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Withdrawal symptoms

The FSA is concerned that relaxation of the income drawdown rules as part of simplification will increase the need for quality advice, says Intelligent Pensions director Steve Patterson.

The FSA has welcomed pension simplification as it believes the changes will make advice more straightforward. Some advisers thrive on complexity but the vast majority see simplification as opening up an area dominated by pension techies.

Yet the new liberties also vastly inc- rease the scope for financial calamity so the regulatory focus on standards of advice and internal controls will become even more stringent.

The FSA says rule changes will be necessary in a number of areas and will start consultation in July. What can advisers expect from this process and how can they start pre- paring for the changes?

A major theme of the FSA’s approach will be the need for continuous and systematic advice on income drawdown. The existing rules (Cob 5.3.29) focus on point-of-sale issues, such as the requirement to analyse and record suitability factors including current and future income requirements, taking account of the relative importance of the plan, given the client’s overall financial circumstances. In other words, how dependent is the client on their pension as opposed to other financial resources, whether of an income or capital nature? This will now extend into the review process.

The regulator has expressed concern about the prospect of income- drawdown investors being able to take higher levels of income than at present. It points out that even under existing limits, funds can be severely depleted if performance is poor, a risk it perceives will increase with greater flexibilityIn its submissions to the Treasury’s consultation on simplification, the FSA said: “Increased flexibility after retirement means that pensioners’ circumstances will need to be kept under review on a continuing basis, with an increased need for professional advice as they get older.”

More recently, its strategic assessment, Financial Risk Outlook 2005, emphasised the increased risk to investors from the fact that withdrawal levels will only require to be recalculated every five years rather than every three years as at present. It concluded: “These factors place more emphasis on the need for informed, quality advice at both the outset of drawdown and on a continuing basis.”

The extension of drawdown after 75 will also be a key regulatory issue. The FSA has said the relaxation of the age limit for annuitisation “raises concerns about consumer understanding of the risks involved” and “emphasises the need for ongoing advice”.

The effects of mortality drag mean that staying in drawdown after 70 is virtually impossible to justify on a pure value-for-money assessment. The implications for investment strategy will be of particular concern as the normal practice of progressively switching into long-dated bond funds will need careful revision on a client-by-client basis. Any adviser recommending an alternatively secured pension will need to have their continuing reasons why meticulously documented for all clients from 70 onwards.

So far there has been little evidence of product providers coming forward with short-term annuities as a retirement product. The internal rates of return will be poor and consequently any structure that focuses on this option will inevitably be viewed as the “poor man’s drawdown plan”.

The opportunity to protect tax-free cash will be a key issue, particularly for controlling directors. Although many people with final-salary benefits would in theory benefit from transferring to a section 32 to preserve tax-free cash, transfer values are currently poor and that will continue to constrain the market. The question of materiality will be a key issue for best advice.

Any pre-A-Day tax-free cash entitlement more than £4,000 or so above the new 25 per cent limit will be perceived to have been worthy of examination on the basis of a notional tax gain of at least £1,000. All clients with occupational scheme benefits should at least be given the option of a fixed-fee analysis. In practice, it is likely that many opportunities to protect tax-free cash will be missed and it remains to be seen whether there will be many compensation claims on the grounds of failure of duty of care.

Simplification offers immense opportunities but the pitfalls are equally cavernous. Well thought-out exit strategies with effective meth- ods of delivery are absolutely essential to avoid major claims.


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