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Sipps can cut ties that bind drawdown

This year&#39s 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

underlying investments.

By limiting the number of potential investments that an income-drawdown

plan can make, the potential for that plan to meet the client&#39s 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&#39s 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&#39s 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

personal pension.

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&#39 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

to expectation.

As a footnote, it is perhaps worth returning to PIA regulatory update 67

which voiced the regulator&#39s 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&#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 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.


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