PensionsSep 26 2014

Staying flexible in retirement

twitter-iconfacebook-iconlinkedin-iconmail-iconprint-icon
Search supported by

“Let me be clear. No one ever needs to buy an annuity again.” With that one sentence, chancellor George Osborne introduced the most sweeping changes to pensions for over a generation. The 2014 Budget brought change of such magnitude that nobody could have foreseen. Before that Budget, more than 90 per cent of people bought an annuity with their pension savings. That number is already falling dramatically. In the first quarter of 2014, 74,270 annuities were purchased but by the second quarter, sales had fallen to 46,368.

Six months later there is greater clarity on the detail of what that bold statement actually meant. However, we will still need to wait for the Autumn Statement on 3 December for detail on important matters such as the rate of tax on pensions in payment at death (tipped to fall to the current rate of inheritance tax or even lower).

As insurers and annuity providers were swiftly identified as the Budget losers, Sipp providers were earmarked as potential winners. Sipp providers have proven experience in already offering drawdown, and generally coped well with the legislative change that introduced it. In recent years they have coped with varying Government Actuary’s Department (Gad) limits as well as replacing unsecured income and alternatively secured pension (ASP) with capped and flexible drawdown. In contrast the scale of work facing more traditional pension providers – who are accustomed to the accumulation phase only – poses an immense challenge.

The new pension income options

April 2015 will see increased flexibility for pension income. The option to buy an annuity remains and, despite immediate reaction post-Budget, is likely to still prove a popular choice for part – or all – of many savers’ pension funds. It is worth mentioning that lifetime annuities are also seeing some changes from 6 April 2015. The annual level of the annuity will be able to reduce as well as increase in value. The 10-year limit on guarantee periods will also be removed, enabling the choice for the annuity to continue to be paid for however long the annuitant chooses at outset.

A simple overview of the two key new options shows:

Flexible Access Drawdown (Fad): Fad is likely to be the default option for those who choose not to buy an annuity. It is akin to flexible drawdown today, with no minimum income requirement and the new ability to continue to contribute up to £10,000 per annum (although carry forward may not be used). There are no restrictions on when and how much of the pension fund can be withdrawn, but the investor must pay income tax on those amounts.

Uncrystallised Funds Pension Lump Sum (UFPLS): UFPLS is a lump sum paid directly from uncrystallised funds, with 25 per cent usually tax-free with the remainder taxed as income. UFPLS will also include payments from money purchase arrangements which would currently be termed as trivial commutation lump sum payments. To qualify for a UFPLS, an individual must have available lifetime allowance and be aged 55 or over. UFPLS cannot be used by those with protected tax-free cash under primary and enhanced protection, or by some others with lifetime allowance enhancement factors.

In addition, capped drawdown remains for those who already have it. Investors can keep capped drawdown provided their withdrawals do not exceed the current limits. In return they keep an annual allowance of £40,000 as well as the facility to continue to benefit from carry forward. Should withdrawals exceed the limits then the fund will be converted to flexible access drawdown (Fad) – no subsequent limits will apply to withdrawals but the annual allowance will reduce to £10,000.

Just because you can, doesn’t mean you should

The natural instinct of the traditional, independent Sipp providers has historically been to deliver whatever changes that legislation permits. But the signs are different now. The Sipp industry is under unrelenting regulatory and financial pressure. Another ‘Dear CEO’ letter followed the third thematic review of Sipp operators – the outcome being that many Sipp providers have now ceased accepting non-standard assets or have placed other restrictions on the investments they are prepared to continue to accept. Two counts of enforcement action were also mentioned.

The regulator also published PS14/12, finally clarifying the new capital requirements for Sipp operators. Despite easing the rules from the original proposal the majority of Sipp operators will have to ask their shareholders for many times more capital in order to remain in business, and to do so by September 2016. Some providers are not sufficiently capitalised under the current regime, demonstrating aptly the financial pressure at play. And all this comes amid market conditions of falling sales among independent Sipp providers, as the business supplied by unregulated investments is cut off and platform providers take a greater share of the collectives market.

Despite the potential opportunity offered by the 2014 Budget it is amidst this turmoil that some Sipp providers may now choose not to implement all the available options. Based on current investor behaviour only a small minority are likely to continue to contribute to their Sipp once they start to draw income, and the demand for UFPLS has not yet been proven beyond a small niche.

Challenging times for advisers and investors

The challenge of finding a Sipp provider who can meet specific needs, both now and in the future, and choosing the best one from that shortlist has never been greater for advisers and investors alike. The Sipp provider selected last year may no longer offer the same investment options, and there is no certainty either that the new pension rules will be implemented next April. Squeezed by the platforms, the niche market that many independent providers rely upon is getting smaller and smaller. By failing to keep up with the possibilities offered from April 2015, that market will shrink even further. Now that the dust has settled following the third thematic review it is no surprise that the pace of consolidation of Sipp operators has increased once again.

Advisers will want to know more than simply whether a provider will offer a particular service. As the new drawdown options become more accepted and widely used, they will increasingly expect enhanced ways of using them. Providers will need to invest to deliver wider drawdown functionality online, both for advisers and investors alike. Consumer expectations will drive this demand, as they get to grips with the new accessibility of pensions and expect to be able to access them in the same way they can move money online from their bank account or Isa.

To ensure they are selecting the right provider for the future, advisers and investors must be prepared to start asking simple, precise questions to their Sipp providers about what their plans are for the future. Their plans for the investments they will allow, their financial strength, the drawdown options they will deliver and their plans for online development.

If the answers prove challenging they should not baulk from continuing to look for the right provider. The new pension income rules mean that they could be together for a very, very long time.

Greg Kingston is head of marketing and proposition at Suffolk Life