The pension annuities revolution has come as a surprise to most advisers and the need to think through the implications for both clients and firms is pretty urgent.
Of course, there is a whole year until the full impact of the changes hits in April 2015 but clients need guidance in the meantime. What is more, the interim changes for the coming year have pretty much immediate effect.
The risk committee of Smith Jones Financial Planners put it in its agenda for the week after the Budget and spent quality time discussing how to sort out some serious issues around pensions, investment strategies and financial planning generally.
The risk committee’s first job was to scope out the key questions and try to identify the main areas for concern. Then it was important to devise advice standards for the new situation and create an action plan. Some of the items on the agenda were urgent.
The most immediate issue was to see how many recent annuity purchases could be unwound. That meant contacting the relevant life offices to see what they were prepared to do and then discussing the pros and cons with clients.
Advisers should be examining their client files to see who is likely to be affected by the new rules. Some of the main categories seemed to be:
- Clients with small pots. With the substantial relaxation of some of the rules, consolidation of small pots into Sippss etc might not be in clients’ best interests in all cases. Here was another factor to take into account in advising on pension switching.
- Clients who had decided not to invest in pensions because of their perception that they would be “forced to buy an annuity” and did not relish the prospect of the costs, restrictions and complications of capped drawdown. Advisers should be approaching them to get them to rethink their attitude to pensions for retirement planning.
- Clients already taking drawdown or contemplating drawing on their pensions very soon. A high priority would be to determine which clients now qualified for flexible drawdown under the new rules and which were still subject to capped drawdown for the next 12 months.
But the fundamental question was what the attitude of the firm to annuity purchase should be.
In the past, everyone needed a minimum of £20,000 secure income to qualify for flexible drawdown, some of which would have almost certainly been index-linked state pension. That provided a helpful bedrock of safety. Now advisers would be discussing the possibility of only £12,000 MIR and none the following year (although the state pension and other such provision would obviously continue to provide some security).
Drawdown vs annuity purchase
How should advisers consider the risks of drawdown compared with annuity purchase?
Risk profiling and lifetime income planning should gain greater prominence than hitherto, as the chances are, the risk committee felt, that many investors will be lured into keeping their drawdown fund in a pension deposit account and taking out cash when needed.
It was very likely that a higher- risk drawdown strategy combined with a conservative deposit-based investment approach would lead to a very high-risk outcome in the long term. Who should now buy annuities? Will there be a lingering loyalty to this form of investment – with returns perceived as very low, loss of funds on death and an increasingly hostile press? Some clients should buy annuities but what criteria should advisers use in their recommendations?
Drawdown investment strategies present a conundrum, especially for the bulk of investors with less than six-figure pension pots. How can an appropriate structure be set up at a reasonable cost?
One sensible-sounding approach might be to set up a series of time-based portfolios with a range of risk profiles. So there would be one set of portfolios for the first five years, another for the next five years and so on, with the client gradually drawing down and the funds being adjusted accordingly.
An adviser hitherto very set against the use of structured products conceded that they too could have a place as long as the costs could be kept under control.
And might there now be a stronger case for using some third way products? There is a lot to think about and work to do as a result of the Budget changes. But all the members of the risk committee agreed that it was really good news for advisers and platforms.
Danby Bloch is editorial director of Taxbriefs Financial Publishing
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