptions noted in the examiners report, namely an annual salary increase of 4% pa (1%+3% price inflation), an asset growth of 6% pa (3% +3% price inflation). I also assumed monthly contribution payments where asset growth is applied in arrears each month and annual salary increases at the beginning of each new year but the retirement pot figure I end up with at the end of the 40 year term is c.£420.5k compared with the examiners £360k.

Can anyone help with where I am going wrong or put forward their insight on how they were able to reach the £360k value in the examiners report?

Thank you!!
 
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