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Pensions: nirvana or nightmare? - Bovill briefing
The document discusses the implications of pension freedoms introduced by UK government reforms in 2015, detailing options for retirement income, tax treatment, and suitability considerations for financial advice. It highlights the challenges wealth firms face in providing informed advice amidst complexities of pension schemes, regulatory requirements, and potential risks of poor outcomes. Additionally, it underscores the importance of guidance and monitoring to improve advice quality and client satisfaction.
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Similar to Pensions: nirvana or nightmare? - Bovill briefing
Pensions: nirvana or nightmare? - Bovill briefing
- 1. Pension freedoms Opportunities andcompliance challenges for Wealth firms Neil Walkling – May 2015
- 2. 2 Agenda – pensionfreedoms 1. Background and context 2. Overview of the pension freedoms 3. Implications for professional advice market 4. Suitability considerations 5. Controls over advice quality and reducing risks of poor outcomes 6. Key messages
- 3. 1. Background &context
- 4. 4 Government pension reformagenda Flat rate state pension Auto enrolment Rising state pension age Charge caps and governance Freedom and choice
- 5. 2. Overview ofthe pension freedoms
- 6. 6 Defined benefit schemes Example(public sector) Teacher 40yrs service, final salary £50k Scheme pension at NRD = 40/80 x £50k = £25k (taxable at marginal rate) Escalates at CPI up to 2.5% Dependant’s pension Pension Commencement Lump Sum (PCLS) = (40 x 3/80) x £50k = £75k tax-free Generous secure benefits, but tend to be inflexible Pension freedoms don’t apply to DB schemes Transfer to DC scheme (private sector DB only) Regulated advice required for transfer above £30k Trivial commutation up to £30k (25% tax free)
- 7. 7 Options for DCfunds from age 55 Do nothing Secure income PCLS only Flexible income Take the money Or some combination of the above options
- 8. 8 Use fund topurchase secure income for life Existing annuity options Level income Escalating income (fixed, index-linked) Investment linked (UL, WP) Max 10yr guarantee Dependant’s annuity Annuity protection New annuity options Income can reduce No max guarantee period Beneficiary other than dependant Tax-free PCLS 25%, plus income taxed at marginal rate from remaining 75% of fund
- 9. 9 Annuities – valuefor money? Scenario Age 65, good health £500K fund £125k PCLS leaves £375k for annuity Single life – no dependant’s pension No guarantee period Male 65 83 Quote 2 Inflation linked A: £23,323 B: £18,468 C: £20,198 A: £15,218 B: £11,933 C: £13,625 Quote 1 Level annuity Female 65 86 Expected age of death (England) Level annuity £363564 Level annuity £424158 RPI @ 3% £279404 RPI @ 3% £342158 If client lives 7yrs longer than average Level annuity £504875 1.2% pa gross Level annuity £565544 2.0% pa gross RPI @ 3% £435068 0.6% pa gross RPI @ 3% £512295 1.1% pa gross Gross: before income tax at marginal rate
- 10. 10 Leave fund invested:drawdown pension Capped drawdown limit 100% 120% 150% of equivalent GAD annuity rate Subject to regular review Before April 2015 After April 2015 Scrapped existing plans can continue or convert to flexi-access Flexible drawdown – no cap on income Min secured pension income £20k £12k Flexi-access drawdown No min income requirement PCLS only: take 25% tax-free from fund and leave the rest invested up-front PCLS 25%: drawdown income taxed at marginal rate
- 11. 11 Take the cash(UFPLS) Before April 2015 After April 2015 Trivial commutation if your total funds < £30k (up from £18k) UFPLS of any size – no product purchase (unless disqualified) 3 x £10k ‘small pots’ (up from 2 x £2k) regardless of your total pension funds Tax treatment 25% as tax-free PCLS 75% as income at marginal rate Tax treatment of UFPLS 25% tax-free element built in to each UFPLS 75% as income at marginal rate
- 12. 12 Too much tooyoung: UFPLS example 1 Dave retires at 65 State pensions £150 per week (£7800 pa) plus £250k DC pension fund. Wants to cash it in and use to dip into to supplement state pension income Option 1: UFPLS for £250k 25% tax-free = £62.5k No personal allowance – taxable income £207800 £31785 taxed at 20% £118215 taxed at 40% £57800 taxed at 45% Option 2: 10 x UFPLS (£25k pa) (assume no rise in personal allowance or tax band/rate changes, no fund growth) £6250 x 10 tax-free = £62.5k £7800 state pensions 0% £2800 x 10 taxed at 0% £15950 x 10 taxed at 20% Tax bill = £59353 (and emergency additional rate tax code) Net annual income £29610 (10yrs) Tax bill = £31900
- 13. 13 Client wants tospend the tax-free cash: example Sharon, age 63, has several DC funds total £750k. Income from employment £50k. Wants £150k from pension fund for holiday home Option 1: UFPLS 25% of UFPLS is tax-free Cash in at least £600k to generate £150k £150k remains uncrystallised Option 2: Flexi-access drawdown 25% PCLS-only option £600k - £150k = £450k remains invested in drawdown account £150k remains uncrystallised Extra tax bill = £201740 (plus emergency tax code) Extra tax bill = £0 Triggers Money Purchase Annual Allowance (MPAA) £10K Retain full annual allowance £40k
- 14. 14 Exercising pension freedomstriggers MPAA MPAA trigger events UFPLS Flexi access drawdown income Flexible annuity (TBC) Scheme pension <12 members Money Purchase Annual Allowance (MPAA) 10k pa eligible for tax relief No carry forward Notification requirements Standard annual allowance 40k pa eligible for tax relief Carry forward 3yrs Take benefits, avoid MPAA PCLS-only (nil income) Traditional annuity Small pots Existing capped drawdown (pre April 2015) Live DB scheme
- 15. 15 Tax charges ondeath reduced Death before age 75 Death on or after age 75 Tax position Lifetime Allowance test applies? Tax position (income) Tax position (lump sum) * Uncrystallised pension fund Tax free Yes Marginal rate (of beneficiary) 45% Funds in drawdown Tax free No Marginal rate (of beneficiary) 45% Annuity protection Tax free No Marginal rate (of beneficiary) 45% Unspent UFPLS proceeds IHT No N/A IHT * For 2015/16. Govt intends to change to marginal rate from 2016/17
- 16. 3. Implications forprofessional advice market
- 17. 17 Guidance & riskwarnings when pension funds accessed Pensionwise The Pensions Advisory Service (TPAS) – phone Citizens Advice – F2F Pensionwise website Guidance about options and their pros/cons FCA sets guidance standards, monitoring role Pension providers must signpost to guidance/advice Low take-up indications to date? Second line of defence Pension providers must: • Ask questions based on how customer wants to access pension fund • Identify risk factor(s) and provide relevant risk warning(s) • Applies even if customer has received Pensionwise guidance or regulated advice Some providers are insisting that clients take regulated advice before exercising freedoms Transfers from DB schemes: mandatory regulated advice from a qualified adviser
- 18. 18 Major advice opportunity& challenge for industry Accumulation • Pension wrappers more attractive v ISAs and other alternatives • Interaction with child benefit and personal allowance limits – enhanced tax relief • Annual and lifetime allowance restrictions Transfers • Many people need to transfer to access pension freedoms • Occupational DC schemes • Legacy DC schemes • DB transfer mandatory advice (£30k+) Decumulation • More choice and complexity • Cost of choosing wrong option • Not always a one-off decision. Ongoing advice? Main improvement required to Wealth firms’ service – advice on pension and tax Cited by 40% of clients, of whom 50% intend to leave if not delivered* How willing and well-equipped is the industry to deliver the advice clients need? *2014 research commissioned by BBA – 250 wealth sector clients
- 19. 19 Do keep up…postA-day changes Pot follows member Accelerated rise in state pension age from 65 to 66 Min pension age up from 50 to 55 Fixed protection 2012 Min income for flexible drawdown cut from £20k to £12k Capped drawdown income up from 100% to 120% of GAD Flat rate state pension from 2016 Annual allowance cut from £50k to £40k Cut in yrs needed for full state pension Fixed protection 2014 No longer need to annuitize by age 75 Annual allowance cut from £250k to £50k USP and ASP replaced by drawdown pension Small pots limit increases from £2k to £10k Contracting out of S2P abolished for DC schemes Individual protection 2014 Lifetime allowance cut from £1.5m to £1.25m Default retirement age scrapped Carry forward 3yrs unused annual allowance Trivial commutation limit up from £18k to £30k Capped drawdown income up from 100% to 150% of GAD Gradual rise in female state pension age to 65 State pension age to rise to age 67 and beyond Lifetime allowance cut from £1.8m to £1.5m Max number of small pots up from 2 to 3 Onset of auto enrolment into workplace pensions Public sector pension accrual reforms Contracting out of S2P abolished for DB schemes from2016 Age discrimination outlawed Pension Freedoms
- 20. 20 Pension advice capacitycrunch? Retirement planning & retirement options All advice not involving transfers from occupational schemes R04 or JO4/J05 R08 (bridging paper on pension freedoms) CPD/gap fill Pension transfer specialist (sign-off) Transfers from occupational DB and DC schemes CP15/07 changes AF3 (G60 until 2006) (plus R04/R08?) Up to date pension knowledge and experience Supervisory/compliance capacity and capability: effective oversight and challenge
- 21. 21 Many people havea variety of schemes – adviser T&C implications Contribution Period Employer DC or DB Occupationa l trust- based? Pension Provider 8yrs Nationwide BS DB Yes Employer 4yrs Which? Hybrid DB/DC Yes Employer 4yrs FSA DC Yes Employer 3.5yrs Sesame DC Yes Employer (Misys) 2yrs Sesame DC No - GPP Friends Life 4.5yrs EY DC No - GPP Friends Life Current scheme Bovill DC No - GPP Standard Life
- 22. 4. Some retirementplanning suitability considerations
- 23. 23 Focused advice: compareand contrast Example 1 We agreed that we would not take account of tax-efficiency (eg. whether it would be appropriate for you to use your annual ISA allowance) when making our investment recommendations. Example 2 We agreed that we would focus my advice and recommendations on your long-term investment needs. You did not wish to consider other potential financial planning priorities, such as pensions and family protection, at this time
- 24. 24 Freedom of access:just another investment? Pension £16667 contribution grows to £30102 Benefits after age 55 £21071 (higher) £25586 (basic) ISA £10000 contribution grows to £18061 £10k for long-term investment. Assumptions: 40% taxpayer, 3% growth over 20yrs Child benefit (tapers away between £50-60k) £58k income, £8k pension contribution Taxable income = £50k Up to 75% effective tax relief Personal Allowance (tapers away between £100-121.2k) £115k income, £15k pension contribution Taxable income = £100k 60% effective tax relief Wrappers - ISAs (TEE) v pensions (EET) Income tax planning: protect child benefit or personal allowance Treat pension annual allowance more like ISA allowance? Double-jeopardy annual (£40k) v lifetime (£1m) allowance
- 25. 25 DC to DCswitches to access pension freedoms Timing When will client wish to start accessing benefits? Await developments – existing schemes and new products? Charges v flexibility How is this trade off affected by client circs and objectives? Client objectives Clear need for extra flexibility? Occupational DC Employer’s plans for scheme? Lost benefits? Transfer specialist AF3 Product research and range limitations Size of pension funds? Guaranteed benefits v flexibility trade-off GARs on older, inflexible schemes
- 26. 26 DB to DCswitches to access pension freedoms Why now? When will client wish to start accessing benefits? Wait until needs/priorities clearer Overriding client objective Serious debt problems? Client-specific needs and objectives key to suitability Importance of DB fund to client Dependants and state of health? Does client want your advice or a rubber stamp? Flexibility & liquidity v guaranteed income How is this trade off affected by client circs and objectives?
- 27. 27 UFPLS or flexi-accessdrawdown? UFPLS Simplicity 25% tax-free cash plus 75% taxed income Impact on marginal tax rate Cashflow impact (emergency tax code) Timing of cash – does client need it all now? Does clear client objective/priority point to UFPLS? Flexi-access drawdown Flexibility 25% tax-free cash plus chosen level of taxed income Viability (afford to bear risk and pay charges) – legal doesn’t mean suitable Product development and cost v benefit comparisons Ongoing advice costs Does client have a foundation level of secured retirement income to build on? Is the MPAA £10k limit a constraint for this client?
- 28. 5. Controls overadvice quality – reducing risk of poor outcomes
- 29. 29 • Sign-off, peerreview, escalation? • G6O holder competent? • Suitability checklist • Risk-based monitoring • Capacity and capability • Focused needs analysis questionnaires • Suitability guidance for contentious trade-offs • Product comparison and selection • Insistent clients • Testing advisers’ technical knowledge • Keeping up with market developments • Suitability Report writing • Knowledge sharing and buy-in/ communication • Fast moving market – challenges for IFA and restricted propositions • Occupational transfers? • Focused advice – investment v pension • Implications for simplified advice models Scope of service Training & Competence Monitoring & controls Advice process
- 30. 30 Transfers from DBschemes: mandatory advice • Client free to reject advice not to proceed • Provider stances differ in this scenario • Advisers concerned about liability – only 27% willing to do DB transfers ‘I can confirm that Mr Jones has taken advice from us when considering the transfer from their defined benefit scheme to a defined contribution basis We are a professional financial adviser authorised by the FCA, and are independent from the defined contribution scheme’
- 31. 31 How should youdeal with insistent clients? Adviser not listening to client Client not listening to adviser Client wants rubber stamp, not advice Transferring responsibility for unsuitable advice to client Insistent client scenarios
- 32. 32 Takeaways 1. Major adviceopportunity 2. Challenge: evidence advice quality/good outcomes 3. Consider impact on advice scope/proposition 4. Suitability: focus on client’s specific objectives and explaining trade-offs 5. T&C of advisers and advice quality checkers 6. Advice process tools/guidance 7. Sign-off and monitoring regime 8. Internal communications/knowledge sharing
- 33.