This year's Finance Bill promisesa welcome simplification of
theincome-drawdown regime but accompanying proposals carry a nasty sting
that could restrict invest-ment freedom.
The first proposal, contained in the bill, is a simplification of the
administrative procedures. In effect, this means that triennial reviews of
phased income 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 welcome and I am sure that a number of advantages
will emerge from this easement which becomes effective from October 1.
The second potential change appeared in the additional information
accompanying the Finance Bill. Later this year, the Inland Revenue will
consult on draft regulationson transfers.
One of the potential changesis the removal of the current restriction that
prevents an individual who is currently in inc-ome drawdown from
transferring to another personal pension scheme. In PSO Update No 8, issued
in August 1995, the Inland Revenue set out the framework for income
Perhaps surprisingly, one of the provisions was that, once in drawdown, a
personal pension could not transfer from that particular personal scheme.
Further correspondence with the Revenue clarified that this restriction
would not even allow an individual to transfer between two schemes from the
same personal pension provider.
The real effect of this restriction is perhaps twofold.
First the individual pensionholder is “tied in” to the particular provider.
This means tied in to its administration systems necessary for income
drawdown. Second and perhaps more important, it means tied in to the range
of investment funds offered by that provider.
It is important not to underestimate the service aspect. Income drawdown
in many cases involves a regular payment mechanism and the deduction of the
appropriate amount of income tax. It also involves other issues such as
flexibility to take ad hoc income payments and even the ability to
disinvest from specific investments most suitable to the investment
strategy of the client 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-drawdown arrangement but the opposite may also be true.
First and foremost, however, it has beenthe lack of investment freedom
that has been the main criticism of this Inland Revenue restriction. Income
drawdown is an investment product that relies on the relationship between
the amount of income required by the individual and the performance of the
By limiting the number of potential investments that an income-drawdown
plan can make, the potential for that plan to meet the client's needs is
arguably also restricted.
For example, when taking out a drawdown plan, a critical-yield figure is
calculated. In a nutshell, this shows, for a given level of income, the
return that the investments need to achieve to prevent depletion of the
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 concerned does not have a better-performing fund?
It is this lack of flexibility that has caused the problem and has led to
the conclusion that anyone considering income 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
accessed through trustee investment policies and you are not locked into
the performance of one fund manager.
Most personal pension providers offer only insurance company funds. These
may suit a client's needs but there may be other investment opportunities
available such as direct investment in equities, other forms of collective
investment such as unit trusts or even commercial property.
If income drawdown is an investment problem requiring advisers to put
together a specific portfolio in line with an individual's requirements and
risk profile, then access to a wide range of investments may be crucial.
In such circumstances a Sipp is likely tobe the most suitable form of
The proposed removal of the restriction on transfers is to be welcomed. It
is important that providers are under pressure to make sure that the
service they offer is the best possible.
It may also give individuals who are currently locked into schemes with
limited investment options the chance to move into a Sipp.
It has been suggested by some parties that such a change may signal the
end for Sipps.I do not think that is true.
The suggestion is that if one drawdown provider does not provide suitable
investment performance, then the solution will be to move to another
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
even any extra remuneration paid to the adviser who advises on the
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 moving to a new provider is very much shutting
the stable door after the horse has bolted.
It is to be hoped that a good adviser will be constantly reviewing his or
her clients' portfolios and will be able to address any instances of
underperformance before they become disastrous and require a transfer.
Rather than having a negative effect on the Sipp market, there is 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
As a footnote, it is perhaps worth returning to PIA regulatory update 67
which voiced the regulator's concerns on income drawdown.
The update says: “The PIA board is keeping pension fund withdrawal
business on its watchlist. It will be looking for evidence of improvement
in the standards of risk warnings to investors and in the training and
competence of advisers. Where the investor's 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 would suggest that the regulator does regard income
drawdown as an investment exercise and surely the wider the investment
choice the greater chance the adviser has to get it right both for the PIA
and, most important, the client.
This year's Finance Bill promisesa welcome simplification of