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High and tied

Later this year, the Inland Rev^_enue will consult on draft regulations

for pension transfers. One of the potential chan^_ges is the removal of the

restriction that prevents an individual who is in income drawdown from

transferring to another personal pension scheme.

The Revenue set out the framework for income draw^_down in Pension Schemes

Office Update No 8 issued in August 1995. Perhaps surprisingly, one of the

provisions was that, once drawdown started, a pensioner could not

tran^_s^_fer from their personal plan.

Further correspondence with the Revenue clarified that this restriction

would not even allow an individual to transfer between two schemes from the

same provider.

This means the pensioner is tied to their provider – both to the admin

systems necessary for income drawdown and, perhaps more imp^_ortant, to the

range of inv^_est^_ment funds offered by that provider.

It is important not to und^_er^_estimate the service aspect. Income

drawdown in many cases involves a regular payment mechanism and the

ded^_uction of the appropriate amount of income tax.

It also involves other issues such as the flexibility to take ad hoc

income payments and even the ability to disinvest from speci^_fic

investments rather than having to disinvest a proportion of all the

different funds held.

Being tied in to flexible and efficient systems may add some value to an

income-draw^_down arrangement while the opposite may also be true.

First and foremost, however, it has been the lack of investment freedom

that has been the main criticism of the Revenue restriction. Income

drawdown is an investment product that relies on the relationship between

the amount of income required by the ind^_ividual and the performance of

the underlying investments.

By limiting the number of potential investments that an income drawdown

plan can make, then, arguably, the pot^_ential for that plan to meet the

client&#39s needs is also restricted.

When taking out a drawdown plan, a critical-yield figure is calculated. In

a nutshell, this shows the return that the investments need to achieve to

prevent depletion of the fund for a given level of income.

This may prove viable if the funds offered under the contract have the

potential to produce this level of return and, more particularly, if they

do produce the performance. But what if they do not perform? The obvious

answer is to switch to another fund with greater potential. But what
if

the insurance company does not have another better-performing fund?

It is this lack of flexibility that has led to the conclusion that anyone

considering drawdown must use a self-invested personal pension or at least

a personal pension with a
Sipp option so that a whole range of

investment options is available. With a Sipp, the
funds of any number

of insurance companies can be acc^_essed thr^_ough trustee investment

pol^_icies.

Most personal pension providers offer only insurance company funds. These

may suit a client&#39s needs but there may be other investment opp^_ortunities

available such as direct investment in equities, other forms of collective

inv^_estment such as unit trusts or even commercial property.

If drawdown is an investment problem requiring advi^_sers to put together

a portfolio in line with an individual&#39s requirements and risk profile,

then access to a wide range of investments may be crucial.
In such

circumstances, a Sipp is likely to be the most suitable form of personal

pension.

The proposed removal
of the restriction on transfers is to be

welcomed. It is important that providers are under pressure to ensure that

the service they offer is the best possible. It may also give individuals

who are locked into schemes with limited investment opti^_ons the chance to

move into a Sipp.

It has been suggested by some that such a change may signal the end for

Sipps (Draw^_down flexibility could kill off Sipps, Money Mar^_keting,

April 13). I do not think this is true.

The suggestion is that
if one drawdown provider does not provide

suitable investment performance, the solution will be to move to ano^_ther

provider. This is all well and good but does not take into account any

penalties inherent in transferring, the costs of setting up a new

arrangement and any remuneration paid to the advi^_ser on the transfer.

It is likely to be more cost-effective to switch investments under a Sipp

wrapper than to have to pay to set up
a new wrapper.

It is also arguable that mov^_^_ing to a new provider is shutting the

stable door after the horse has bolted. It is to be hoped that a good

adviser will be constantly reviewing his clients&#39 portfolios and so will be

able to address any ins^_tan^_ces of underperformance bef^_ore they become

disastrous and necessitate a transfer.

Drawdown in most cases is for individuals who have relatively large

pension funds (perhaps 300,000-plus) which would probably necessitate
a

degree of diversification. Sipps tend to be very cost-efficient at this

level and provide the ideal vehicle.

There is perhaps a real opportunity for Sipp providers to target personal

pension drawdown cases where the investment choice is limited and the

performance has not been up to expectation.

It is perhaps worth returning to PIA Regulatory Update No 67 which voiced

concerns on drawdown.

It said: “The PIA board is keeping pension fund withdrawal business on its

watchlist. It will be looking for evi^_^_dence of improvement in the

standards of risk warnings to investors and in the training and competence

of advisers. Where the investor&#39s attitude to risk was recorded, it was

sometimes at odds with the risk profile of investments already held by the

investor but the discrepancy was not explained.”

These comments suggest the regulator regards income drawdown as an

investment exercise and, surely, the wider the investment choice, the

greater chance the adviser has to get it right.

The publication of the Finance Bill paves the way for a simplification of

the admin procedures for drawdown. In effect, this means that trienn^_ial

reviews of phased drawdown can be done on one specific valuation date and

that such reviews can be done in a given 60-day period.

This simplification is to be welcomed and I am sure that a number of

advantages will emerge from this easement which becomes effective from

October 1, 2000.

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