Navigating the complexities of USP reviews

Andy Zanelli, head of professional edge technical sales at AXA Winterthur Wealth Management, says the importance of regular client reviews, particularly in the current economic conditions, cannot be over-emphasised.

In recent months, there has been a downturn in fund performance and interest rates on gilt-edged securities which form the basis for the Government Actuary’s Department (GAD) rates used in income withdrawal products.

This highlights the need to regularly review the needs and circumstances of those clients either already using, or considering the option of, income withdrawal as part of their retirement planning strategy. This also serves as a timely reminder of the factors that clients need to take into account when considering income withdrawal.

What triggers a USP review?

To ensure the unsecured pension (USP) fund can continue to provide an income for life for the member, the maximum annual income that may be drawn from that fund must be calculated at outset and reviewed at least every five years. This is known as the quinquennial review.

In addition to the basic requirement to review at five-yearly intervals, certain events will also trigger an additional review:
•    Where the scheme administrator agrees, the member may request that a review of the maximum amount is carried out before the end of the current five-year period. These reviews must be done at an anniversary of the date the USP started, and a new five-year review period will commence
•    Where the fund value is reduced because part of the USP fund is used to purchase a lifetime annuity and/or:
–    used to provide a scheme pension and/or,
–    transferred to a Qualifying Recognised Overseas Pension Scheme, or
–    taken away from the member due to a pension sharing order the revised maximum annual income will apply from the beginning of the following pension year. The existing five year review period remains in place.
•    The USP fund is increased by the additional designation of uncrystallised funds still held in the arrangement. In this circumstance, the maximum annual income needs to be reset immediately to reflect the increased fund size. The existing five year review period remains in place.

The client review

The FSA would normally expect the adviser to undertake an annual review of any income withdrawal arrangement. This would be to assess whether any changes need to be made.

According to the FSA, the key issues for income withdrawal sales are suitability and the clients’ understanding of the risks involved. These risks and any additional costs involved must be clearly explained to, and understood by, the client.

When a firm is making a personal recommendation to a client about income withdrawals, it should consider all the relevant circumstances including:

• The client's investment objectives, need for tax-free cash from any uncrystallised funds and state of health;
• Current and future income requirements, existing pension assets and the relative importance of the plan, given the client's overall financial circumstances; and
• The client's attitude to risk, ensuring that any discrepancy is clearly explained between their attitude to an income withdrawal and other investments. When a firm is making a personal recommendation to a client about income withdrawals, explanation of possible disadvantages in the suitability report should include the risk factors involved in entering into an income withdrawal contract.

However, the client should be aware of the risk factors involved:

• The customer will be taking an income from a fund that remains invested in the stock market or from an asset which is subject to fluctuating market conditions.
• Taking withdrawals may erode the capital value of the remaining fund, especially if the investment returns are poor and a high level of income is taken.
• Depending on the levels of income and charges, a high-risk investment strategy may be necessary to achieve the required levels of income at each subsequent review.
• The level of income is not guaranteed under income withdrawal and will vary according to the performance of the underlying assets. The investment returns and level of income may, therefore, be less than those shown in the illustrations.
• Lifetime annuity rates or scheme pension levels may be lower in the future, resulting in a lower future income for the client.
• When maximum withdrawals are taken, high levels of income may not be sustainable.
• The maximum rate of income that can be withdrawn under an alternatively secured pension after age 75 is significantly less than the maximum that applies under USP before age 75.
• Where a critical yield calculation is carried out, an increasing critical yield may imply the need for a more aggressive investment approach. This may not be suitable for the client, in which case a reduction in the level of income withdrawals may be necessary.

Member-initiated reviews
In the present economic climate, it may not be an attractive proposition for a member to be locked into a maximum level of income withdrawal for the next five years, based on a low pension fund value and low GAD rates. Therefore, a product that allows members to request a review of the maximum annual income amount before the end of the current five-year period can be very useful to keep clients updated on their policies and encourage regular engagement with their advisers.

The client can request that the maximum annual income on their USP tranche is recalculated on the tranche anniversary, without having to wait until the compulsory five-year review. So, particularly in times of rising markets, this could be advantageous to those clients who want to take the maximum income from their USP tranches, or, for those that want to 'lock in' to a higher maximum should they wish to take a higher income in the future. Should the maximum have increased, the five-year review period will be re-set from the date of the increase and this level of income will be available for the next five years, subject to the tranche having a sufficient fund value to maintain the income level.

The importance of regular client reviews, particularly in the current economic conditions, cannot be over-emphasised. With careful consideration and documentation of a client’s personal and financial circumstances, advice on income withdrawal is more likely to be considered suitable by the FSA, as well as the development of stronger relationships with your clients, which can only be good for advisers’ business.

Further FSA guidance for advisers and frequently asked questions can be found in the small firms section of the FSA website: www.fsa.gov.uk/smallfirms/index.shtml