View more on these topics

Income drawdown – fact or friction?

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&#39 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&#39s fund", where the beneficiary must be either the cli ent&#39s spouse or individual who is financially dependent at the date of the death, or

– disposal is at the trustees&#39 discretion if the beneficiary is the client&#39s 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&#39s 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&#39s 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&#39s 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&#39s spouse or financial dependant, or when death benefit trustees select a beneficiary who is the client&#39s spouse or financial dependant, then the payment is treated as a "survivor&#39s fund".

This "survivor&#39s fund", "allocation" or "nomination" means that the benefits must be paid to the client&#39s spouse or financial dependant before any other category of beneficiary can be considered.

Those of you who have used Sun Life&#39s 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&#39s 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&#39s 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&#39s 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&#39s fund"? If disposal is at discretion of the trustees and the payment is treated as a "survivor&#39s 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&#39s 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&#39s 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&#39 drawdown contracts and suggest some potential wording for reasons-why letters and reports.

Example 1

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&#39s 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&#39s 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.

EXAMPLE 2

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.

Recommended

The issue over the closure of Fimbra

A news article noted the Fimbra AGM and that Brian Cochrane and others had called for a poll (Money Marketing, December 18) but without giving any indication of the issues at stake. As such, I feel that you did most IFAs a disservice. It is now over three years since the PIA was established and […]

Caught in network

I read with interest a recent letter concerning the way that some networks treat their members. Having become an IFA a little over two years ago following 28 years&#39 insurance company experience, I was amazed to find the high-handed manner with which I was treated by a leading network. As Ivor Harper intimated in his […]

International jurisdictions

By Neil Jones, Canada Life Investing through international providers has grown in popularity over recent years as investors seek out the benefits of gross roll-up and the wider range of investment options that can be available. When considering a recommendation for a lump sum investment, not only does the adviser have to select a suitable tax wrapper […]

Newsletter

News and expert analysis straight to your inbox

Sign up

Comments

    Leave a comment