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The IFP’s View

The twin forces of the 2004 Finance and Pensions Acts will forever change the way that trustees, employers and employees experience additional voluntary contributions.

Perhaps the most fundamental of these changes is the removal of the need for pension schemes to offer employees an AVC option at all. Section 267 of the Pensions Act 2004 removes this requirement, which was contained in section 111 of the Pension Schemes Act 1993.

Employers and trustees now need to decide whether they wish to continue with their AVC scheme or scrap it altogether and allow employees to make their own arrangements. Central to this decision, particularly for money-purchase AVC schemes, is whether trustees and employers can negotiate a better deal, or additional features at lower cost, than the employee could find on their own. For big AVC schemes, this is almost certainly likely to be the case.

Current AVC arrangements are normally established as part of the main scheme’s trust. This need not be the case in future. From April 2006, full concurrency will allow employees to contribute to an occupational pension scheme and personal pension simultaneously in respect of the same employment and regardless of their level of earnings. For example, AVCs could be made available as a group personal pension, group stakeholder or group self-invested personal pension.

The market is likely to see a new form of group arrangement. This will be a hybrid of what we currently know as group personal pensions and group Sipps. This type of scheme will offer a wide range of funds from a large number of fund managers at discounted prices to those generally available in the market. Those employees who want even more investment flexibility will be able to use self-investment options. Employees using self-investment will have to pay extra to cover the costs of Sipp administration but they will do so at their own choice.

The investment possibilities created by the changes to pension tax rules will have wide appeal. Greatest demand for self-investment is likely to come from business decision makers. Many finance directors, human resources directors and other executives will want to control their own AVC pot, perhaps investing directly in assets such as property, wine or art.

Another relaxation of the tax rules will allow people other than employees to join the AVC scheme. These people could include the spouse and children of the employee. This will be an important feature for employees who wish to pass down pension assets to the next generation on their death. However, this ability to pass on remaining funds on death after 75 (called a transfer lump-sum death benefit) only applies where the member was taking income withdrawals, rather than an annuity, immediately before their death. Schemes offering this option will therefore need to permit drawdown before 75 (unsecured income) and after 75 (alternatively secured pension). Again, demand for this option is most likely to come from business decision makers.

All these features make the design of the post-A-Day AVC scheme radically different from today’s AVCs, which at their most limited offer only one or two fund options. Charging structures may also be less than clear in older schemes, with some still incorporating initial unit charges and bid-offer spreads.

There are many things to think about. Should the AVC be trust or contract-based? Should it have self-investment? Should it have drawdown? What sort of deal can be negotiated? Should the employee’s close relatives be allowed to join? Should AVCs be offered at all?

The answer will be different for each business. In reaching a conclusion, business decision makers will need help. This presents an opportunity for IFAs to demonstrate their expertise.

John Lawson is marketing technical manager at Standard Life

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