Pension simplification brings many opportunities for advisers to develop relationships with clients by giving sound guidance and writing more business for them. But opportunity comes with risks for the unwary and in this article I will highlight three possible pitfalls in the run-up to A-Day which is scheduled for April 6, 2006.Risk 1 Inadequate communicationA fundamental change like this tests how well you know your clients. Can you identify those with funds over or near the lifetime allowance – 1.5m initially – or entitlement to over 25 per cent tax-free cash from their pension arrangements? What about clients who planned to retire at age 50 after April 2010 but will now have to wait until 55? Product providers will be carrying out massive communication exercises but you know your clients much better than they do and must make sure that none slips through the net. It is particularly important there are no irrecoverable errors, such as a client accidentally losing enhanced protection by paying a contribution after A-Day. Other oversights may only be rectified with great difficulty, for example, failure to ensure trustees obtain details of tax-free cash protection for a scheme member who is entitled to tax-free cash above 25 per cent at A-Day. Advisers should now be drawing up action plans to make sure that they have identified and communicated with all their clients who will be affected, well before A-Day. Risk 2 Unjustified transferTransfer activity will form a major part of the pension market this year because those who can protect tax-free cash entitlements of more than 25 per cent of their pension funds may well lose that entitlement if they transfer after A-Day. It is important that before A-Day they are in an arrangement they are happy with for the longer term. However, the FSA will be looking for signs of unjustified “buy now while stocks last” activity and trying to identify “manufactured” transfers, especially if they involve big commission payments. There are two main reasons why a client might be well advised to transfer before A-Day. The first is that a transfer would be best advice regardless of simplification and A-Day only introduces the need to do it quickly. For example, the client’s pension may be invested in a closed with-profits fund with little or no equity content and little prospect of future bonuses. The second reason is that the new arrangement will offer features after A-Day that the client actively wants and which the old arrangement does not have. This could be, for example, an opportunity to take unsecured pension (income drawdown) after drawing protected tax-free cash of more than 25 per cent of the fund value. The key thing, as always, is to be clear about why the transfer is best advice and to document it carefully so there can be no doubt that the advice is sound and the reasons for transfer and that any issues are explained clearly to your client. Risk 3 Premature retirementA feature of pension simplification is that if you would be better off under the old regime, you can benefit from transitional protection if you retire after A-Day but if you would be better off under the new regime you cannot benefit if you start your pension before A-Day. There are significant groups who could benefit from waiting to start their benefits, if they can afford to. These include people in executive pension and SSAS schemes who are currently overfunded but have funds under the lifetime allowance. If they retire now, benefits are restricted to the Inland Revenue maximum and anything beyond that remains in the scheme or goes back to the employer. If they can wait until after A-Day, their overfunding disappears and they are entitled to the full benefits their funds can buy. A second group who could gain from waiting is those who will be entitled to higher tax-free lump sums under the new regime than under the old. This will include many members of occupational schemes as well as some who have transferred to personal pensions with certified tax-free lump sums under 25 per cent of the fund value. Another significant group is clients who have no tax-free cash entitlement from part of their pension provision under the current regime, including many with AVCs or FSAVCs or protected rights benefits. If they can afford to wait – and all of these can be deferred, subject to scheme rules, even if other benefits are started, they will be entitled to 25 per cent tax-free cash under the new regime. Then there are clients with very small pension funds. If these amount to less than 15,000 in total, clients over age 60 will be able to commute them, with part of the proceeds taxable as income. Finally, some clients may not gain financially but will enjoy much greater flexibility under the new rules because taking benefits becomes independent of physical retirement for all types of pension, and can be phased, subject to scheme rules and policy conditions. So, for example, directors who can currently only draw pension when they stop working for the company will in future be able to ease into retirement by drawing part of their pension while working on a part-time or consultancy basis. Most people need to start their pension when they stop working, but some may have the flexibility to defer at least part of it if that will benefit them. If you allow them to start their whole pension without being aware of all their options, you could end up with a dissatisfied client. All of us would rather be writing business than managing risk but advisers who can avoid the kind of pitfalls outlined in this article should benefit from satisfied and loyal clients, who will happily come back for further advice in the future.
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