Part 6 of our thought provoking report 'Redefining Retirement: Pensions Freedoms. Pensions Future'.
Retirement planning is evolving and the new pension freedoms and conversations bring with them new advice opportunities.
Advice opportunity 1 - location – location – location
Location, location, location; proverbially, these are the three most important things to consider when buying a house. We believe the same applies to pensions. That is why ensuring your clients are located in the right pension is the number one advice opportunity.
Clients, reasonably enough, will expect that the change in pension rules means their own contract will be able to provide all the flexibility the Chancellor has promised. Not all of them do, of course.
It is crucial to ensure that clients are located in a pension contract which offers (to give its full and correct name) “flexi-access drawdown and beneficiaries’ (dependants’ plus nominees’) flexi-access drawdown”. This is so they can have the reassurance of knowing that it can provide a tax-efficient legacy for their beneficiaries when they die. In addition, as their adviser, you will have mitigated any potential risk, should the family wishes not be fulfilled. It is evident that many people are located in contracts without such flexibility and, unfortunately, “dying in the wrong pension” is by no means an uncommon circumstance.
A warning from a genuine recent pension case (names withheld)
In a recent £700,000 pension case (not with Old Mutual Wealth), the money had to be paid to the estate as a lump sum, minus a tax charge of 45%. This was contrary to the client’s wishes that it should be paid as an income to their children and grandchildren at their marginal rate of tax, through nominee drawdown.
The client in this case was located in an old style pension. This table shows the outcome of that compared with what it could have been with a pension offering “flexi-access drawdown and beneficiaries’ (dependants’ plus nominees’) flexi-access drawdown”.
Advice opportunity 2 - pensions: first to fund, last to draw
The hierarchy of sources from which income is to be drawn may have changed for some clients as a result of the freedom and choice legislation.
It may be that, with advice, your clients decide not to draw an income from their pension. Instead they can leave that money outside the estate and take income from their ISA, collective investments, on/offshore bonds, or alternative assets such as buy-to-let properties.
We are also likely to see an increase in equity release, as more people recognise that accessing equity in their own home represents a viable alternative to downsizing and may be viewed as an inheritance tax arbitrage strategy.
Deferring pension income may have implications at the second LTA test at age 75. However, with the right advice, this is a trade-off between keeping money outside the estate, a potential tax charge and income taken to stay below the thresholds.
Making the most of allowances
Utilising all available allowances would seem entirely sensible for an individual or couple, from personal allowances to the more recent savings and dividend annual allowances.
Advice opportunity 3 no time like the present, or no present like a legacy
The ability to leave money to dependants is important for many clients, yet most will require their pension and other investments to provide an income they can live on.
In many cases, the outcome is that beneficiaries receive whatever money remains on death. But with timely planning and commitment, this issue can be tackled in a way that provides a greater level of certainty and reassurance for both benefactor and beneficiary. An alternative approach to gifting pension money is now being used by a number of advisers. This involves the use of a guaranteed whole of life plan (GWOL) as a form of asset protection or wealth creation.
Doing the maths - a real recent GWOL example (names withheld):
A 65 year old couple paid £255 a month into a guaranteed whole of life plan on a second death basis.
With a joint life expectancy of 22 years, based on UK Government actuary statistics, the couple’s plan would provide a sum assured of £200,000 on death, yet the total premiums paid over the presumed life of the plan would only be £67,449. In investment terms this would represent 9.0% pa equivalent growth rate. If the clients were to actually invest the same premium for the same 22 year period at an assumed net investment compound return of 5%, the projected investment value at the expected age of death would be £120,993 – just 60% of the sum assured.
The outcome suggested in this example is obviously not guaranteed and issues such as longevity and affordability play a part in individual cases.
Advice opportunity 4 - Not as critical (yield) any more
Before the new rules were introduced, the main benchmark to assess the pros and cons of a DB to DC transfer was the critical yield calculation. The new flexibility however means that there are now many more considerations to be taken into account. These include:
- low gilt yields
- higher transfer values
- an increasing emphasis on more personal control, and
- the previously unavailable opportunity to keep the fund within the family upon the death of the Defined Benefit (DB) scheme member and spouse.
The increasing number of transfers from defined benefit schemes shows no sign of abating. Our own TVAS service has seen a 300% increase in requests so far this year (up to 30 September 2015) and we will continue to support your DB advice in this area.
Among the many reasons why some clients are considering a transfer from DB schemes are:
- concern that the pension protection fund (PPF) limits, (currently a maximum of £32,000 pa at age 65) are inadequate.
- inability to provide a different shape of income at retirement, more specific to individuals’ tax and varying personal circumstances, indicated by the ‘Retirement Smile’ on page 12.
- health issues and marital status, around which DB rules are typically inflexible.
- death benefits and dependants’ benefits are key drivers.
While critical yield remains a factor in the decision to transfer or not, the above considerations put a broader context around the CY calculation. In cases where affordability may become a problem for the plan owners, their ultimate beneficiaries may well decide that the calculations behind it are compelling and choose to take over payment of the premiums themselves, either immediately or at a later stage.
The Redefining Retirement report covers key conversations and opportunities for you to help guide clients through the evolving retirement landscape. Visit our website to find out more about our new retirement proposition, IncomeSelect.