In my article headlined Drawdowns and death (Money Marketing, February 12, 1998), I encouraged advisers to ensure they have control of all the facts relating to income drawdown, particularly when it comes to death benefits.
My concern is that in three years' time, or whenever, we will be required retrospectively to show that we have provided such details to our clients.
The problem is that no real consensus of opinion seems to exist with the providers of drawdown products. They, in turn, blame this on the differing opinions of local Inland Revenue offices.
If there is a commonly held opinion about the treatment of the remaining fund on the death of a policyholder during drawdown, it is certainly not clear from all the technical guidance notes provided.
I believe that, ultimately, an institution such as the Association of British Insurers needs to lobby the Inland Revenue for clarification to enable clear and unambiguous adv ice to be given to our clients.
Following my previous article, very few product providers beat a path to my door to explain their interpretation of the situation. Even these companies – Axa Sun Life, Friends Provident, and Scottish Amicable – admit there is a deal of ambiguity on the issue.
I have, however, had many interested advisers phone me to seek clarification of the points I raised. So where does the confusion lie?
Expectation that the beneficiaries have three options
You will be aware of the three options available to beneficiaries in choosing to take the benefits. These are:
– in pension form,
– as a lump sum after deduction of 35 per cent tax or
– through continuing income drawdown.
However, these options are applicable only if:
– disposal is through a "survivor's fund", where the beneficiary must be either the cli ent's spouse or individual who is financially dependent at the date of the death, or
– disposal is at the trustees' discretion if the beneficiary is the client's spouse or financial dependant.
If this is not the case, the only option is that payment be made as a lump sum after deduction of 35 per cent tax. How many reasons-why letters have been issued simply quoting the three options with no further comment?
Forfeiting excess funds
There are basically two options for the disposal of the fund available on death. One is through a "survivor's fund", the other at the discretion of the death benefit trustees. Tremendous confusion exists in this area. The problem is that different product providers use different terminology to describe it.
The first option is variously described as "nomination", "allocation" or a "survivor's fund". This is not to be confused with naming a specific beneficiary to assist the death benefit trustees with their discretion. Is it any wonder that we are confused?
It is this payment through a "survivor's fund" that allows the beneficiary – known as the survivor – to choose to take the benefits in one of the three forms mentioned above.
Just to confuse matters a little further, when a specific beneficiary is named and they are the client's spouse or financial dependant, or when death benefit trustees select a beneficiary who is the client's spouse or financial dependant, then the payment is treated as a "survivor's fund".
This "survivor's fund", "allocation" or "nomination" means that the benefits must be paid to the client's spouse or financial dependant before any other category of beneficiary can be considered.
Those of you who have used Sun Life's Flexible Retirement Income plan (before the merger with Axa Equity & Law and setting up of the Axa Sun Life personal pension scheme) will be used to this form of the disposal of death benefits and would have been right in advising your clients that there were three options for the taking of benefits.
What you may not have done is to advise your clients that the fund being used for the survivor or survivors may have to be restricted. Let me quote directly from Scottish Amicable's very thorough guide for IFAs on its Flexible Retirement Portfolio: "Section 636(3)(b) of the Income and Corporate Taxes Act 1988 imposes another restriction: a test. This could result in a reduction in the value allowable as a survivor's fund.
"The pension which the client could have brought at the time of death has to be determined first. The cost of this same pension level must then be calculated for the survivor (or the cost of splitting this pension among the survivors). If the resultant cost is less than the remaining fund in the income drawdown plan, the excess is forfeit. (The Revenue says that any excess is treated as a windfall profit to the scheme.)" (Scottish Amicable, The Flexible Retirement Portfolio, A Market Guide for IFAs, p47).
While I am encouraged by this literature explaining these facts, it requires a lot of reading before discovering such important details.
Axa Sun Life suggests that this restriction applies even if the survivor decides to take cash (less 35 per cent tax) or purchase an annuity.
But what is not clear still is whether disposals made at the discretion of the death benefit trustees which are treated as a "survivor's fund" are caught by these restrictions. Let me elaborate the restrictions with a few examples supplied by Axa Sun Life (above and below).
Do you have any drawdown clients who may be survived by a child and have set up the disposal of the fund available on death through a "survivor's fund"? If disposal is at discretion of the trustees and the payment is treated as a "survivor's fund", will the same restrictions apply?
One life office suggested to me that the Revenue might allow insurance companies to make an ex gratia payment representing the forfeit to beneficiaries. I doubt very much if that could be achieved without losing approval.
Great care obviously needs to be taken in deciding beneficiaries in these circumstances. It is likely that Section 636(3)(b) ICTA 1988 restrictions will apply where:
– the spouse is older than the client,
– the client is female and her husband is younger or about the same age, or
– the survivor is a child.
I am fairly sure that those of you who used Sun Life's Flexible Retirement Income plan and products provided by other offices which were similarly structured should be reviewing your files to ensure that these considerations have been taken into account.
I know from off-the-record conversations that many life offices are concerned by the potentially onerous duties placed on them as trustees and administrators of these arrangements.
Just suppose that the disposal of death benefits was through a "survivor's fund" and restrictions were to apply. Could they overturn this decision made by the member in their lifetime and what would be the implications for the beneficiaries? Is it their duty to chase around and find beneficiaries?
There is clearly a need for product providers to sort out these issues and I am sure that standard practices will follow. For the time being, we as advisers need to ensure that these details are covered in our advice.
We might even have to indicate to our clients that we are unsure as to precisely what will happen if they die during drawdown. It is obvious, surely, that this issue needs urgent and thorough consideration and I am tempted to suggest that cases should remain pending until there is clarity.
In a future article, I will provide some further analysis of the structure of various product providers' drawdown contracts and suggest some potential wording for reasons-why letters and reports.
Female member aged l Fund at death £200,000
Survivor – husband also aged 5l At the date of death, £200,000 using F54 Government Actuary's Department table (7 per cent yield) buys a maximum £16,000 withdrawal
The maximum withdrawal for the husband is therefore £16,000.
You must work back from the £16,000 to determine the husband's maximum fund using his GAD rate. His GAD rate will be better because, as a male the same age as his wife, his mortality should be higher and, hence, less fund is needed.
The actual fund needed to secure £16,000 for him is £184,046 (7 per cent yield), hence £13,954 (£200,000 -£184,046) is surplus and lost.
Female member aged l Fund at death £200,000
Survivor – child aged 1l As the income stops at 18 or when the child ceases full-time education, the fund required to secure the same £16,000 is £56,939 and, hence, a surplus of £143,061 is lost.