1. April 2015: The pension and tax rules.
2. The implications for advice models.
3. Planning client communication and segmentation strategies.
Tutors on the panel are:
Vince Smith-Hughes, Head of Business Development, Prudential
Jan Holt, Business Development Team Manager, Just Retirement
The implications of the April 2015 pension freedoms
Vince, some big changes coming to pensions in April this year; what are the most significant ones?
VINCE SMITH-HUGHES: Well I guess the most major one and the one that’s got the most attention, Mark, is the ability for people to effectively cash their pension fund in. So instead of either buying an annuity or buying a drawdown they can say instead of that actually I want to take all of my fund or part of my fund as a lump sum, with typically 25% tax free and the rest subject to income tax. That’s the big one, although there are several other quite sizeable changes as well.
PRESENTER: Well if that’s the key one, just headline implications of that, because that sounds very very simple or is it reality?
VINCE SMITH-HUGHES: Yes, I think it is simple, but I think it does have some pretty big implications. I mean first of all people have got much more freedom and I guess I’m firmly in favour of that, so people have got a choice over what to do, but of course people also need to think about how long they need to make that money last for. So if people are cashing in their pension pots possibly as early as they can, maybe even while they’re still working, what they’ve got to be thinking about is well what am I going to live on in retirement? If they’ve cashed their pension fund in potentially that might just be the state pension, which is only really going to give them a fairly subsistence level of existence I would say.
PRESENTER: Okay, so that’s the first key change. Jan Holt, what else is there coming on the 5th of April?
JAN HOLT: Well, Vince is right, we’ve got complete access to pension funds that are invested in DC, so that opens up a whole new world of opportunities for people; however, they still can choose to invest that fund into an income producing vehicle, such as a lifetime annuity or scheme pension. So that continues, and then the two options if they want more flexible access would be to use an uncrystallised fund and actually take the money out as a lump sum or a series of smaller lump sums through an uncrystallised funds pension lump sum, or they could use something called flexi-access drawdown, and at that point they can take out any amount they want at any point in time. And similar in terms of the flexible access; however different in terms of tax treatment.
So, with the uncrystallised funds pension lump sum, the money that’s drawn out each time a withdrawal is made is taxed 25% tax free, 75% taxed. Whereas with the flexi-access drawdown there’s a 25% tax free lump sum available and any withdrawals made once that’s been used will be taxed at marginal rate, so a slight difference there.
The impact of the April 2015 Budget on DB pensions
PRESENTER: Now we’ve talked a lot about DC, but what happens in the world of DB?
VINCE SMITH-HUGHES: Well I think most DB schemes will be fairly unaffected by the change in the rules, which means that if people want to access the new flexibility, whether it’s uncrystallised fund pension lump sum or flexi-access drawdown, they’ll need to transfer out into the DC realm to be able to do so. Now I always say at this point, and I think it’s absolutely true, 99% of people are probably best placed to stay put, because you’ve got some valuable guarantees in the defined benefit regime. But for people who do want to access new flexibilities, or possibly the new death benefit flexibilities, then it might well suit some people to come out from that regime into the DC regime.
Death benefits for annuities and drawdown
PRESENTER: Okay, well now you mentioned benefits or death benefits there, let’s bring up our chart on annuity and drawdown - it’s table number 3 if we can bring that up. Jan Holt, could you talk us through what’s the same, what changes from April 2015?
JAN HOLT: Okay, so what you can see here is well the two different tax treatments on death benefits from annuities and drawdown depending on whether the client actually dies before or after age 75. So this first chart’s showing us what happens on death before 75. And effectively what you’re seeing is that the death benefits for annuities have been brought in line with death benefits from drawdown in terms of the tax treatment.
So we’ve got three types of death benefit that you could have from an annuity. So first of all we’ve got lump sum value protection, and then we’ve got income either from a dependent’s pension or paid under a guarantee period. So what you can see there is that under the new rules all of those benefits can be paid out tax free and to any beneficiary.
So similarly for drawdown you could either have a lump sum death benefit. So the remaining funding drawdown returned as a lump sum, and that can be paid again to any beneficiary and free of tax. And if any dependent’s drawdown pension is taken from a drawdown, again tax free and payable to any beneficiary.
So quite useful and important; however what you need to bear in mind is how many people actually are predicted to die before age 75. So if you look at mortality studies for 65 year olds then you find that about 10% of men and only 8% of women will actually die before they reach 75.
PRESENTER: Well, we’ve got a mortality table. So let’s bring that up. This shows the percentage of single life annuitants surviving to each age, so again if you make it to 65 you’ve got a very high chance of making it to 75.
JAN HOLT: You have, and the other point here coming back to Vince’s earlier point, one of the real issues for people is actually how they make their retirement funds last throughout what could be a very long life expectancy indeed. So here if you look at age 90, just in isolation, you know, we’ve got around about half of all women still alive and not far short of that in terms of how many men will still be alive.
PRESENTER: Okay and I suppose that the previous chart we’d shown was what happens to death benefits up to age 75. Let’s have a look now at how that picture changes on death benefits after 75, that’s chart number 4.
JAN HOLT: Okay, so what’s happening here is again for the annuity benefits, then, for any lump sum value protected benefit that’s paid out, under the new rules on death after 75, that would be subject to a 45% tax charge in the 2015/16 tax year, and thereafter expected to be taxed at marginal rate tax in the hands of the recipient, but it can still be paid out to any beneficiary. And then for the income benefits, no change, so they have always been and will continue to be subject to marginal rate tax, the tax that the recipient pays.
The only change there of course is that we can now pay those benefits out to any beneficiary rather than it have to be a spouse or dependent. And for drawdown, a similar picture really for lump sum death benefits, 45% tax in the next year and marginal rate income tax thereafter, and for any dependent’s drawdown pension paid out as income then that would be subject to marginal rate tax.
The implications of these rules for tax and IHT planning
PRESENTER: Vince Smith-Hughes, the government, which we hear is always keen on tax, why is it getting so much more generous around this?
VINCE SMITH-HUGHES: Well they made a statement when the changes were first made, they felt that the 55% tax charge on drawdown funds and funds post 75 was too penal, so they’ve decided to reduce it. And I think also maybe there is something behind the scenes that they want to make pensions much more attractive and actually encourage people to save. And I think relative to the conversations I mentioned earlier around the new freedoms that people have in terms of how they take their pension, I think the death benefits is equally a bigger game changer, because what it means is that in effect people will be able to cascade wealth down the generations.
And from an advising point of view it does mean that advisers will need to start thinking about where am I best placed to take income from to pay my clients? Am I best to take it from ISAs, from bonds, from savings or whatever, but the pensions wrapper now looks like a very attractive place to leave money in, certainly until age 75. So advisers ought to be looking at this and saying well we’ll review where income streams are being taken from in lieu of these new rules.
PRESENTER: So in terms of the pension changes as a basis for tax planning and inheritance almost there’s a whole field opening up here.
VINCE SMITH-HUGHES: Absolutely right, you know, I can see people looking and saying well pensions are now much more attractive because of the freedom of how I access it, but they’re also much more attractive because the death benefit’s been significantly improved. And since we’ve been talking to advisers around the country, since Budget day, many of them have actually said that one of the real objections to pensions or paying into pensions for clients is simply that I don’t want the pension to die with me. Well this gives you an opportunity to pass it down to the next generation. And as Jan has actually quite rightly said it needn’t even be a dependent, it can be anybody that you’re leaving your fund to.
PRESENTER: I mean that could open up for clients a quite tough decision. I mean previously if you had a financial product and it went to a named beneficiary, and that’s just the way it worked, that’s one thing, but now does that mean you could take that and give it to somebody completely different? I mean that could open some quite big family politics I would have thought.
VINCE SMITH-HUGHES: Well effectively it could, and actually the real key point here I think is that most schemes operate with discretion over where you pay pension death benefits to. So, typically, you would fill in an expression of wish form, which although it’s not binding would give trustees an idea of who you wanted to actually pay the fund to. Critical planning point for me is for advisers to review those and just make sure that what is on the form currently represents the pension holder’s wishes as to where they want the fund to go when they were to die.
The advice complexity generated by pension freedoms
PRESENTER: Okay, well I guess this brings us on the next topic, which when it comes to client need for advice, the changes outlined sound pretty simple in some ways. Is the world a simpler place now or, Jan, has it got a lot more complex?
JAN HOLT: Definitely more complex. Definitely many more decisions that have to be made, and we’ve already touched on a couple of them already, but I think that there’s a risk that you give people too much choice and they end up in complete paralysis, because they just don’t know which way to turn. So I think there are major opportunities here for advisers, in terms of helping people make the right decisions, not just in the short term, in terms of those early retirement years, but decisions that will see them through well as we’ve already seen could be quite a lengthy retirement.
PRESENTER: And presumably you as product providers, I don’t mean this nastily, but you’re going to add to that complexity, because you’ve got opportunities to create all sorts of new products, annuities for example that have limited life rather until death, I mean what are your responsibilities there to not overcomplicate things for advisers and clients?
JAN HOLT: Well I think that’s a fair point and I think indeed the regulator has said that whilst they want to see flexible products that are suitable for the mass market, what they wouldn’t want to see is overly complex charging structures or hybrid products that actually make comparisons really difficult. Because of course once you do that you then disincentivise somebody from shopping around and making those proper comparisons. So if that’s true for the end consumer, then that has to be true for the intermediary as well; we have to make things reasonably straightforward for them to understand.
PRESENTER: Well, given that chart we had up earlier about mortality rates, which from the point of pensions look depressingly low you could almost argue, but I suppose a key decision is making sure the money doesn’t run out. How big a job is that for the adviser, Vince? How tough are those decisions to have?
VINCE SMITH-HUGHES: I think it is quite a tough job, Mark, and in fairness there’ll be some clients who have lots of different needs, so some clients for example will be saying well I want to take my money out over a shorter period of time, but equally there’ll be an awful lot of clients who’ll be saying well I want this money to last me a lifetime. Clearly one way of doing that is to buy an annuity, that’s certainly going to suit an awful lot of people, certainly those who are risk averse. Another way of doing it of course is to go into drawdown and take what would be a sustainable level of income.
We’ve got a modelling tool which does just that, so it basically works on showing you the impact on both the fund value and ongoing income based upon selected growth rates, also to how long you could actually make your money last for and it also overlays onto that mortality as well. So that’s proven really popular with advisers, because it actually starts to help them to plan out well actually if you’re looking at taking a sustainable level of income this is the kind of range of income you need to talk about.
PRESENTER: Okay and one thing just before I come back in the conversation there, do by the way have a look around this video, the player that it’s in, because a lot of background documentation like some of the things that we’ve been referring to, Vince has just been referring to there, will be available on the site. So you can have a play around with those in your own time and also have a look at them with your clients.
Annuites and annuity deferral
Well, again, annuity, not taking annuity, I mean Jan do you get any sense of whether people will want to take all their money and just be responsible for it out in the future or do you see a lot of essentially annuity deferral going on?
JAN HOLT: A couple of points to that question really. I think first of all yes we did see a lot of annuity deferral happening immediately post-budget. And we don’t think that money was being diverted elsewhere, we think it was just genuinely people stopping and thinking well we’ll wait until next April and then we’ll see what’s available. So if that was part of a considered strategy and the client was happy to either carry on working or use their other assets to draw income from, then that makes perfect sense.
However, I think people sometimes forget to think about some of the implications of any annuity deferral strategy. Such as on the plus side you could actually see growth on the fund, you could see annuities change in your favour at some point in the future; however, people need to understand the implications and the risks. So you might not achieve the performance on the fund that you wanted to, annuity rates might not improve, but I guess most crucially is the fact that for every year you defer using your fund to take an income from annuity then effectively you’ve lost one year’s income.
PRESENTER: Well I think we’ve got an illustration of this, chart 5 please. I think we’ve got an illustration of that, let’s bring this up now. Now, Jan, can you talk us through this bar chart?
JAN HOLT: Yes. So what we’re seeing here is where somebody’s actually deferred annuity purchase just for one year. We’re starting to see so from age 65 how long it will take them to make up that one year’s lost income. So if we look at the different fund growths. If we look at the 7% figure, you can see there that even if you achieve 7% fund growth in the year that you deferred, you’re still going to be 75 before you’ve actually clawed back if you like that one year’s missed income. And then of course the lower the fund growth you get in the year of deferral then the longer it takes you and the slimmer the chances become of you actually recouping that difference. And I think this is one of the implications that people sometimes forget to think about when they’re holding off annuitisation.
Now I’m assuming here that we’re talking about clients who would actually annuitise and not clients who have deferred annuitisation, because actually they intend to access the freedoms that the new rules bring, because that’s a different scenario.
PRESENTER: Vince, what’s your take on annuities?
VINCE SMITH-HUGHES: Quite a good planning point I think for advisers is if you’ve got someone who’s looking to create a sustainable income stream, why not go and find the best annuity rate you can find for that particular client, put that income into one of the modelling tools and it’ll tell you what sort of risk you need to take in order to generate that income. That seems to me quite a sensible thing for advisers to do at the at retirement point.
PRESENTER: And the other thing is we’re all talking at the moment when annuity rates and interest rates, full stop, are incredibly low, but in ten years’ time we might be in a totally different circumstance. I mean how careful do you need to be about plugging in a 30-year view on the assumption that base rates are 0.5%?
VINCE SMITH-HUGHES: Well you do need to be careful and I think what will happen in practice is we’ll see a lot of people go into drawdown, drawing out hopefully relatively sensible levels of income in the early years, but look at annuitising later on. Obviously the advantage of that is that they may have become eligible for an enhanced annuity or a better rate on the annuity, but also it simplifies their income stream. And it’s a bit of a sweeping statement, but obviously for a lot of people who are getting older they may welcome simplification of how their income’s delivered to them.
JAN HOLT: And just to come back on the second part to one of your earlier questions, so did we think that people would want to access their pensions differently to annuities, then that’s what all the excitement was about immediately post-budget, but we have seen a significant shift in both the headlines and the views coming from consumers themselves. So there have been several major pieces of research issued in the last few months and pretty much regardless of which one you look at you tend to get around 70% of people who’ve expressed a strong preference for having the certainty of guaranteed income for life, rather than taking undue risk with their pension fund. So I think that gives us a strong indicator of what some clients might do even with freedom and flexible access to their funds.
Importance of communication with clients at times of change
PRESENTER: We’ll come back to that point in a moment if I may, particularly for those who’ve got small pots of money and indeed if that’s an area that advisers want to be in, but just in this run-up to April 2015 as an adviser running a business what should you be doing? How do you look at your client base? How do you talk to them? What are the key things to bear in mind, Vince?
VINCE SMITH-HUGHES: I think the first thing, Mark, is communication. There’s quite a lot of stories out there, which are at best half-truths, so communicating with your client bank to make sure that they’re aware of the key changes. Express the need for advice, because I think for a lot of people they are going to really need advice. When we talked earlier about this we said it is a more complex world now, more choice is more complexity, and people will need advice. And it might be that it’s not a case of annuity or drawdown or taking some of your pension fund, it might be a combination of all three of those things.
So certainly I would say advice is going to be the key for an awful lot of people, just re-stress that, but also I think it’s important to just remind people there are going to be individuals out there who are going to be trying to encourage money away from pension funds possibly even before you’ve reached the legitimate retirement age of 55, you know, the pension liberators, the pension scammers whatever you want to call them. And I’ve already had a lot of IFAs tell me that they’re out and about already, so just make sure you’re warning clients against those sort of people, because they can seriously damage your pension wealth.
PRESENTER: Yes, so pensions liberation and drawdown are two very very different things.
VINCE SMITH-HUGHES: Absolutely!
PRESENTER: Okay, Jan?
JAN HOLT: I think there’s a lot to do in the realms of communication, as Vince has said, it’s not just looking at the clients who did defer, who are due to retire in the next 12 months who are currently already sitting in capped drawdown, because all of those potentially have got decisions to make once we get beyond April, but it’s also that that sense check on all of the firm’s marketing collateral, so the website, any brochures, any bulletins that go out they all need to be updated in light of the new rules. The second key area that I think advisers need to start to look at is process.
So for example most advisers will have clients who are in capped drawdown. So when that next drawdown review takes place they’ll have additional options in terms of the outcome of that review. So they could stay in capped drawdown, which they may wish to do, but equally they could move into flexi-access drawdown. They could fully or partly annuitise their fund or indeed they could choose to cash in using the new flexibility. So lots of choices to make there and I think advisers would be well served to start to think about what that drawdown review process needs to look like for those who are going to have it beyond April.
Best practice in light of pension freedoms
PRESENTER: Well, sticking with that point, I mean again with all this change, what do you need to be documenting and how? Because presumably at some point regulators will do a thematic review or say we’ve gone and talked to a few firms and had a look at some files, what do you think’s best practice in this space?
VINCE SMITH-HUGHES: Well I think in respect of best practice we had quite a lot of help with what advisers should be doing on drawdown prior to the changes, and to a certain extent nothing’s changed. So absolutely they need to be looking at their process, doing all the things the FCA have said in the past and I’m expecting some more from them throughout the course of this year. One thing that has changed which was quite important is that they’ve changed the COBS rules on suitability letters and they’ve now got to refer to sustainability of income rather than maximum income levels.
So advisers need to make sure they’ve changed their process in that regard. I don’t know if anybody had gone to the positive compliance sessions that the FCA were running at the end of the year before last. They were very good. There’s lot of information out there in terms of things they were looking at there for advice process. Make sure you’ve got all of that in an absolutely watertight process in your own business and make sure you’re giving the right risk warnings as well. But certainly I think sustainability of income might be the one that catches people out, because it is a very recent change in the COBS rules.
JAN HOLT: Yes and I think good documentation starts with a good fact find, so being absolutely clear on what the client’s needs, objectives and priorities are, because there will be many who think they can access the new flexibility, but actually when it comes down to it they’re going to have to make that trade-off between sustainable income or getting their hands on that pension money. And so if advisers haven’t sense checked their fact find documentation recently then now I think would be a good time to make sure it is asking the right questions and being able to prioritise what clients are really looking to do.
PRESENTER: And is there any specific training that advisers should be looking for? I mean I wouldn’t say the world’s turned upside down, but it’s certainly been shunted through 90 degrees.
VINCE SMITH-HUGHES: Well certainly providers like ourselves have run many sessions actually since the budget and I’m sure Jan with Just Retirement have done the same in terms of looking at the process. We’ve created a number of checklists, which we’ve taken some of the information from the FCA and some of our own other information, and I think it’s always good to use that as a process to say well have we talked about this, have we talked about this? You know, a very simple example and something that the FCA and the FSA before them have said many times is around have you considered all of the different retirement options for people? Which is why I like the idea of going to get an annuity quote, establishing the rate and then seeing how drawdown compares with that, establishing what sort of risk you’re needing to take. Now I think all of that sort of thing is good practice and I would expect the FCA to really hone in on that.
The other one which I know is very topical at the moment is around the danger of what’s called a negative pound cost averaging or pound cost ravaging and this is where people are taking a level of income, the market falls, the funds you’re in falls and effectively it’s very hard to recover that particular loss, because effectively you’ve crystallised it at the point you’ve taken income. So it’s another risk to really guard against.
JAN HOLT: I think with an increased range of options available to clients, I think benchmarking is key, and I think probably when you’ve got a different range of products to compare and contrast against, your benchmark probably would be a fully underwritten whole of market annuity rate, because that’ll give you a start point against which you can assess the alternatives. I think as well as the learning and development I think advisers probably need to start to think about product research at a provider level. So keeping in touch with all of the providers who will have new solutions coming to market and making sure that they’re not just up to speed in terms of the technical aspects of how those products work, but that they’ve done some due diligence on them. Particularly if they’ve got panel research in place and they need to get all of that done and dusted before the rules actually change in April, as soon as those products become available. So it’s watch out for that I think is a key point.
Advising clients on cashing in small pension pots
PRESENTER: All right. Well I mean another thing in the run-up to April is does it make sense to look at a slightly different business model? We heard lots about people with smallish pension pots buying well not necessarily Lamborghinis, but certainly are there people who want to spend that money as tax efficiently as possible, as quickly as possible. Are those typically adviser clients or is that something advisers should keep well clear of, Vince?
VINCE SMITH-HUGHES: Well I think it’s very much down to the individual adviser and certainly I’ve had some advisers who've said to me if we have a client walk in the door and say I want to cash my pension pot in, they’ll say the first thing we’ll do is resign as your adviser, because that’s a decision that you’ve made and clearly you’re going to go and spend the money on whatever. There’s another school of thought though which is that if you’ve got someone even with a relatively modest pension pot, let’s say sort of £40,000 or £50,000, maybe even £30,000, I think we might even have an example, the Karen example.
PRESENTER: Yes, we’ve got chart 1 please. Yes, we do have an example here, talk us through this and why it makes sense to deal with Karen.
VINCE SMITH-HUGHES: Well this is a very simple example of a lady, we’re not going into the practicalities of why she’s doing it, perhaps she’s not receiving advice in this example, but she’s got £30,000 in her pension pot. She can take that now actually under the triviality rules. She’s retiring in March of this year and she actually wants to cash her pension fund in. So let’s assume she does that. You can look at the numbers as to what that’s going to achieve for her if we just move onto the next slide and you can see because she’s got all her earnings in the current tax year, what she’s really doing is getting her tax free cash and having the rest of the fund taxed to 40%.
Now assuming she stops work before next year she’s got the whole of her personal allowance and basic rate tax bands to apply to it, what you’ve really done there is you’ve increased her wealth from this transaction by well over £6,000 just by deferring for a couple of months. Now you might say this is an extreme example, but my sense is that there are a quite a lot of people who’ll say well I’ve got a relatively modest fund, £30-40-50,000, as I said, I want to take it all as cash, but perhaps instead of taking in one go by doing it over four or five years can really help you from a tax perspective to actually keep your tax numbers down.
Now I think there’s an opportunity there for advisers to say well we could help those sort of people. Jan and I were talking about this actually before and we kind of badged it as a tax planning service, where someone just says right £40,000, I want to take that over five years, we can give you advice on what amount to take and actually how you do that and just charge perhaps a one-off fee to do it. Quite different from a lot of advisers’ models, but I think there’s an opportunity there.
PRESENTER: I can see if you put that in front of an adviser that looks quite an easy one to do, not least because she clearly has got enough money in ISAs I mean essentially her pension pots in ISAs, but I think particularly the point of view of the regulator, Jan, I mean fears of how the regulator would look at that if you had that £30,000 lump sum, but you didn’t have any other retirement income to fall back on apart from the state. Would there be a nagging fear somewhere that it might just come back to bite you at some point?
JAN HOLT: I think some advisers are fearful of that. Particularly maybe less so about what the regulator would say today, but what would happen if the client comes back in five, ten years down the line to say the fund’s exhausted and the adviser helped them do it and they’re looking for some recourse there, so I think that would be the main concern. Clearly every client is different and it comes back to good fact-finding, good documentation and being able to evidence all of the discussions that have taken place in terms of what options were available to clients, why the selected ones have been chosen and what that actually means in terms of not just benefits but of course risks and drawbacks.
Deferring taking state pension
PRESENTER: But, Vince, what about if we took this example of Karen, but she’s got £30,000 but no other savings, after that she’s going to be reliant on the state, what happens if she defers taking her state pension?
VINCE SMITH-HUGHES: Well at the moment if you defer taking your state pension you get a return of over 10%, so it could be attractive for someone like Karen to draw out her pension and defer her state pension. Unfortunately it’s not quite so generous when the new state pension comes in, but I think this highlights people will want to do all sorts of different things. I think the key point, it goes back to something Jan was saying was, advisers have got to be really sure they’re documenting this in the right way.
So if you have got someone for example who’s stripping their pension fund out over a short period of time be absolutely crystal clear in suitability letters that this isn’t an income that’s going to last forever, it is only going to last for X amount of years, it’s not going to provide a sustainable income, and just make sure that point is absolutely made crystal clear.
Fees for advice in pensions
JAN HOLT: I think one of the other things that advisers can start to do in the run-up to April is actually take a fresh look at what their at retirement proposition actually is. So they need to decide, bearing in mind the different clients and the different ways they’ll want to use their funds, who do they want to offer services to and how, in terms of the actual advice model and process, and also how much they’re going to charge for that. Because we’ve had conventional charging models that tend to be percentage based, and of course if you’re working with somebody who intends to strip out a retirement fund fairly quickly then that model may not be appropriate as we move into the new world.
So it’s not really a provider’s place to tell advisers how much they should charge for their services; however, I think it’s worth suggesting that they review the charging structures in place at the moment are actually going to be fit for purpose in the new world.
PRESENTER: But I suppose a chunk of this certainly around this tax planning advice over say a five year period that you’re talking about is how difficult is it to give that advice? I mean that’s quite a simple piece of work, I guess you could put quite a simple fee on it.
VINCE SMITH-HUGHES: An appropriate fee.
JAN HOLT: And this is what advisers need to work out, what’s the process involved in that, how much does the process cost and what do they need to charge? The second point of course is and we looked at longevity early is to start to think about the ongoing need for advice and services that clients will have as they go through their retirement. So there are some advisers who have chosen to specialise in the later life market, but for those who haven’t they might need to start to think about how do I meet those needs on an ongoing basis, because my clients potentially could be coming back for help and advice at a point in time when they’re quite vulnerable or in distress and if I’m not geared up to deal with those specialist needs then do I form alliances with somebody else who can and do I outsource for those?
So thinking about the need for later life planning, i.e. care fees funding, thinking about once pension assets have been utilised what other assets does the client have, for example property, and how those can be used in financial planning.
Guidance: an opportunity or a threat to the adviser model
PRESENTER: Okay and I suppose the other one to pick up, we’ve talked a bit about advice, but a lot of talk at the moment about guidance, having an advice model sat next to a guidance model, is that a potential way of increasing your business or is that blurring a line that you just don’t want to blur, Vince?
VINCE SMITH-HUGHES: Well I think there are a couple of things here. First of all we should distinguish what an intermediary would do from the guidance service, so the guidance service which we know is going to be provided by the Citizens Advice Bureau and The Pensions Advisory Service. And actually I think there’s an opportunity for our advisers to work in tandem with guidance. Let’s hope that actually those people go and receive guidance, they have more understanding of their choices, advisers are having more informed conversations more quickly because of that service. So I think there’s an opportunity for advisers to do that and work in tandem with it.
In terms of should they be offering a non-advised or transactional service themselves to help people with their retirement funds, I’m sure that model will have a place. And to a certain degree that already exists, you know, you’ve got annuity brokers out there who are providing that service, and as long as people understand what it is that they’re actually buying, how their retirement income is being paid to them and they know they haven’t received advice, then I see no reason why that shouldn’t carry on and still provide that valuable service.
I guess my only counter to that is what we’ve already talked about is there is a lot more choice, and also there’s more complexity for some people, so if they’re looking to do this thing where I want to create a sustainable income stream or I want some advice specific to tax in my own individual circumstances, then they would be well placed to see an adviser.
JAN HOLT: And I think the key point about the relationship between the guidance and advisers is that at some point in the guidance process there will be signposting to clients with a further need for more information, more guidance or indeed advice. And Money Advice Service is actually building its retirement advisers directory and there are other retirement specific directories that exist. And so for advisers who want to be part of that and want to actually attract new clients into their business through those sources then it’s worth starting to look at how you actually register for those now, what the eligibility criteria are and so on, and have all of that in place before the guidance guarantee actually kicks in.
PRESENTER: I suppose that brings us on then we’re talking about other people potentially offering guidance or advice, I mean what are the threats out there to advice? We talked a bit about regulatory, but from other people giving advice or guidance, is this a worry?
VINCE SMITH-HUGHES: I think it could be a worry. In fact actually I saw the first advert this morning in the press, which was an advert from a holiday company making the explicit link between your pension fund and you could actually go and do any one of these number of holidays, and I think we’ll see a lot of more of that starting to come out over the course of the next few months. So the press are no doubt going to be also talking about now’s the chance to cash your pension fund in and buy your new car or go on holiday, whatever.
So I think advisers need to be really careful about that and make sure they’re communicating with their clients as to why that might not be a very good idea to do in their circumstances. I think that’s going to be quite important. They also need to guard against the pension liberators. But it’s just about showing the value that they can give to a client with advice and actually give the client the best possible outcome.
JAN HOLT: I don’t think the guidance guarantee as such is a threat, but I think there is a real threat that if you don’t talk to your clients then somebody else is likely to want to. Equally of course another threat is that clients decide they’re just going to go it alone and put some kind of DIY retirement plan in place, which again has lots and lots of risk associated with it. So there might be clients who have appetite for risk and think that they understand investment risk, but what they almost certainly won’t be factoring in are the other risks that are associated with retirement planning, such as longevity, such as tax planning, you know, a lot of the things we’ve touched on already today. Change risk, what happens when things change, and of course they could end up not with the retirement that they were hoping for and with no recourse because they did it all themselves.
The dangers in decumulation
VINCE SMITH-HUGHES: And I think it’s important as well, Jan mentioned DIY investors, a lot of investors won’t appreciate the difference between accumulating and saving funds as opposed to actually stripping income out of them. And I mentioned the negative pound cost averaging, - that’s a real risk to people which they won’t appreciate if they are a DIY amateur investor.
JAN HOLT: Yes, they won’t be thinking about the need for exit strategies from being fully invested; they’re unlikely to be thinking about the need for regular ongoing review and of course the relationship between pension and non-pension assets; and then finally because it may seem so far off they certainly won’t have factored in things like care fees planning if that need should arise later on.
VINCE SMITH-HUGHES: We mentioned earlier, it’s important, as Jan said about the assets, to consider where do you take your income from? We saw the example about the lady who’s cashed her pension in, but has got an ISA fund that she’s drawing income from. Actually there’s a good argument to say you should be drawing more income from the ISA fund and not from your pension.
PRESENTER: Well I suppose to your point, a lot of people will describe themselves as DIY investors. There’s very few who cheerfully say they’re DIY tax planners.
VINCE SMITH-HUGHES: Yes, that’s right.
PRESENTER: Which I guess probably tells you where some of the complexity lies on that. Are there any specific issues around this that get thrown up if you’re an adviser to a corporate scheme? Particularly now with things like auto- enrolment and DC schemes coming up, Jan, anything that you need to be aware of there, because again you’re going to have a spread of clients within the company from the directors all the way down?
JAN HOLT: You are, and I think a lot of corporate advisers have been working to put retirement income facilities in place for schemes, but they’ve been primarily focussed around annuity desks, so clearly they may need to be changed and reviewed in light of a wider range of options. And then there’s been a lot of talk about default funds and how appropriate they’re going to be if you’ve got this lifestyling approach that de-risks you as you get closer to annuitisation, then annuitisation for many may not be the choice and so does that work? So there’s been lots of talk about those things and how schemes and their advisers deal with them.
The attitude of the regulator to pensions changes
PRESENTER: A final topic to move on to is what’s the attitude of the regulator in all of this? We’ve touched on the regulator a little bit here, but a lot of change going through. Vince, do you think they’ll be sympathetic if there are a few hitches on the way as everybody gets used to the new rules or are they perhaps going to be a little less merciful than that?
VINCE SMITH-HUGHES: Well I’m not sure I’d use the word sympathetic. I think it’s a case of sticking to the rules as we have them today, making sure that you’re flagging up all the things we’ve talked about, sustainability of income things like the changes in the death benefits, making sure that people understand there is a real risk of running out of money, making sure that all of the different retirement options are considered, and particularly the sustainability of income as we’ve seen that change in the COBS rules. And I think we will see some crucial information from the regulator throughout the rest of this year on this subject, so keep a watching brief on what’s said.
Having said all of that I think if you can do that, make sure you’re absolutely watertight in your process, then you can give these people advice without too much of a concern as to something coming back to bite you in the future. But what I would say is just make sure your process is absolutely watertight with everything we know today.
JAN HOLT: And the regulator put three papers out just before the end of 2014, so they released their thematic review into annuity sales practices, their retirement income market study and an occasional paper that looked at the money’s worth of annuities compared to alternative drawdown strategies. So there were quite a few things that came out of that. They’re kind of consistent themes I think across all three papers.
So I wanted to address the one about annuity sales practices. Not in detail, because that was focussed on the ceding providers essentially, but one of the things they were really concerned about was people who were entitled to enhanced annuities, but didn’t get them for one reason or another. So I think if you translate that to the advisers’ process it would I think make sense for advisers to ensure that they’ve got that underwriting process absolutely nailed down, so it couldn’t happen to a client who transacts their annuity on the open market with an adviser, so asking the right questions about health or lifestyle and so on.
And I guess by way of an indication of well how many people would that apply to? We know from our research and our experience as an enhanced annuity provider that 60% of retirees have got the sorts of conditions or lifestyle factors that will actually enable them to qualify for an enhanced annuity. So if that feels like a benchmark for advisers to think about, then their processes need to make sure that they’re getting that sort of outcome for clients.
PRESENTER: Because we always hear about papers and things coming out from the regulator, I’m sure more people claim to read them than do, but I mean around those ones that you were talking about though, Jan, is it worth reading them in detail if you’re an adviser? Should you read the press release version?
JAN HOLT: Well I think the press release version actually summarises quite nicely what their views were, and I touched already on what they thought about product design and complexity and transparency of charging, for example. They also talked about they were wanting to see tools and business models developed that would actually help people work through the options and understand the risks and what potentially could happen. So I think there’s lots of development already underway by various providers and indeed adviser firms to make sure that we’re in line with where the regulator is thinking this should all go.
PRESENTER: Okay, well we’ve got to bring it to a close here. Final question, I’ll come to you first Vince, do the opportunities for advisers outweigh the potential threats?
VINCE SMITH-HUGHES: I think they do. I think there’s some great opportunities for advisers. Depends very much on the individual adviser business model as to whether they want to give that tax planning service we talked about for people who want to take their money out in short order. I think there’s an opportunity there for advisers who want to do that. You know, you can make money out of that, just do it very carefully I think is my message. But looking at clients who want to stay invested for the longer term or make sure they’ve got the right annuity, I think it’s a huge opportunity. And I guess the other side of the coin is it’s really encouraging for people to put money into pensions. So the more money goes into pensions the more money that people will have when they actually come to retire.
So it’s not just a case of looking at it in isolation saying these are the choices when you reach retirement; it’s also a case of saying pensions look really attractive as an investment wrapper, let’s look at those clients who are perhaps in the run-up to retirement and seeing if they’re actually paying enough into their pensions.
PRESENTER: Jan, a final thought from you?
JAN HOLT: Well I’ve seen already that some firms are actually building advice propositions to serve what you might call the mass market, and I think that’s a real opportunity. And if you think about the needs of people in that market then what they’re unlikely to want is high levels of risk or any big or nasty surprises throughout their retirement. However, there is an opportunity to maybe offer them some sort of packaged retirement that will guarantee a minimum level of lifestyle through secure income, typically provided by an annuity, and give them some flexibility.
So you could call that either the rainy day money or the bucket list money that’s provided by a simple low-cost drawdown solution, and I think that’s a key area that advisers could look out for, because of course whilst there are some firms who deal exclusively with high net worth clients then most firms actually have quite a broad base of clients within their client bank. So that’s the type of solution that we think will emerge and would be very useful for people to benefit from the new freedoms.
PRESENTER: We have to leave it there. Jan Holt, Vince Smith-Hughes, thank you both very much.