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Alistair Cunningham: Beware innovative pension products

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The Budget changes to pension withdrawals have been widely welcomed but there are several reasons to treat the proposals with some scepticism.

Take the removal of restrictions on withdrawal limits. The observant (not mainstream media) will note that the expected revenue generated from the changes is £3bn over the next five years. We now see a major restriction in pension tax reliefs (£40,000 now versus £215,000 in 2006) and a rise in taxable income allowed for withdrawal.

Imprudent savers will pull funds out of pensions, investing in, for example, buy-to-let properties. This has a second benefit to the Treasury because on top of the income tax on pension withdrawals, revenue will also be collected from these properties in the form of stamp duty, income tax on rent, capital gains tax on profits, VAT on agents’ and other fees and, of course, IHT on death, where most pensions would have been exempt.

Even the short-term withdrawal increase to 150 per cent GAD is foolhardy. A 65-year-old male should not expect to withdraw more than 9 per cent a year from their fund without a major erosion of capital.
I understand some individuals may have extreme needs, or even other assets to rely on, but many will make unwise levels of withdrawals. When this inevitably fails, they will seek someone to blame.

Pensions minister Steve Webb may claim not to be paternal but I believe the FCA and FOS are and our PI and FSCS fees tend to subsidise the feckless.

My experience is that individuals underestimate their continued good health and longevity. I often tell clients in their sixties that they may need to rein in their expenses in their late seventies or early eighties. They think they will be over the hill by this point but I am sure we all know people in this category who are anything but.

The ONS suggests that a 65-year-old has a dozen years in “good” or “very good” health and that a 65-year-old couple have a 50 per cent chance of being around a quarter of a century later.

Product innovation will come – an idea that fills me with dread. It seems to me that most innovation in financial products serves the innovator far more than the end-client. Hybrid products often have the disadvantages of both annuity and drawdown but few of the advantages. Guaranteed drawdown is often costly and to guarantee an investment-linked annuity will not fall, you must take a big discount from the level variety.

I foresee banks re-entering the consumer advice market. Sipps, now regulated, are still fairly simple to “manufacture” and can be filled with cash and structured products. These investments are what banks like to sell and consumers fleeing the perceived inflexibility of drawdown may be suckered into the lure of “guarantees” with greater accessibility. Which high-street bank will be first to launch an Isa and Sipp wrapper with a debit card attached?

I risk sounding unduly cynical. These changes will be great for advised clients who can accrue funds avoiding higher rates of tax, and often NI, and ultimately decumulate with no more than basic rate. But the advised are the minority and the Treasury, high-street banks and ex-PPI ambulance chasers may be rubbing their hands at the opportunity presented by the Chancellor.

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Comments

There are 6 comments at the moment, we would love to hear your opinion too.

  1. Samuel Lewis Mayes 27th May 2014 at 9:21 am

    Hi Alistair – good article and one that sounds some caution with all the impending changes and flexibility.

    “I understand some individuals may have extreme needs, or even other assets to rely on, but many will make unwise levels of withdrawals. When this inevitably fails, they will seek someone to blame.”

    When the money runs out with max GAD or total pension stripping the FCA, TPR, FOS and FSCS will all take note. In my estimation, if you have other assets to rely on, why disturb a tax efficient pension environment first? You wouldn’t disturb an OEIC over an ISA? Why not treat the pension pot as a significant part of your overall portfolio that is callable at a time convenient to the client? Don’t forget the advantageous death benefits too…

    Robust justification is needed in the above circumstances. If a client required a secure income for life before the Budget 2014, the client will still require that same secure income for life on April 2015.

    Sam

  2. Christopher Lean 27th May 2014 at 10:05 am

    I wonder what percentage of the public understand the tax consequences of full encashment when the new rules take affect?

    How many will be told to encash their pensions by marketing firms that then recommend alternative investments?

    The losses in terms of tax and charges could be catastophic- There probably won’t be an IHT issue in the end, due to the small size of the resultant savings.

  3. Excellent article Alistair, very balanced and well-reasoned points. It is up to us as advisers to advise our clients of the perils of taking out unsustainable pension withdrawals, whether they be lump sums, excessive regular withdrawals or a combination of the two. Rather than taking the route of no resistance and doing what the client asks, we need to earn our salt and counsel against unwise withdrawals. And if clients decide to take this course of action against our advice, we need to document this properly, not so much to protect ourselves but to make it clear to the client again and again that they are risking severe depletion of their funds.

  4. Amongst the wisest commentary I have observed in this arena.

    Hat tipped

  5. I still detect an irrational antipathy towards structured plans. Most of these plans offer substantial growth when the market is not growing, income even when the market is falling, and at least return of capital if the markets have not suffered a catastrophic fall. Clients know what sort of returns to expect in the future in relation to the major market indexes.

  6. Christopher Lean 27th May 2014 at 12:58 pm

    Ken,

    Not sure if structured plans, on the whole, are the issue. It is more the proliferation of off-plan offshore properties in exotic locations, timber plantations, store pods, student accommodation, life settlement funds and so on that tend to be offered to those that least understand the risks.

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