Sipps in a changing market

The traditional nudge into annuities has been removed, with new annuity plan numbers at approximately 50 per cent of pre-2014 Budget figures and some sources predicting a further 50 per cent decrease post-April. What remains is an unrestricted market, where people can choose the solution that suits their own requirements.

It was an eventful 2014 for Sipps as well. August saw the release of two sets of rules affecting the market. Together these introduced greater emphasis on a provider’s own due diligence processes for investments and revised classification of standard and non-standard assets, as well as clarifying new capital adequacy requirements, effective from September 2016.

Post-April pension changes

In spite of the gloomy outlook, annuities will remain a popular choice for many savers – for at least part of their funds –seeking secure lifetime income. Additionally, newer style annuities offer income which can increase or decrease as well as removing guarantee period limits, enabling savers to choose at the outset how long the annuity will be paid for.

Everyone is aware that clients can take withdrawals, either from capped drawdown plans set up before April, or from flexi-access drawdown (Fad) plans. Capped plans can switch to Fad at any time but cannot change back. Alternatively, money can be taken in the form of an uncrystallised fund pension lump sum (UFPLS), either as a partial withdrawal or by taking the full fund.

Fad will offer them the same options as UFPLS, but with additional flexibility over how to split the tax treatment of withdrawals. In other words, savers can choose to take tax-free cash alone, take the cash plus subsequent amounts as taxable income, or use phased withdrawals, which are partially taxable.

A new annual allowance – the money purchase annual allowance (MPAA) – will apply to all savers taking income through any of the new options, reducing the allowance from £40,000 to £10,000. Savers in capped drawdown will continue to benefit from the higher allowance until they choose to move into Fad. The new allowance will apply to money purchase pensions only, and savers accruing benefits in a final salary scheme will see this assessed separately.

Passing on unused pensions

is changing, offering savers

new choices about who can receive monies and how these amounts will be taxed. Reaching age 75 changes how beneficiary withdrawals are taxed. Paying death benefits before this age allows beneficiaries to withdraw income tax free. However, once the saver passes age 75 the withdrawals are paid less 45 per cent tax (although it is expected that the tax deduction will change to the beneficiary’s marginal rate, from the start of tax year 2016-17).

These new rules will also apply to beneficiaries looking to pass on unused funds to their successors, allowing multi-generational succession planning with pensions for the first time. As pensions usually remain outside of the estate, their importance in inheritance tax planning will increase.

Financial advice must be taken by savers wanting to transfer their defined benefit pension to a more flexible plan, where the pension is worth at least £30,000. However, some providers may still require that the transfer is advised, regardless of the value, before they will accept the funds. It is possible that any plans including certain protected benefits may also require savers to take financial advice, pending the outcome of a consultation taking place at the moment.

Using the new freedoms

New flexibilities have been applied across the pension income options, but the individual features are likely to lead to more savers considering a combination of solutions throughout retirement, or taking a new approach as to how they use their pension.

Punitive income tax charges will prompt many savers to avoid full withdrawals on all but the smallest funds. Instead they are likely to prefer spreading out their withdrawals across multiple tax years in order to minimise taxation. Monies earmarked for payment can be held in liquid assets and the remainder of the fund can continue to be invested, offering the opportunity for growth before further withdrawals are required. If large amounts are required – to repay debts for example – divesting alternative investments to pensions may be preferable.

The age-75 cliff edge offers a tactical opportunity for savers to consider who will benefit most from inheriting any unused pension funds on death. Up to age 75 no individual beneficiary will be taxed, leaving an open choice for the saver. However, savers approaching this age can choose to change their nominated beneficiaries to those who are likely to pay less tax on any money they take out.

This process can be repeated down the generations, assisting savers who are looking to manage the inheritance tax bill that could arise on their death.

However, the new pensions tax freedom does not remove the need for further benefit protection in certain circumstances. For example, spousal bypass trusts will retain a useful role to ensure that the saver keeps full control over the choice of beneficiaries after their death. Savers who have remarried may wish for their spouse to receive payments from the fund (which is permissible provided the Bypass Trust’s appointed trustees are in agreement) but also wish to ensure that the fund is paid to their children, thus preventing the spouse from redistributing the fund elsewhere.

How can Sipps benefit in the new pensions world?

Sipps have always provided the most bespoke solution for an individual. They suit those who want to take control of their pension assets, manage their tax position and who want to look beyond the limited range of traditional investments usually available in pensions.

However, the new Sipp rules have created an additional challenge for the operators, with many choosing to restrict the investments that they will accept, or requiring additional capital in order to meet adequacy requirements from September 2016. To ensure they are selecting the right provider for the future, advisers and investors must be prepared to ask simple, precise questions to their Sipp operators about what their plans are for the future, for the investments they will continue to allow, and their financial strength. Ultimately, a higher quality, safer, more resilient Sipp market should emerge for both advisers and investors.

The new pension rules will gradually change many savers’ perspectives on what a pension means for them and how it can be used. Providers will need to respond to customer expectations for more versatility and accessibility, in order to allow greater investment control and more useful ways to take money out of pensions.

The majority of Sipp operators have a proven track record in responding to change and have continued to deliver drawdown in all its forms since it was first introduced. They have had to implement the variations in the Government Actuary’s Department (Gad) limits, as well as changing from the unsecured/alternatively secured world to capped and flexible drawdown. The challenges facing the wider pensions market are not so straightforward, coming from accumulation-focused propositions.

The most recent changes are unlikely to be the last. For the majority of savers, pensions represent either their largest asset, or second largest after their home. Savers will be keen on choosing a solution which will continue to offer them the greatest opportunity to adapt, both to their own changing needs, and to whatever direction pensions follow in the future.

Paul Evans is pension technical manager at Suffolk Life