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June 2019

Professionals’ guide to drawdown 2019/20

ContentsIntroduction 3

Acronyms 4

Section 1 (S1) The drawdown advice process

Learning objectives 6

The drawdown process 7

Identifying savings available 8

Identifying capital needs 9

Identifying income needs 10

Identifying attitude to risk 11

Identifying suitable investment options 12

Connect income sources to income needs 13

Putting it all together 14

Taking benefits from DC savings 19

Advising on drawdown 22

Advising vulnerable clients 24

Death and taxes 26

Evidencing suitability 28

Packaging your advice 30

Overview of risks 31

Key changes from 2018/19 37

Due diligence checklist 40

Learning objectives 42

Test yourself for CPD purposes 43

Section 2 (S2) Prudential retirement solutions

Holistic financial planning and advice 45

Prudential’s financial strength 46

Prudential Retirement Account 47

Prudential online support for advisers 49

Appendix A: PPP/SIPP vs SSAS 51

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Welcome to our annual Professionals’ guide to drawdown. This guide is full of facts and tips to help you research and provide compliant drawdown recommendations.

Introduction

Drawdown is the name given to the process whereby defined contribution (DC) pension savings are invested while benefits (income) are being withdrawn as and when required.

In 2018/19, the FCA published guidance on defined benefit (DB) pension transfers, and we have incorporated some of the best practices from that into this guide.

We have split the guide into two sections to aid your navigation and separate out the CPD accredited content:

We hope you find this guide both interesting and informative.

Richard Hulbert Insight Analyst (Wealth) rhulbert@defaqto.com

Section 1 (S1): The drawdown advice process Section 2 (S2): Prudential retirement solutions

This section provides structured CPD and gives you all you need to know when advising on drawdown. You’ll find lots of facts and tips to make giving advice easier and more compliant, while enhancing your client’s experience.

This section focuses on Prudential, their pension scheme, the fund ranges and the support tools it has available for advisers.

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AcronymsThe most common acronyms used in this document are:

ATR Attitude to risk

CPI Consumer price index

DB Defined benefit

DC Defined contribution

ETF Exchange traded fund

FAD Flexi-access drawdown

GAD Government Actuary’s Department

ILC International Longevity Centre

LTA Lifetime allowance

MPAA Money purchase annual allowance

ONS Office for National Statistics

PCLS Pension commencement lump sum

PRA Prudential Retirement Account

PPP Personal pension plan

RPI Retail price index

SIPP Self-invested personal pension

TPR The Pension Regulator

UFPLS Uncrystallised funds pension lump sum

Pension Wise is a free and impartial government service designed to help individuals understand their pension options. Their guidance includes the risks of different pension withdrawal options, how to shop around, and what to look out for on taxes and fees. It also includes how to avoid common pension scams, which are a very real risk.

In March 2019, the government announced Pension Wise, along with the Money Advice Service and The Pensions Advisory Service, would be amalgamated in a new organisation known as the Money and Pensions Service. This had not happened at the time of production.

The aim of the Money and Pensions Service is to provide free and impartial guidance around pensions and monetary issues. We recommend you use them when Pension Wise ceases.

If you are not a finance professional, we highly recommend that you contact Pension Wise.

pensionwise.gov.uk 0300 330 1001

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Section 1 (S1) The drawdown advice process

6

Learning objectivesThis document is accredited by the CII/PFS and CISI for up to 60 minutes of structured CPD. Reading this document will enable you to:

1 Design a compliant initial and ongoing due diligence process for drawdown

2 Explain the different retirement options

3 Evidence the suitability of a selected level of income or withdrawal

4 List the key issues in managing an effective drawdown strategy

5 List the risks associated with drawdown

6 List the death benefit options and understand how they impact on advice

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But, it’s not that simple

One of the main issues with drawdown is that individuals enter into it without understanding the implications. In particular, not understanding if and how their decisions will produce the income required for the rest of their life and their beneficiaries' lives.

Professional financial advisers and paraplanners can add considerable value by helping their clients avoid the common pitfalls, which include:

• Tax on withdrawals

• Tax on contributions

• Tax on savings

• Lost capital

• Lost income

• Lost partner’s income

There is no second chance

Get just one element of the advice process slightly wrong and there is the potential to destroy the standard of living for your client and those dependent upon them for the rest of their lives.

Having a defined process, which you follow without fail, will help you identify the common pitfalls and issues, while ensuring your advice remains suitable and compliant.

This guide will help you identify the factors to consider in your advice process, and how to mitigate some of the issues and risks involved.

It’s an ongoing job

It is important not to forget that a drawdown solution needs to be reviewed on a regular basis as circumstances and needs evolve.

S1. The drawdown processIn essence, drawdown advice is relatively simple. All you need to do is follow the diagram on the right and repeat on a regular basis:

Identify savings

available

Identify capital needs

Identify income needs

Identify suitable investment

solutions

Connect income sources to

income needs

Pull it all together and

create drawdown

Identify attitude to risk

8

S1. Identifying savings available

When recommending how to produce income in retirement, it is important to consider your client’s entire financial position and that of their dependants.

Managing assets as one, irrespective of the tax wrappers in use, can often produce the best overall outcome. For example, use ISAs to provide an income and savings in DC pensions for inheritance tax planning.

Consider using the following assets to produce income in retirement:

Each of the assets listed can produce income, the flow of which can be turned up or down to help maximise tax efficiency and meet ongoing income and capital needs.

This is where the professional adviser really makes a difference. It requires considerable knowledge and skill to balance the positives and negatives of each income source alongside individual risks and the need for access and control, while selecting the flow of income that is appropriate from each asset and determining the timing of it.

Cash Pensions

ISAs Onshore bonds

Property International bonds

Stocks and shares Equity release

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S1. Identifying capital needsWe recommend that advisers identify their client’s capital needs over at least the next three years, and put aside sufficient cash to meet these costs.

For clarity, capital needs are in addition to the income needs we discuss in the next few pages. It is what your client expects to spend over and above normal expenditure, in the short to medium term.

Examples of capital needs include:

Twenty years ago, it was not unusual to see advisers recommend that every penny available for investment be invested. This resulted in cash then needing to be realised from the investment to meet needs. We now know that this strategy is rarely in the client’s best interests.

The counter argument is that cash tends not to perform well, indeed after tax and inflation are included, the return could be negative in real terms. However, the low return is unlikely to be as great as the cost of investing and disinvesting and comes without any investment risk.

We suggest advisers document their recommendations on how they came to the capital reserve, where it is held and why.

Notes on cash in DC pensions:

• Drawing down cash from a pension makes it taxable, so that is rarely a good idea.

• Crystallised tax-free cash ceases to be tax-free cash when it is held in a pension for over a year.

1 Rainy day fund/ cash reserve (instant access-short term notice reserve)

2 Expected notable expenditure such as:

• Professional advice fees (including your own)

• Home improvements

• Holidays

• Replacing the car

• Anniversary and birthday presents

• Educational costs for others (eg grandchildren)

• Funeral costs for others (eg elderly parents)

It is good practice to put aside cash to fund

capital expenditure

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Categorise income needsOnce you have ascertained your client’s capital needs you now need to understand how much your client is spending and on what – their income need.

To understand the income need, ask your client to list their expenditure and then categorise it as indicated in the picture below:

If your client does not know their expenditure, they will find much of it detailed in their current account and credit card statements.

Remember to add in ad hoc costs such as birthdays and Christmas as well as planned expenditure, including changing the car and having holidays. This will help you with identifying the capital needs discussed on the previous page.

Once you have identified the capital and income needs, it is possible to start to plan from where these needs will be met, and we explain how to do this over the coming pages.

S1. Identifying income needs

Unless you fully understand your client’s wealth and income needs, it is impossible to give suitable drawdown advice.

The easy bit The hard bit

Working out what income is needed to meet current core and aspirational expenses

Ascertaining the evolving future income needs and whether the savings available can realistically produce the required income, after market movements, inflation and taxation, so the client has income for their remaining life and that of their dependants and beneficiaries

Income that is not being spent, perhaps being held

in cash or invested

Income required to maintain a desired standard

of living

Income required to maintain a home and a reasonable standard of

living

Emergency fundHome improvements

Estate planning

EntertainmentHolidays

Lifestyle insurancesHealth support

Home maintenanceDebt management

Key insurancesTransport/car/care

Nice to have income

Aspirational income

Core income

Source: Defaqto

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There are a number of attitude to risk (ATR) assessment tools available, and these are usually the quickest and simplest way to make an assessment. Whichever tool you use, here are some things to consider.

It is important that you understand the assumptions and philosophy the tool uses. For example, if we assume you have assessed you client as being risk level 5 (balanced):

• What exactly does risk level 5 mean, look like, what personalities tend to use it and what does it invest in; how does it differ from other levels, especially levels 4 and 6?

• Does risk level 5 match your client’s expectations or understanding of risk level 5?

• It is unlikely the fund manager's own assessment of the fund's risk and the ATR assessment you completed with your client use the same underlying scale. How do you evidence compatibility of these different scales?

Rules of thumb

• ATR is usually based on personality traits. Therefore, your client's risk level is unlikely to fluctuate much, if at all. This is also generally true even in economic downturns and through major life changing experiences.

• If volatility in the value of the investments is worrying your client, then you have either assessed their ATR incorrectly or the underlying assets do not match the agreed risk level.

• ATR is more than just ascertaining an investment risk level. You also need to consider capacity for loss.

• If you client’s stated objectives and needs can be met by a lower risk level than the one indicated by the assessment tool, then recommend the lower level. There is no point taking on unnecessary risk.

• Periodic reassessments are a sensible way to evidence ongoing suitability.

S1. Identifying attitude to risk

It is important to evidence the suitability of the investment you recommend meets both your client’s needs and beliefs. Without this assessment you cannot evidence the suitability of your advice.

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S1. Identifying suitable investment options

In this section we look at the multitude of options and retirement solutions available to meet the needs of retirees who have accumulated savings in DC pots.

Despite pension freedoms having been with us for 5 years, and on average over 250 product changes each month, the retirement options remain broadly unchanged, namely:

The retirement pick and mix

Retirement solution selected

74Workplace pensions

45,000Funds

58Platforms

41PPPs

47SSASs

137SIPPs

Source: Defaqto, February 2019

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S1. Connect income sources to income needs

Advisers should generally look to cover unavoidable expenditure with secure income sources.

As the need for security of income decreases, it may be appropriate to accept less security of the income source in return for the potential of a greater return.

Risk

Drawdown without protection

Drawdown with protection

Scheme pension

Lifetime annuity

State pension and benefits

Nice to have income

Aspirational income

Core income

Source: Defaqto

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S1. Putting it all together and create drawdown

Blended verses hybrid

or

Most retirees use a blended solution without realising the hybrid option exists.

The difference between these types of solution is subtle, but the outcomes can be significantly different.

Only a hybrid solution provides retirees with the flexibility and control over the income they receive, because the transactions happen within the pension scheme (trust) itself. For example, when we consider annuity income, a hybrid creates two clear benefits:

We recommend advisers consider both a blended and hybrid solution in their compliance file and document the rationale for their choice. This is important because client circumstances will undoubtedly change, and if their income cannot evolve with them, then the recommended solution could be considered unsuitable.

Blended

Combination of separate retirement solutions, facilitated through a multitude

of individual product wrappers

Hybrid

Combination of separate retirement solutions, facilitated through a single

product using a trustee investment plan

1 ‘Annuity income’ can be received and accumulated before being paid out, creating income tax planning benefits

2 ‘Annuity income’ can be received and reinvested without being subject to income tax; in other words annuity income can become an investment return

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Reduced annual allowance

The government has introduced two solutions to prevent abuse of the tax system. Both can be in force at the same time. Advisers are best placed to help their clients avoid these restrictions.

Tapered annual allowance

This restricts the amount of annual allowance on a tapered basis for individuals with income:

£150,000+ including the value of pension contributions

£110,000+ excluding pension contributions

Those affected see their annual allowance restricted by £1 for every £2 that their income exceeds their ceiling, up to a maximum reduction of £30,000 (ie a £10,000 allowance).

State pension The new style basic state pension is now firmly in place for new retirees. Advisers should remember that not everyone is guaranteed to receive the full amount.

A minimum of 10 qualifying years on your National Insurance record is usually required to receive anything, and 35 to receive the full amount.

State benefits For those below the state pension age there is a limit on the total amount of state benefits available. Taking benefits from pension savings can affect entitlement to state benefits.

Tax-free cash Also known as the pension commencement lump sum (PCLS).

Under normal circumstances, the maximum allowance is 25% of the fund value at the time of taking the benefits.

MPAA The money purchase annual allowance (MPAA) is a reduced annual allowance for contributions into money purchase pension schemes. When pension benefits have been "flexibly accessed", the amount that can be saved in the future tax-efficiently in a money purchase pension is reduced. It is currently £4,000.

Lifetime Allowance The Lifetime Allowance (LTA) is an overall limit on the amount of pension benefits that can be taken before the LTA charge is levied. In essence, it reduces the benefit of saving in a pension where the combined value exceeds the LTA (£1,055,000 in 2019/20). We explain this below.

Tax on death and value protection

Changes to death benefits now mean that pension funds can be passed as income to any beneficiaries, giving more choice to pension scheme members. If beneficiaries choose to move into drawdown, then, on their death, the fund can be passed on again.

The availability of death benefit options depends on the scheme, and not all schemes will offer full flexibility.

Table 1: Key points to consider before taking benefits from pension savings

Restriction Allowance Who is affected

Tapered annual allowance £40,000 to £10,000 High earners (ie £110,000+)

Money purchase annual allowance £40,000 to £4,000

Many who have flexibly accessed their benefits have their annual allowance for future money purchase contributions limited to the MPAA

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The MPAA

This was introduced to prevent abuse of the tax system by individuals taking money purchase pension benefits and making use of the proceeds to make tax relievable pension contributions.

Designed to counter an individual using the flexibilities around accessing a money purchase pension arrangement as a means to avoid tax on their current earnings, by diverting their salary into their pension scheme, gaining tax relief, and then effectively withdrawing 25% tax free.

It also restricts the extent to which individuals can gain a second round of tax relief by withdrawing savings and reinvesting them into their pension.

This can be an issue for older employees who have been auto-enrolled into their workplace pension scheme by their employer and have not considered/understood the implications of not opting out.

Many who fall foul of this legislation change will do so retrospectively, as they would have taken benefits before the MPAA was introduced. No protection is available for these individuals. Common events that do or do not trigger MPAA are shown in Table 2.

Lifetime Allowance

The Lifetime Allowance (LTA) is an overall limit on the amount of pension benefits that can be taken without a lifetime allowance charge being levied. In essence, it reduces the benefit of saving where the combined value of an individual's pension savings exceeds the LTA.

Common events that trigger MPAA Common events that do not trigger MPAA

• Taking the entire pension pot as a lump sum or taking adhoc lump sums from DC pension savings

• Drawing income from a flexi-access drawdown (FAD) strategy, including from a short-term annuity

• Receiving a payment through uncrystallised funds pension lump sum (UFPLS)

• Exceeding the permitted maximum (150% of Government Actuary’s Department (GAD)) in a capped drawdown arrangement

• If a standalone lump sum is paid from a pension scheme where the member has primary protection, but not enhanced protection, and the protected rights lump sum rights exceeds £375,000

• Taking benefits from a pension scheme with fewer than 12 members

• Taking income from a flexible annuity that can vary in a way not allowed before April 2015

• Tax-free cash with nil income in drawdown• Receiving benefits under the small pots

allowance• Receiving a lifetime annuity that cannot go

down except in prescribed circumstances• Those in capped drawdown who remain

within the permitted maximum allowance• Receiving benefits under DB trivial

commutation • Taking benefits from a DB pension scheme

Financial year Lifetime allowance

2019/20 £1,055,000

Table 2: Events that trigger or do not trigger MPAA

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The LTA is a moving target; each year it is set to increase by the previous September’s consumer price index (CPI) rate.

The LTA used to be much greater. When it was reduced some individuals were able to apply for protection called ‘enhanced protection’, ‘primary protection’, ‘fixed protection’ and ‘individual protection’. Advisers should ascertain if their client hold certificates for these protections. They can hold more than one, and they can make a significant difference to the advice and the client’s potential income and their LTA may be higher.

There are three trigger points for LTA tests:

• Crystallising benefits (taking benefits)

• Turning 75

• Transferring to a qualifying recognised overseas pension scheme

Valuing pension savings for the LTA test

When the LTA is exceeded, tax is payable on the excess. It is in addition to any tax payable on the income in the usual way. The tax rate payable depends on how the client takes the benefit, as summarised below:

Where the client takes benefits over time, each crystallisation event is tested against the LTA. Advisers should therefore ensure their clients retain a copy of every LTA assessment, as it is the compounding calculation that is relevant.

For DC funds, the LTA test is relatively easy; it is similar to the calculation used for the tax-free cash allowance:

Scheme Value LTA used

A £250,000 23.70%

B £500,000 47.39%

C £500,000 47.39%

TOTAL £1,250,000 118.48%

Pension type What counts towards your lifetime allowance

DC The accumulated value of all schemes

DB Usually 20 times the pension you get in the first year plus any lump sum

Tax rate How benefits are taken

55% As a lump sum

25% As a regular retirement income, ie buying an annuity

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Individually taking benefits from the three schemes expressed above does not trigger a LTA tax charge. However, when the third (order is irrelevant) is crystallised, the charge will be triggered.

In this example, the excess is £195,000 (18.48% of LTA) and presuming the benefit is taken and retained in the pension or a level/increasing annuity is purchased, the £195,000 is taxed at 25%, giving a £48,750 tax charge.

When a client requests benefits from their pension savings, the provider will issue a statement showing how much tax is payable. The pension provider will normally deduct the tax before making any payment to the individual.

Advisers should recommend their clients report the tax deducted by filling in a tax return.

Points to consider:

• Clients with some form of protection may have a different lump sum available and the way the LTA assessment is undertaken may differ from that illustrated above.

• When benefits are being taken or tested at the same time (ie at age 75) then the member can elect the order in which the schemes are assessed, this can create benefits.

The LTA is often considered a financial penalty on saving, but it does create some financial planning opportunities for the adviser, which include:

• Pension savings over the LTA are allowable. As tax is payable on the benefits taken, or at age 75, exceeding the LTA may be good advice. This is especially true for those close to or just over the LTA who have a number of years to go until they will be subject to an LTA test.

• Many high earners, especially those in DB schemes, may find taking early retirement from their employer is a financially prudent step. Examples include civil servants, medical professionals and pilots.

LTA creates opportunity for advisers

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Flexi-access drawdownFAD is the only drawdown option now available, unless the individual was in capped drawdown before 6 April 2015.

The individual can take as much or as little of their fund as they wish. They have control and responsibility for their own strategy, including the underlying investments used and the level and frequency of income payments.

• FAD allows unrestricted withdrawals

• At any time, it is possible to take the remaining balance and purchase a secure income or annuity

• Taking FAD income triggers the MPAA of £4,000 (see page 16 for details)

Taking benefits from pension savings can result in the individual paying too much tax at inception. It is common for the first FAD payment to be subject to an emergency tax code; however, as this is done under PAYE rules, this normally results in the correct level of tax being payable in due course.

Those taking withdrawals only a few times a year and/or on an ad hoc basis should keep in mind that there is the possibility of an overpayment of tax occurring. Always check the tax paid and apply for a refund from HMRC where appropriate.

The five choices

Over the next few pages, we will look at each of the five vehicles available to those taking benefits from DC pension savings.

S1. Taking benefits from DC savings

It is possible to take the remaining value at any time and buy a secure

income or annuity

FAD

UFPLS

Annuity

Scheme pension

Small pots allowance

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Uncrystallised funds pension lump sumUFPLS allows someone to withdraw some or their entire uncrystallised fund as lump sums without purchasing a product such as an annuity or designating to drawdown.

Each UFPLS payment is usually 25% tax free and 75% taxable as pension income.

UFPLS payments

AnnuityAn annuity is where the value of pension savings is exchanged for a secure income for their owner’s lifetime and potentially for someone else’s.

Annuities are commonly sold as level annuities, which means the same benefit is payable each month for the remainder of the insured’s lifetime. By forgoing some of the income payable, it is possible to cover certain contingencies and purchase additional benefits, which include:

The key facts:

• If under the age of 75, the individual must have some LTA remaining that is equal to the amount of the UFPLS being withdrawn

• If aged 75 or over, the individual must have some of their LTA remaining

• Taking benefits will result in the MPAA being applied

UFPLS cannot be paid:

• Where the member has enhanced protection from the LTA charge, the protected lump sum is over £375,000 and the protection certificate sets out the protected lump sum percentage

• From a disqualifying pension credit, because no tax-free cash is payable

• Where there is an LTA enhancement factor relating to primary protection, periods of non-residence, transfers from recognised overseas pension schemes or pension credits prior to 6 April 2006

The default for most providers is to tax at least the first UFPLS payment under an emergency income tax code. This results in many individuals initially paying too much tax, and so advisers should advise their clients to reclaim this from HMRC.

25%

75%

25% tax-free income

75% taxable income

25%

75%

25% tax-free income

75% taxable income

It is possible to take any remaining value at any time and enter into FAD

and/or buy a secure income or annuity

Inflation protection Where the balance of income received increases each year to reflect the general increase in the cost of living. This is commonly facilitated by an increase that is either a fixed amount each year or in line with an indexed annual increase, such as the CPI.

Joint life Where an income is to be paid to someone else. Legislation now allows this to be paid to anyone who was chosen at the time of the annuity purchase, although some providers do have their own restrictions.

Value protection Where a lump sum is paid on the death of the annuitant. The maximum that can be paid is the annuity purchase price minus the amount of annuity payments made to date of death. It is payable to the estate of the annuitant.

Guaranteed period This is a minimum amount of time for which an annuity will be paid regardless of how long the annuitant lives. There is no limit to the length of a guarantee period, although it depends on what the provider allows. The value of any outstanding instalments form part of the estate of the annuitant. The calculator for this can be found at

assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/681280/guaranteed-annuity-calc.pdf

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Fixed-term annuities are technically not annuities, although providers often market them as such. With fixed-term annuities, the individual chooses the length at the outset and the arrangement is run through drawdown, bearing in mind access restrictions will probably apply.

The FCA thematic review of annuities (October 2016) found that 39 to 48% of consumers who bought a standard annuity from their existing provider may have been eligible to buy an enhanced annuity.

Enhanced annuities enable those with specific conditions or lifestyles that are known to shorten life expectancy, to receive a greater income. For this reason, annuity providers will consider each application on its own merits, with individual underwriting required to identify any enhancement available.

For the purpose of COBS 19.9.6AR, examples of the sorts of health and lifestyle circumstances that may indicate eligibility for an enhanced annuity are:

Always research if an enhanced annuity

is available

It is critically important to shop around for the best annuity return. The Money and Pensions Service (formerly MAS) has a free annuity calculator on their website, which is an excellent way to gain free illustrations. It was updated in 2019 to enable you to carry out enhanced assessments.

moneyadviceservice.org.uk/en/tools/annuities

Scheme pension This is a ‘secure’ pension option, only available in specific circumstances through some older occupational pension schemes and some self-invested personal pension (SIPP) schemes.

The pension scheme may provide it, or it may purchase the benefits with an annuity provider. The scheme rules will determine the benefits payable, and full details will be available from the provider.

Small pots This gives those with pension pots worth up to £10,000 each to take lump sum balances without affecting their annual or lifetime allowances.

Certain conditions must be met for a small pots payment to be made. One of the key conditions is that only three can be paid from non-occupational arrangements but an unlimited number from occupational schemes.

1 Smoker status (current and historic)

2 Height, weight and waist size (outside normal ranges)

3 Alcohol consumption (per week)

4 Medication for high blood pressure and/or high cholesterol

5 Medication for serious health conditions

22Source: Defaqto

Client circumstances will always evolve. This will impact on the drawdown objectives and therefore they need to be reconsidered periodically.

The key factors to consider during every drawdown review

Capital preservationPerformance

Inflation

Flexibility

Products

Costs

Risks

Estate planning

Drawdown

Annuities

Health

Professional financial advisers are best placed to establish, administer and advise on drawdown arrangements. Some of the key areas advisers’ expertise will influence are:

S1. Advising on drawdownFor most, drawdown is a strategy, using a mixture of products, to provide cash and income in retirement that needs ongoing management to be effective.

Fact finding, researching solutions, evidencing their

suitability and then designing and implementing a prudent

strategy

Ongoing analysis of the suitability of providers,

products, risk, existing assets, alternative solutions, growth

and income

Recommending prudent changes in a timely and

accurate way, including a switch from drawdown to an

annuity

Drawdown is not a product!

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“You must always be able to predict what’s

next and then have the flexibility to evolve”

Marc Benioff

Drawdown is available through most UK registered pension schemes, including workplace pension schemes. Where a scheme provides drawdown, some may offer more flexibility in the way it is delivered than others.

Advisers should keep in mind that, for many clients in the future, the attraction of a less risky and simpler strategy to produce a secure income for life will become an overriding need. If it does, then an annuity (probably an enhanced annuity), for all or part of their income needs, is likely to be the appropriate recommendation.

Over the last few years, we have seen a number of publications telling us about the experience of those in retirement, all with different shaped experience. Collectively, these studies tell us three things:

1. Accurately predicting your client’s expenditure is impossible

2. The amount of time spent in each of the four stages, if any, is completely dependent upon individual circumstances and needs

3. Advisers need to plan for the unexpected as well as the expected

Considering recent FCA guidance on the transfer of ‘safeguarded benefits’, if a reasonable assumption of income required cannot be made then advice should probably not be given.

One of the biggest challenges with drawdown is where to invest the residual fund to achieve the overall objectives and the required balance of return between growth, income and estate planning (see Table 3).

Table 3: Challenges when considering drawdown

Benefits of drawdown Matters to consider

Control and flexibility in when and how much income and tax-free cash is taken

Getting it wrong may possibly result in a worse standard of living for the rest of the client’s life

Ability to benefit from any potential growth in the underlying assets

A decrease in the value of the investment can:

• Reduce the capital value• Reduce the income now and in the future

Ability to control the level of income tax paid

Ability to purchase an annuity at a later date with some or all of the remaining balance

Solutions and tax benefits available in the future may not be able to provide the expected outcomes as prudently as today.

COBS guidance and rulesAbility to leave the pension savings to others as part of estate planning

The evolving income need – the hard bit!From experience and well-documented surveys and commentary, we know there are broadly four common spending stages in retirement. The vast majority of us will experience each of the stages, albeit for completely different amounts of time:

Active

Where health and wealth allow an active lifestyle

Passive

Spending starts to decrease as health begins to restrict

capability

Assisted

Spending increases as amendments

are made to home to accommodate

lifestyle

Supported

Where ongoing and perhaps full-time care is required

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S1. Advising vulnerable clients

With 2 out 3 retirees entering drawdown, there is a growing and maturing pool of individuals who will benefit from guidance and advice. Often decreasing health is a trigger for seeking professional help and so advisers would benefit from having a process in place to deal with them.

Mental capacityWe suggest advisers have a policy for dealing with vulnerable clients and those where mental capacity may be an issue. Factors to consider include:

• Involving family members in meetings

• Putting in place an up-to-date lasting power of attorney

• Evidencing that the client has the ongoing capacity to make decisions, including outsourcing to third parties, such as discretionary fund managers and their adviser

• Balancing the need for capital and income against investing a lump sum that:

- Is not considered realisable to immediately pay for care costs

- Meets the needs of an attorney and/or future beneficiary rather than the owner

There is a lot of guidance available to advisers on how to advise on later life needs from professional bodies, and we encourage advisers to familiarise themselves with this.

We also encourage advisers to establish and follow a working practice when dealing with elderly clients and those with limited capacity to understand.

There are now a number of off-the-shelf, impartial assessment tools that are worth considering to help you assess mental capacity. These are useful in moving the burden of the assessment and conclusion away from the adviser and onto a third party, making the process easier for all involved.

Other organisations provide accreditation that you can use to evidence your expertise, and often these organisations can act as a source of new clients. These include:

Advisers can assess mental capacity in a similar way

to the process they use for assessing attitude to risk

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International Longevity CentreThe International Longevity Centre (ILC) is undertaking one ongoing study that advisers should periodically revisit. This is a think tank looking at longevity, ageing and population changes.

The ILC study can help advisers give evidence-based guidance on retirees’ income needs. It can also help identify target groups for future business activity.

To summarise the ILC’s findings, we discover that for many retirees:

Ultimately, the question is whether advisers should be recommending a higher level of income in the early stages of retirement with a lower level later in life. While this might be the most likely experience, what if it isn’t?

You can access full research at ilcuk.org.uk

ilcuk.org.uk

ILC findings Advice opportunities

They spend significantly more in the active and supported stages than the passive and assisted.

This means the most appropriate advice may be to recommend a higher level of income in the early years of retirement with a lower level later in life. We suggest advisers use a modelling tool with their client to illustrate the implications of such advice.

As health declines their ability to spend decreases as does their income need, but rarely is their income reduced.

Income needs evolve and therefore income sources need to be able to react to this tax efficiently. Where a client receives unused (taxable) income, consider efficient ways to get this working for them and/or those important to them.

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S1. Death and taxesMaking a pension taxable on death The general rule of thumb is that the value within a pension scheme is free of inheritance tax on contributions and on transfer, but this may not always be the case.

According to HMRC, health and life expectancy aspects can affect the treatment of contributions. HMRC can consider transfers to another scheme a ‘chargeable lifetime transfer’ and therefore taxable if the holder dies (normally) within two years of the transaction.

HMRC usually considers contributions and transfers a ‘lifetime transfer of value’ with no value and so these are excluded from the holder’s estate. However, if death was a likely outcome at the time of the contribution/transfer, HMRC may consider the value taxable as the benefit created by the transaction was not primarily for the deceased.

We suggest that advisers, when making any form of pension recommendation, document their thoughts on their client’s health and consider the potential for a chargeable lifetime transfer so they can answer any claims.

Especially when health is in question, the adviser should carefully document the rationale for recommending changes and the tax implications. If any tax is potentially payable, advisers should document this in their suitability reports and make sure the client is aware of it and ideally their beneficiaries too. This will help protect from future claims by interested parties after the advised client has died.

Tax on death and value protectionIt is unlikely that many of us will die on the day we spend our last pound. While some will experience financial ruin/difficulties, others will die with savings still in place.

The level of tax payable on pension savings depends on the holder’s age at death and, for those aged over 75, their beneficiary’s tax rate:

When you recommend ongoing contributions

and/or transfers, you may inadvertently make the pension

value taxable on death

This makes assets held within a pension fund potentially very tax efficient, and for some it may be appropriate to consider these assets for estate planning rather than solely as an income source.

To make sure wishes are considered, pension scheme administrators should be informed of the proposed recipient(s) of any death benefits. Most providers have simple forms that a pension plan holder prints off, completes and returns to the provider.

For those clients who wish to retain some control, eg to ensure benefits go to their children rather than their former spouse’s new husband or wife’s beneficiaries, a spousal bypass trust should be considered. The main downsides to this solution are the loss of flexibility and the fact that the value of the savings would incur a (45%) tax charge if the member was aged 75 or over. However, when the money is then passed onto an individual, they could also receive a 45% tax credit.

Where the value is subject to the 45% tax charge, this is not reclaimable by the estate beneficiaries. It would therefore be prudent for executors to ask for the scheme to pay the balance directly to beneficiaries, as under these circumstances normal PAYE will apply, resulting in the beneficiaries only paying tax at their marginal rate.

The other disadvantages are potential periodic and exit charges, and administration and trusteeship reporting.

Age at death Tax rate applied

74 or below 0%

75 or above Beneficiary’s marginal rate, or45% to non-qualifying parties (ie discretionary trust or estate)

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Types of beneficiary

Table 4 summarises the tax implications created by the death of the holder when they have different types of pension arrangements.

Table 4: Tax implications on death of pension holder with payments to individuals

Beneficiary Notes

Dependant • Spouse or civil partner• A child of the deceased who is under age 23• A child of the deceased of any age, who was dependent upon them due to mental or

physical impairment• Others who are financially dependent upon the deceased, such as a non-married

partner or a mentally or physically impaired individual

Nominee • A non-dependant nominated by the deceased or the scheme administrator• A scheme administrator can only nominate if there is neither a dependant alive nor an

alternative nominee

Successor • Successors are nominated by a dependant, nominee, successor or the scheme administrator

• A scheme administrator can only nominate if there is no successor nominated• With successors being able to nominate successors, future generations can decide who

gains access to the fund in perpetuity

Value Previous holder dies aged 74 or younger

Previous holder dies aged 75 or older

Crystallised • Income received is free of income tax• No test against remaining LTA

• Income received is taxed at the beneficiaries’ marginal income tax rates under PAYE

• No test against remaining LTA

Uncrystallised • Income received is free of income tax• The funds will be tested against the

member’s LTA and any excess will be taxed at 25% if used to provide an income and 55% if used to access a lump sum

• Income received is taxed at the beneficiaries’ marginal income tax rates under PAYE

• No test against remaining LTA

Intergenerational planningAs pension savings can now be left to future generations, they have become intergenerational planning tools. They are, in essence, similar to the family trusts of old.

As identified over the two previous pages the age of the holder and the status of the beneficiary both affect taxation. This makes accurate intergenerational planning extremely difficult, as does the UK's evolving taxation of pensions and trusts.

That said, effective management could result in pension savings benefiting many future generations to come. Being able to provide this service to clients for decades to come could make your proposition attractive.

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S1. Evidencing suitabilityThe stakeholder comparisonWhen an adviser recommends a pension transfer or switch, the FCA’s expectation is that they consider a stakeholder pension plan. This is because the FCA views them as the low-cost solution with sufficient investment options to be suitable for most.

In the same way that the FCA’s starting point for a DB transfer is that it is unlikely to be suitable advice, their view on DC transfers is that a stakeholder solution is likely to be the best solution.

While it may be clear to you that a stakeholder solution is not suitable advice, unless you can evidence this, you have little defence against any complaint or investigation.

The reality is that there are only seven stakeholder plans* to choose from, each with quite limited fund options. When we consider the costs, many charge less than the legal restrictions, which are:

Evidencing suitabilityEvidencing the suitability of a drawdown strategy is not straight forward as there are so many factors to consider. There are a number of modelling tools to help illustrate the recommended solution projected forward over the client’s lifetime.

These tools prove very useful in helping retirees to visualise and understand the implications of the decisions they are taking. Importantly, from a compliance perspective, they also help evidence suitability.

Advisers must be sensible with the assumptions used in the illustration regarding facts such as economic circumstances, taxation, investment returns and income yields.

Evidencing why you chose x% will help improve accuracy, comparability and understanding.

Advisers should consider and document the assumptions and limitations each tool uses and creates. Importantly, advisers should also be sure to include a client’s entire financial position (ie not just the investment being considered) as without all the facts, the accuracy is diluted.

Benchmarking returns

Advisers should look to evidence that the level of income being taken is both suitable and sustainable. We therefore suggest, at least annually, that the capital balance and the income being taken are tested against one or more of the following benchmarks:

• Critical yields

• Natural yield

• GAD rates

• Annuity rate (enhanced if applicable)

First 10 years Maximum fee of 1.5% per annum

Remaining years Maximum fee of 1.0% per annum

If you don’t recommend a stakeholder pension, always

show your workings and detail why in your compliance file

How do you ‘evidence’ initial and ongoing suitability?

*Source: Defaqto, 25 January 2019

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It may also be helpful to ascertain sustainability and test drawdown income against a realistic estimated life expectancy (not the average), to try to gain a clear view of any ‘safe’ withdrawal rate, subject of course to realistic evidence-based assumptions. Most cash flow modelling can undertake this assessment and illustrate the likely outcome(s).

While using GAD rates as a benchmark is no longer a regulatory requirement, it is still good practice to evidence (ongoing) suitability. Doing this can also enhance the client’s experience.

Evidencing value for money‘Value for money’ is the regulator’s preferred benchmark. The bad news is neither the FCA nor The Pension Regular (TPR) has defined it, but using hindsight, they may well test the suitability of your advice against it.

Only by setting the expectation (benchmark) is it possible to understand and evidence value for money. So, should the test be meeting expectations through value for money?

When we apply this to drawdown, an assessment along the following lines seems like an appropriate headline strategy to follow:

Advisers put themselves at risk if they fail to define ‘expectations’ and what the ‘value for money’ assessment is at inception. This will also help avoid having unreasonable objectives and also to manage competing objectives.

Advisers can do this by ascertaining exactly what the client’s needs and objectives are, challenge and amend them where required, and then agree and document SMART benchmarks for each one. Collectively, these benchmarks can help define and evidence ‘value for money’.

WARNING

Always document the implications of the loss of any existing benefits held, such as guaranteed/protected growth rates and/or

annuity rates

Competitive cost

Economyspend less

Efficiencyspend well

Value for money

Effectivenessspend wisely

Comparable risk

Income needs met

Great performance

Fantastic service

Suitable outcome

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S1. Packaging your adviceThere are three reasons for doing this:

Check your advice

Combining your recommended solutions and summarising the outcome allows you to check that the outcome is as you expected.

Ensure client understanding

Advisers need to express information in a way their clients understand and relate to. Matching your descriptions and illustrations to their learning style will help.

Consider the following useful facts from nationalnumeracy.org.uk

• Numeracy skills decline with age

• The proportion of working age adults in England with skill levels equivalent to GCSE grade C or above is low:

Suggestions:

• When quoting percentages include an example showing the benefit/cost in pounds and pence; this is an FCA requirement in specific areas.

• Where appropriate, use pictures and graphs to illustrate – cash flow modelling tools can help with this

Demonstrate tax efficiency

While 25% of pension savings are usually tax free, there is no requirement to take the cash as a lump sum or indeed at inception. The tax efficiency of income can be increased by phasing benefits payments and bespoking the split between the tax-free and taxable elements. Common tax planning options to consider include:

• Using the tax-free lump sum to provide tax-free income; useful for those still working

• Using sources, other than pension savings, to produce an income (ie ISAs)

• If a client is only just inside a tax bracket, consider lower income requirements and/or using alternative income sources to move them into the lower tax bracket

Tax-free cash cannot be held in a pension wrapper indefinitely as it loses its tax-free status. It must be paid within an 18-month period starting 6 months before and ending 12 months after the member becomes entitled to it.

Advisers should consider this restriction carefully as paying tax-free cash as an income from the pension over the longer term may not be prudent. If crystallisation is happening to pay tax-free cash as an income over a number of years, then consider staging crystallisation events or transferring tax-free cash outside of the pension wrapper (making it taxable) and paying it as income from there.

CARE

Literacy

2003 200344% 26%57% 22%2011 2011

Numeracy

1 To check your advice

2 To ensure client understanding

3 To demonstrate tax efficiency

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Flexibility

S1. Overview of risksDrawdown is a balancing act between mitigating risk, receiving returns and retaining some flexibility.

Some of the key risks to consider with clients when assessing their options for annuities and drawdown include:

Mitigating risk

Net returns

Risk Description

Market evolution Risk that products may not be available or cost effective to meet needs at the required time

Longevity Risk of living too long (longer than income can be produced)

Inflation Risk of inflation eroding the buying power of the capital and/or the sustainability of income produced

Sequence A poor sequence of returns when income is being taken, especially in the early years, can have a detrimental effect on capital values and therefore the income available in the future

Investment Risk of poor market returns that reduce capital sums and by association the level of income produced:• Systemic market risk – an event impacting on a market or asset class• Specific risk – a specific investment underperforming

Commitment Risk of selecting a solution and not being able to change the product choice, benefit shape, income level or death benefits

Financial ruin Risk of exhausting the capital and income while still alive and as a consequence experiencing a lower standard of living for remaining years

Diversification Risk of putting all your eggs in one basket, or too many baskets

Insurer credit and counterparty

Risk of failure of a provider of all or part of the solution

Political Risk that a change in legislation and/or regulations will impact on the net benefits received and by whom and on the advice

Timing Risk of securing the level of income required at the time required

Interest rate Risk that interest rate movements may adversely affect annuity style products and guaranteed or protected funds/solutions

Health Risk that deteriorating health will bring about the need to access retirement capital or income to cover non-insured medical expenses and healthcare, or that better than expected health introduces longevity risk

FSCS Insurance-based contracts, such as an annuity, carry 100% protection whereas a drawdown solution may be less

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We have highlighted in orange market evolution, longevity and inflation risks, as the FCA considers these minimum requirements. However, the most prudent approach would be to explain and cover off all risks within your advice process.

There are many factors retirees need to consider both initially and ongoing. We will focus on market evolution, longevity, inflation and sequence risk over the next few pages.

Market evolutionAs markets evolve, and there is a risk that, in the future, the solution you recommend today, or parts of it, may not be available or indeed may no longer be suitable.

There is no guarantee that in the future the tax wrappers, funds, providers and/or products will still be available or that they will still be cost effective for your client.

UK government gilts are a very good example of a solution where the benefits have decreased. Fifteen years ago, gilts formed a strong percentage of most model portfolios and were the main income-producing asset. After 10 years of quantitative easing, funds use gilts less. Where they are used, they control risk and volatility, and are no longer the main income-producing asset class.

Advisers should explain the risk to their clients and state clearly that changes outside of their control may affect the suitability of their advice, so ongoing checks will be required.

Longevity risk If we all knew how our health would evolve and the exact date on which we were going to die, it would make retirement planning so much easier.

Longevity risk creates two outcomes most people would wish to avoid:

Longevity risk is living too long; however, for many it can be a case of living too long with poor health. Those suffering from poor health fall into two categories:

To understand longevity risk, it is useful to know the average life expectancy, and we have selected the starting point of age 65 in England. According to the Office for National Statistics (ONS), in 2012 to 2014 it was for men 83.8 years and for women 86.2 years.

Chart 2 illustrates the average healthy life expectancy (proportion of retirement spent in ‘good' health) and average life expectancy for males and females by region.

Under-spending Having not used pension savings to the maximum during their lifetime

Financial ruin Spending too much and/or investing poorly and seeing pension savings used up, resulting in financial hardship for the rest of their life

Leading a restricted lifestyle

Often under-spenders

Leading a restricted lifestyle with paid for assistance

Face financial ruin (often unknowingly)

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When you assess sustainability of the income solution, never use average life expectancy as at least half of people will exceed this age.

Facts to consider:

• Poor health will impact many before they reach state pension age and in retirement

• The average time spent in ill health before death will impact on the spending habits of those affected: for men 16.1 years and for women 19.2 years

To summarise, understanding that while many of us will live longer than the average, many of us will also experience ill health in later life for some years before we die. This will affect how long each of us spends in the four stages of retirement (active, passive, assisted and supported), affecting both our income needs and our ability to spend.

Taking guidance from the FCA paper on transferring ‘safeguarded benefits’, advisers are reminded to not plan to an average life expectancy as very rarely is this experienced.

Chart 2: Life expectancy and healthy life expectancy by region

55.0

60.0

65.0

70.0

75.0

80.0

85.0

South East South West

East of England

London East Midlands

West Midlands

Yorkshire & the

Humber

North West

North East

Male life expectancy Male healthy life expectancy

Female life expectancy Female healthy life expectancy

Source: ONS Healthy life expectancy and life expectancy at birth by region, England, 10 March 2016

The ONS website is very useful.

The page ‘How long will my pension need to last’ helps clients to understand how longevity risk might affect them:

visual.ons.gov.uk/how-long-will-my-pension-need-to-last

Inflation riskTo maintain the buying power of money, those taking income from their savings will need both the investment and the income it produces to increase by at least the rate of inflation each year.

One of two indices commonly measures UK inflation:

• RPI – Retail price index

• CPI – Consumer price index

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Irrespective of the method by which individuals access their pension savings, when inflation is considered, it is clear that for most, some form of protection against inflation will be critically important to avoid a decrease in the standard of living in retirement.

Identifying exactly what your clients spend their money on will enable you to produce a more accurate understanding of the likely impact of inflation on them. That said, inflation is notoriously hard to predict, and so it is important that the rate you use in your assumptions is appropriate to your specific client.

Since 2003, the Bank of England has been responsible for maintaining the CPI target of 2.0% per year. During this time, the UK has experienced annualised rates of between 0% and 4.5%.

Source: ONS data released January 2019

Year

RPI

RPI: Housing: Council tax and rates RPI: Fuel and light

RPI: Food RPI: All items index excl mortgage interest

50

100

150

200

250

300

350

400

1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018

Housing, taxation and fuel costs have consistently increased by more than the general rate of RPI

The actual rate of inflation experienced very much depends on what each of us spends our money on (in other words, our personal shopping basket). Looking at some common costs that we all incur, especially pensioners, we can see some significant differences, as illustrated in Chart 3.

Chart 3: RPI indices from 1987 to the end of 2018

CPI 1.8% (12 month rate January 2019)

The common ‘lose-lose’ experience

Sequence risk‘Sequence risk’ or ‘Sequence of returns risk’ is a significant issue for those living off income taken from capital.

Retirees are more vulnerable to sequence risk because if they experience capital volatility while also withdrawing income produced by the same capital, they can find themselves having to lock in losses. This decreases their future income while also restricting their ability to recover the capital.

To illustrate the dangers, we have plotted the capital value of £100,000 invested over a 10-year term, where the total net return is 50% (see Table 5).

Sequencing risk example

Expressed as the average compound net return over 10 years of 50% there is little to choose between the sequences of returns expressed in Chart 4 however, when we illustrate the different sequences, the dangers become clearer.

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Table 5: Sequencing risk example

*28% is actually 28.4055% ^4.1% is actually 4.138%

Chart 4: Sequence risk with no withdrawals

Chart 5: Sequence risk with withdrawals of £4,000 pa (£333.33 pm)

Conclusion

Where no withdrawals are taken, the net return is the same for all solutions:

Conclusion

Where withdrawals of £4,000 pa are taken, the total net return is significantly affected by the sequence of returns:

Sequence of returns 1 2 3 4 5 6 7 8 9 10

Compoundedreturn

Positive start 50% 40% 30% 20% 10% −5% −10% −15% −20% −28%* 50%

Linear 4.1% pa^ 50%

Negative start −28%* −20% −15% −10% −5% 10% 20% 30% 40% 50% 50%

Positive start £150,000

Linear £150,000

Negative start £150,000

Positive start £124,594

Linear £101,667

Negative start £48,287

Value growth rates each year

£0

£50,000

£100,000

£150,000

£200,000

£250,000

£300,000

£350,000

£400,000

1 2 3 4 5 6 7 8 9 10 11

Capi

tal v

alue

in £

Year

Positive start Negative start Linear

£0

£50,000

£100,000

£150,000

£200,000

£250,000

£300,000

£350,000

£400,000

1 2 3 4 5 6 7 8 9 10 11

Capi

tal v

alue

in £

Year

Positive start Negative start Linear

36

Summary

As illustrated, the sequence of the returns can significantly affect the capital value and therefore the potential future level of ‘sensible’ withdrawal (income) that can be produced.

It is worth noting that increasing the volatility of returns also increases the potential damage caused by sequence risk.

Using investments with a linear type return and/or protected returns can help to mitigate the potential damage caused to capital and long-term income by a poor sequence of returns, especially if that poor return is in the early years.

Conclusion on riskAny risk experienced creates issues for clients and their advisers. However, more than one risk may occur at the same time and the compounding affect of multiple risks can have a more significant impact than just one.

For example, a combination of sequence risk and longevity risk experienced in an environment of high inflation can be extremely detrimental to those in drawdown. Especially where the peace of mind alternatives, such as buying an annuity, may no longer be prudent options.

Sequence of return Value available Monthly Annualised 10 years

Positive start £124,594 £520 £6,241 £62,410

Linear £101,667 £425 £5,104 £51,040

Negative start £48,287 £200 £2,410 £24,100

Source: Money Advice Service lifetime annuities, 3 April 2019

Table 6: Indicative potential annuity income

The impact of sequence risk on income

Using the values realised after taking withdrawals as illustrated in Chart 5, we have examined the possible annuity income that could be purchased with the different capital values available at the end of the 10-year term (see Table 6). We have based these calculations on a single adult aged 65, non-smoker in good health looking for a level income for life, requiring no PCLS, dependants’ income or guarantees.

37

FCA consultation paper 19/5 investment pathways

• Proposes requiring pension schemes to either signpost to advice or to provide investment pathways to access capital and/or enter into guided drawdown

This is important for advisers, as where pathways are available advisers, will have to take them into account when making recommendations.

FCA retirement outcome review final report June 2018

• One-third of consumers not taking advice in drawdown are entirely in cash; over half of these are at risk of losing out by remaining in cash

• Retirees in drawdown, invested in cash, could receive an income of up to 37% more over 20 years by moving to a mix of assets

• Competition is not working well – 94% of unadvised consumers are in drawdown with their original provider, compared to only 35% of advised consumers

• The FCA found charges vary from 0.4% to 1.6%. Some consumers could increase the income from their pot by up to 13% by switching to providers with lower charges

• The FCA is consulting on remedies that:

- Protect consumers from poor outcomes

- Improve consumer engagement with retirement income decisions

- Promote competition by making the costs of drawdown clearer and comparisons easier

- Require providers to either give access to advice or provide investment pathways for those in drawdown

FCA policy statement 19/1 retirement outcomes review – final rules and guidance

• Introduces improvements and standardisation to key features illustration (KFI) documents to promote competition by making the cost of drawdown products clearer and comparisons easier

• Recommendations based solely on critical yields do not meet FCA expectations

• COBS 19.1.7 requires advisers to make clear to their clients the loss of safeguarded benefits* and the transfer of risk from the scheme to the individual. Also, detail specific risks to your client including investment risk, longevity risk and the risk that products may not be available or cost effective to meet their needs in retirement

*Safeguarded benefits are benefits that include some form of promise or guarantee over the amount of income that will become payable in the accumulation phase.

S1. Key changes from 2018/19

In this section, we summarise some of the key regulation and legislation changes since we produced the 2018/19 version of this guide.

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Pension transfers

While this guide is focused on DC to DC transfers, the DB to DC sector has come under close scrutiny in recent years. Much of the recent FCA guidance and rule changes are also relevant to pension switches and therefore we felt it prudent to highlight them.

For clarity, a pension transfer is where there is a loss of ‘safeguarded benefits’, hence they are often mistakenly referred to as DB transfers. That said, broadly the following differential is normally relevant:

The FCA’s starting assumption for the analysis is that a transfer, conversion or opt-out of safeguarded benefits will not be suitable (COBS 19.1.6).

This places the emphasis clearly on the adviser to demonstrate (on contemporary evidence) that the change is in the client’s best interests.

It is worth reminding ourselves why the FCA is worried about pension transfer advice:

• FCA study October 2017 – only 47% of advice reviewed on DB to DC transfers could be shown to be suitable

• British Steel Pension Scheme – only 51% of transfer advice given to members could be shown to be suitable

• In 2017 and 2018 the FCA removed over 30 FCA authorisations to provide pension transfer advice

Putting aside the issue of unsuitable advice, there can be good reasons to transfer out of a DB scheme, including:

• Requiring access to capital

• Shortened life expectancy making a scheme pension unattractive

• Wishing to create estate planning options

• Fear of employer failing

• The scheme moving to the Pension Protection Fund, where the benefits could be less

Key points from the FCA’s advice on pension transfers – our expectations (24 January 2019):

• Advice must be provided by a firm with pension transfer FCA permissions

• The process and advice must comply with COBS 19

• The advice must consider the receiving scheme as well as the underlying investments

• Generic assumptions should not be used in the comparison

• The transfer value analysis requirement has been replaced by a requirement to undertake an appropriate pension transfer analysis of the client’s options and a prescribed transfer value comparator indicating the value of the benefits being given up and the cost of purchasing the same income in a DC environment (FCA PS18/6)

• The advice has taken into account the likely expected returns of the assets, as well as the associated risks and all costs and charges that will be borne by the client (COBS from 19.1)

Pension transfer Where safeguarded benefits are involved

Pension switch Where no safeguarded benefits are involved

Most individuals are likely to be worse off transferring

out of safeguarded benefits, even if their employer

incentivises them to leave

The FCA is scrutinising pension transfer advice

like never before

39

• Recommendations based solely on whether the critical yield is below a certain rate do not meet FCA expectations. Advisers should evidence the likely expected returns of the new assets relative to the critical yield. The due diligence should also consider the client’s personal circumstances

• The advisers should make clear the loss of any safeguarded benefits and the consequent transfer of risk to the client, including:

- Investment risk

- Longevity risk

- Market evolution - the risk that products may not be available or cost effective to meet the client’s needs in retirement

There needs to be consideration of the client’s attitude to risk including, where relevant, in relation to the rate of investment growth necessary to replace the benefits they are giving up.

Professional indemnity insurance requirements and cover can restrict pension transfer advice business. Double check exactly what cover you hold before making any recommendations.

The rule changes and clarification by the FCA highlight that advisers need to create and follow a comprehensive and compliant process. Evidencing that solution A is better than solution B is not sufficient. Importantly, the responsibility (liability) for the advice does not end when the transfer is completed.

Advisers need to be able to evidence comprehensive due diligence and that the client understands the full implications of the changes, including the costs and risks, and has the capacity to absorb them.

PROD rules

The FCA Product Intervention and Product Governance Sourcebook (PROD) came into effect on 3 January 2018.

Based on MiFID II, these rules set out that all firms should ensure they offer ‘good product governance’ by evidencing that products:

• Meet the needs of target markets

• Are sold to target markets by appropriate distribution channels

• Deliver appropriate client outcomes

While these rules may appear aimed at providers, they are also relevant to advisers.

In essence, advisers must ensure the products they recommend/sell are suitable for their target market. In addition, if they recommend/sell the product to a non-target market individual, how do they justify it?

Qualifications

The FCA announced in October 2018 that they would increase qualification requirements. From 2020, all pension transfer specialists will have to have the full qualification for retail investment advice.

For many diploma-qualified advisers and above, this will entail no new qualifications. However, we suggest you check your personal situation with your examination body, ie LIBF, CISI and the PFS/CII.

If you wish to specialise in a certain type of advice, the examination bodies have study materials and exams aimed at specific subjects, such as equity release.

Advisers should read and understand COBS

By following the philosophy of DB pension transfer

rules, advisers can provide better advice on producing

retirement income

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S1. Due diligence checklistThe most important factor when making recommendations is to meet the client’s needs and objectives. It is good practice to consider, at least, the following items in your research:

• Provider strengths and capabilities

• Product weaknesses

• The application process

• Cost (advice, product, investment and administration)

• Payment capabilities

• Quality of communications

• Quality of service

• Extras (such as online tools and technical help)

Establish needs and objectives Are the client’s objectives reasonable – do they need challenging and changing?

What cash is required to meet core income needs?

What cash is required to meet aspirational income needs?

Does this impact upon the ability to save into a pension in the future?

Establish sources of income What current income sources exist and from when are they available?

Will any guarantees/protections be lost, and why is this appropriate?

Establish a retirement strategy What should happen, the order it should happen and dates if known

Establish health and longevity factors Assess health and life expectancy

Sense check this against the level of income and risk indicated

Establish non-investment risks Document, evaluate and address

Establish client’s risk profile What is the client’s attitude to risk, capacity for loss and need for risk?

Collectively, what does the client indicate is an appropriate way forward and why?

Establish timescalesAgree clear timings for when objectives need to be met

Establish death benefits What does the scheme allow in relation to death benefits?

To whom do they want death benefits to pass?

Are death benefits more important than retirement income?

Ensure an expression of wishes form is completed for each pension plan held

3

Cont.

41

Establish cash reserve requirements Liquidity needs

Future liabilities/expenses

Ring-fence sufficient to cover income and cash payments for an appropriate period

Establish an investment strategy Evidence how this meets the client’s circumstances and needs (initial and ongoing)

Establish benchmark(s) How should the appropriateness of the strategy be assessed and when?

Carry out an initial assessment before embarking on any change

Make recommendations Detail how the recommendations meet the client’s needs and objectives

Be sure to meet regulatory requirements as well

Establish an income strategy Detail balances expected from each source (gross and net) and when

Set out the immediate and longer-term tax implications

ReviewSet periodic reviews of the solutions as all circumstances evolve

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Learning objectivesHaving read this document you will now be able you:

1 Design a compliant initial and ongoing due diligence process for drawdown

2 Explain the different retirement options

3 Evidence the suitability of a selected level of income or withdrawal

4 List the key issues in managing an effective drawdown strategy

5 List the risks associated with drawdown

6 List the death benefit options and understand how they impact on advice

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Name

Signature

Date

CPD time recorded

CII/PFS and CISI accredit this document for up to 60 minutes of structured continuing professional development (CPD).

Answers

1) Half 2) a) £40,000 b) £4,000 c) £1,055,000 3) Market evolution, longevity and inflation 4) Critical yields, natural yield, GAD rates, annuity rate (enhanced if applicable) 5) Dependant, nominee and successor

You can find all the answers within the text.

Test yourself for CPD purposesTo assess your knowledge following completion of this publication, why not work your way through the following questions?

1 In round terms, what proportion of pension transfer advice was assessed by the FCA to be unsuitable: a) quarter b) half c) three-quarters d) all

2 What are the key allowances you need to know for drawdown advice regarding:

a) the annual allowance?

b) the money purchase annual allowance?

c) the lifetime allowance?

3 List the three key risks the FCA requires advisers to consider with their clients

4 List the four income yield benchmarks to consider using with clients

5 List the three types of death beneficiary

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Section 2 Prudential retirement solutions

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In addition, the same funds can be used across a range of tax wrappers to enable truly holistic financial planning to be undertaken and, importantly, to manage costs and tax efficiency.

Advisers should remember that using one provider with a family of funds, such as the PruFund range, not only makes moving tax wrappers easier, but also moving between funds in the same range as the client’s attitude to risk and reward evolves.

S2. Holistic financial planning and advice

One of the aspects of using Prudential as a drawdown solution provider is that it has a comprehensive family of products and funds to meet the evolving needs of clients.

Pensions

ISAsTIPs

Collectives Bonds

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S2. Prudential’s financial strength

All good due diligence processes assess the stability and strength of the institution providing the drawdown solution. Our experience is that AKG financial strength ratings tend to be the most commonly used benchmark for this.

AKG is an independent organisation specialising in the provision of ratings to the financial services industry. AKG published financial strength ratings for the different elements of Prudential. We have listed the ratings in Table 7.

Table 7: AKG ratings for Prudential products

Source: AKG, January 2019

Tax wrapper Prudential product Rating

ISA Prudential ISA A

Pension Prudential Retirement Account A

Onshore bond Prudential Inheritance Bond A

Onshore bond Prudential Investment Plan A

Onshore bond Prudential Onshore Portfolio Bond A

International bond Prudential International Investment Bond B+

International bond Prudential International Investment Portfolio B+

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Defaqto Engage users can research the PRA through either the Personal Pension Plan or SIPP table. Looking at this data we have identified the following key points:

Retirement vehicles available

Investment options

Capped drawdown FAD UFPLS

S2. Prudential Retirement Account

Prudential Retirement Account (PRA) is designed to meet the drawdown needs of many retirees.

More information

Defaqto has published a document looking at the Prudential fund ranges. Adviser can download this, defaqto.com/advisers/publications/the-benefits-to-advisers-and-their-clients-of-using-risk-bound-fund-families/

Source: Defaqto, February 2019

Cash account PruFund range

Fixed interest securities Passive/Index funds

Permanent interest bearing shares Ethical funds

FTSE shares Risk bound funds

Unit trusts/OEICs Funds of funds

Alternative Investment Market (AIM) shares Manager of managers

Exchanged traded funds (ETF) – UK Guarantee/Protected funds

ETF – non-UK Model portfolio provider led

External fund links Model portfolio adviser led

Defaqto publication

The benefits to advisers and their clients of using risk bound fund families

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Table 8: How the PruFund and risk managed range can be accessed

Fund name Retirement Account

Trustee Investment Plan

Defaqto Star Rating

LF Risk Managed Active 1-5 Yes No

Risk Managed Active 1-5 Yes No

LF Risk Managed Passive 1-5 Yes No

Risk Managed Passive 1 Yes Yes

Risk Managed Passive 2-5 Yes No

Risk Managed PruFund 1-4 Yes Yes

Risk Managed PruFund 5 Yes No

Cautious (£) Yes Yes

Growth (£) Yes Yes

The prefixed ‘LF’ indicates that ‘Link Fund Solutions Ltd’ are responsible for all the legal and regulatory aspects of the fund.

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Retirement ModellerAs part of any long-term financial plan, it is considered good practice to model recommended solutions. Not only does it aid client understanding, but it also helps evidence the suitability of your advice.

The Prudential modelling tool enables advisers to illustrate complex retirement planning, including:

These can be illustrated quickly and used directly in front of a client:

Accumulation Decumulation Accumulation and decumulation

• Bridge to state pensions

• Tax-free cash only

• Lump sums only

• Offset of a second-level income

• Phased income before buying an annuity

• U-shaped income

• Guaranteed income

• Cashing out (extract) quickly

• Leaving a legacy

• Capital guarantee on transfer value

I want to know my fund value at my preferred

retirement age

I want to know how much of my fund I need to allocate to provide my planned income

I want to know how long my fund will last

I want to know the growth rate needed to achieve my

income goals

I want to know how much I need to save to achieve my desired fund at retirement

I want to know how much I need to save to achieve my

planned income

I want to know the maximum income I can

take in my first period of retirement

S2. Prudential online support for advisers

Pruadviser.co.uk is free to access and is one of the most comprehensive online guidance and support tools for advisers.

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Chart 6: Example of Prudential retirement modeller output

This illustrates some interesting subjects to discuss with the client, including:

• Is the 22% decrease from the earned income of £30,000 to the retirement income of £23,500, both before tax, affordable?

• How does the client’s health and family experiences compare to the proposed decrease in income need between 75 and 85?

• The capital value being exhausted ties in with the life expectancy (survival probability). Does this meet with expectations or is a capital value required to be passed on?

• We used a 2.5% inflation rate and a 5% investment growth rate, with no adviser charges. Are these assumptions realistic and acceptable to the client?

Thoughts on the modeller

The Prudential’s Modeller is relatively easy and quick to use. It is able to report on four different facts at the same time, namely contributions, fund value, income and survival probability, making it one of the more comprehensive free tools available.

Cont

ribut

ions

(£)

Income (£)

Survival probability

Fund

val

ue (a

t end

of y

ear)

(£)

56 57 58 59 60 61 62 63 64 65 66 67 68 69 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99100

101102

100k

200k

300k

400k

0k

20k

40k

60k

80k

0k

25%

50%

75%

100%

0%

1k

2k

0k

4k

0k

The policy anniversary during the age displayed

Other income Income Fund value Survival probability Contributions

Individual Male, aged 55

Salary £30,000

Pension contributions £250 per month, increasing by 2.5% pa

Pension savings at age 67

£228,037

Taking benefits At age 67

Income sources in retirement

• State pensions of £11,500 (at age 67), increasing at 2.5% pa

• £1,000 pm (net) from pension savings, increasing at 2.5% pa - Decreases by 50% between ages 75 and 85 as health limits activity and expenditure - Increases by 50% at age 85 to cover living and care costs

The Prudential Retirement Modeller can be used by advisers to illustrate the implications of their advice and help evidence suitability. To illustrate this we have modelled the following scenarios using the Prudential Retirement Modeller (see Chart 6):

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Appendix A: PPP/SIPP vs SSAS PPP/SIPP SSAS

Availability 41 PPPs, 137 SIPPs 47 SSASs

Who can join Anyone Those invited by the trustees of the scheme, commonly employees and directors of the sponsoring employer.

Tax relief on contributions

Available only to ‘relevant UK individuals’ making contributions within their relevant earnings.

Governance The scheme rules are set by the provider for all members.

Within HMRC rules, the scheme can be tailored to the individual members, objectives and needs.

Regulator HMRC regulates the scheme. The FCA regulates the provider.

HMRC regulates the scheme. TPR regulates SSASs with more than one member.

Providers SIPP providers are subject to minimum capital adequacy rules, which means that in the event of the business ending funds are available to administer the transfer of business to a new solution.

SSAS providers are not subject to capital adequacy rules.

Control Overall control sits with the SIPP provider. A scheme administrator has day-to-day responsibility for the running of the scheme; this is often the same company as the provider.

The trustees have overall control. A scheme administrator has day-to-day responsibility for the running of the scheme. There is a sponsoring employer.

Investment decisions The individual members can make their own investment decisions within the options made available by the provider, usually in conjunction with a financial adviser.

The trustees have overall control and responsibility.

Investment options SIPP providers usually offer a wide selection of investment options, mostly publicly available assets registered on regulated exchanges, although a number of providers do provide access to some commercial property and unregulated assets.

SSAS providers offer more flexibility in the assets held than in SIPPs, including direct commercial property ownership and investment in unregulated assets.

Ownership The investments will probably be held in the provider’s nominee name, but ultimately the SIPP holder is the beneficial owner.

The investments will probably be held in the provider’s nominee name, but the assets are owned in the name of the trustees and earmarked for different uses.

Cost PPPs tend to offer less choice and flexibility and so can be slightly cheaper than SIPPs, although this is not always the case. Individual members pay their own fees from a bank account within the plan.

Scheme fees can either be paid by the scheme or the sponsoring employer. SSASs tend to be more flexible than SIPPs and are priced to reflect this.

Loans Loans can be made by members to unconnected third parties, such as to buy government or corporate loan stock.

As with PPPs and SIPPs, SSASs can also make a loan to the sponsoring employer of up to 50% of a scheme’s net asset value; there are detailed rules around this.

Pooling SIPPs can be joined together for joint investment, eg to buy a commercial property.

The SSAS is a single trust and all assets are jointly owned. All members must agree on investments, and earmarking of assets is not permitted. This can make succession planning easier as transfers out can be taken from anywhere, not just from an individual’s allocation.

Source: Defaqto, February 2019

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Send us your feedback Your feedback is extremely important to us and we would be grateful if, after completing this publication, you would take a few minutes to complete a short survey. Your answers will be treated in the strictest confidence and the results of this will help the development of future publications.

The survey can be accessed at:

https://www.snapsurveys.com/wh/s.asp?k=144610976149

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Our experts research, collect and continuously assess over 43,000 financial products. Our process is extremely robust and is driven by over 60 specialist analysts who have unparalleled knowledge of financial products, services and funds in the market. Our independent fund and product information helps banks, insurers and fund managers with designing and promoting their propositions.

Defaqto RatingsDefaqto Star Ratings are the most trusted expert assessment of products in the market. Products can receive a Rating of 1 to 5, depending on the quality and comprehensiveness of the features it offers. A 1 Star Rating indicates a basic product, while a 5 Star Rating indicates one of the highest quality products in the market. Star Ratings provide consumers, advisers and brokers with an accurate benchmark so that they can see at a glance how products and policies in the market compare.

A Diamond Rating reflects the performance of a managed fund or fund family. Funds or fund families can receive a Rating of 1 to 5 based on a detailed and well-structured scoring process, allowing advisers and other intermediaries – and their clients – to see instantly where they sit in the market in terms of fund performance and competitiveness in areas such as fees, scale, access and manager longevity. A 5 Diamond Rating indicates it is one of the best quality funds available in the market.

Service Ratings provide advisers with a simple and unbiased assessment of provider service. Based on advisers’ perceptions of the service they receive, providers are rated Gold, Silver, Bronze.

Risk Ratings use the projected volatility of a fund using asset allocation and historic volatility, based on observed standard deviations, to map a fund to a Defaqto Risk Profile. Risk Profile 10 indicates highest risk and Risk Profile 1 represents lowest risk.

Income Risk Ratings are unique to the market, comparing fund objectives, asset allocations, income and capital volatilities, and maximum drawdown. The Ratings are mapped to four Income Risk Profiles based on the income required and the level of risk. They are: capital preservation, low income volatility, medium income volatility, high income volatility.

About Defaqto Defaqto is an independent financial information business, helping financial institutions and consumers make better informed decisions.

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Defaqto Engage and Engage CoreDefaqto Engage is our end-to-end financial planning software solution enabling advisers to manage their financial planning process all in one place.

Engage Core, the latest version of Defaqto Engage, combines risk profiling, three-way fund, platform and product research and suitability letters templates into one easy-to-use tool. Visit defaqto.com/advisers/engage to learn more.

The Service Ratings and satisfaction results by category are available within Engage. Advisers can use the Service Rating and the individual category satisfaction scores (for example, new business servicing, existing business administration, online servicing) during the research process as one of a number of selection criteria. They can also be added to comparison tables.

Advisers should note that not all providers are rated; to qualify for a Service Rating, providers must receive a minimum number of responses from advisers. So, using any service results in the filtering process may exclude providers offering potentially suitable client solutions from the research output.

We really couldn’t create the Service Ratings without advisers – they are different from our Star and Diamond Ratings, which are created by our experts and based on facts, not opinions.

Prudential is a trading name of Prudential Distribution Limited. Prudential Distribution Limited is registered in Scotland. Registered Office at Craigforth, Stirling FK9 4UE. Registered number SC212640. Authorised and regulated by the Financial Conduct Authority.

Funds that revolve around real client needsExplore a simpler, more diverse investment option with the PruFolio Risk Managed Range. Transform your client’s investment universe with a choice of 15 funds across active, passive and smoothed investment styles and 5 consistent risk strategies, available on 23 platforms.

Discover more at pruadviser.co.uk/prufolio

This is just for UK advisers – it’s not for use with clients. The value of any investment can go down as well as up so your customer might get back less than they put in.

PruFolio

8647_Pru_Education_Ad_210x297_AW.indd 1 02/05/2019 17:52

Please contact your Defaqto Account Manager or call us on 0808 1000 804

defaqto.com/advisers

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