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Appraise you like I should

In my last few articles, I have started to discuss the stages involved in giving investment planning advice on a target benefit basis. In particular, I am attempting to highlight the following throughout this series of articles:

•The assumptions which have to be made in this process.

•The way in which the assumptions should be determined.

•The need for periodic reviews of these assumptions up to the date when the plan reaches maturity.

•The effect, over time, of variations in the level of the assumptions against those made originally when forming the client&#39s investment strategy.

All these issues form part of recommendations relating to the targeting of client investments which I believe will feature in the Sandler report.

Two weeks ago, I started to look at the importance of taking into account the nature of existing investments which may be expected to provide at least part of the client&#39s required level of income at the target future date.

Having, in that article, discussed the existence and level of the client&#39s entitlement to the basic state pension, I would like to move briefly to entitlement to benefits under Serps. I noted last time the convenience of using form BR19 to receive an estimation of the client&#39s level of entitlement to the basic state pension and I can start this article by confirming that the same form also includes a statement of the client&#39s entitlement to Serps&#39 benefits. However, it should be noted that, as with the statement of basic state pension entitlement, the client&#39s Serps&#39 benefits are illustrated as a level of current entitlement, not the expected future level of benefit.

Thus, this illustrated level of benefit must be revalued by the appropriate rate between the date of illustration and the date the benefit is due to come into payment – usually the client&#39s 65th birthday, with the exception of women, when it will be between 60 and 65.

What level of revaluation should be used? Serps&#39 benefits are revalued, up to the date they come into payment, in line with increases in the level of national average earnings – an assumption which we have discussed in previous articles, being derived from Government bond redemption yields.

You may wish to note the existence and possible use of BR20 which, in contrast to BR19, illustrates the accrued Serps&#39 benefits as a capitalised lump-sum value rather than an annual income. This might be useful in some target benefit strategies although, for the most part, this series of articles is concentrating on target income benefit rather than target fund values.

As an aside, BR20 is most useful when considering pension-sharing negotiations as it is now possible for the courts to make a sharing order against a spouse&#39s Serps&#39 benefits.

More relevant to our current discussions, as regards both the basic state pension and Serps&#39 entitlement, the adviser might seek to make some attempt to factor in a client&#39s future additional entitlement to benefit as BR19 and BR20 only provide illustrations of current accrued benefit levels. Such attempts are fraught with problems and almost certain inaccuracies, so I would strongly recommend restricting efforts to estimations of the basic state pension entitlement, perhaps using the full level of basic state pension, appropriately revalued, if the client appears likely to accrue enough contributions or contribution credits in future years.

As regards Serps&#39 benefits, my suggestion would be to revalue the current entitlement, as noted above, and submit a new BR19 form every year, in readiness for the annual review with the client.

Furthermore, I would suggest that attention is paid to long-running speculation that the basic state pension might at some stage in the future be made means-tested (rendering an assumption of future entitlement useless or misleading for most clients) and other speculation that the value of Serps (replaced with S2P) may be further reduced below the current level of entitlement.

Nevertheless, I feel that it would be very dangerous for advisers to omit either or both of these benefits because of this speculation and I would suggest that both benefits are included at full current value but, separately, that notes are included to bring the client&#39s attention to the possibility that, as regards state pension benefits, perhaps what he currently expects is not what he might actually get in the future.

Time now to move away from the value of state pension benefits to the value of benefits accrued privately, whe-ther within occupational or personal pension schemes. In order to identify appropriate revaluation factors, we must identify whether the pension benefit is expressed as:

•Fixed benefit.

•Defined benefit (final-salary scheme) or

•Money purchase (defined-contribution scheme).

Fixed pension benefits are expressed as a fixed level of future benefit and, therefore, require no future revaluation. This type of pension is usually only found in a relatively small number of occupational pension schemes (either as the main benefit structure or only in respect of transfers in) and in bulk buyouts (typically without member consent) from final-salary schemes, the latter being more technically known as non-profit deferred annuities.

As the future level of benefit within these types of scheme is stipulated and fixed, the adviser does not need to make any further assumptions and there is no need for future reviews.

As regards defined-benefit schemes, we need (as with state pension entitlement) to determine whether we are taking into consideration only accrued benefits or both accrued and anticipated future accruals. Moreover, we must further take into account whether the client is an active member of the final-salary scheme or has deferred benefits.

We will look at the situation regarding active members in my next article but to close this week we will look at preserved final-salary pension scheme benefits.

Here, I could write a book on the different revaluation methods and only pension transfer specialists will be able (although perhaps not willing) to revalue a client&#39s preserved pension benefits by the appropriate rate or, much more likely, rates.

I suggest that preserved benefits should be revalued up to the date when benefits are due to be paid (usually the scheme&#39s normal retirement age but, alternatively, a client-specified age could be used) by the future expected rate of price inflation subject to an over-riding limit of 5 per cent a year, this being by far the most common rate of revaluation for most preserved pension benefits.

Throughout all the calculations and projections we have discussed in this article and, indeed, over the next couple of articles, the level of benefit which may be expected to derive from the client&#39s existing entitlements to pension must – as I have stressed throughout this series – be reviewed regularly in the light of the level of actual increases contrasted with the level of assumed increases.

For the state pensions and preserved pensions outlined this week, this review will depend primarily on the ongoing level of price inflation and, in addition, the state pension entitlement must be further reviewed in the light of the client&#39s ongoing accrual of further entitlement.

Moreover, note should be made in all instances of the rate of increase in benefit under each pension scheme after the pension comes into payment. Further discussion of this point in my next article will conclude our look at the importance of existing pension entitlement in target benefit-based financial planning.

Keith Popplewell is managing director of Professional Briefing

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