Moret on the new pensions regime

The new pensions regime will have a profound effect on the way advisers discuss retirement planning with clients, John Moret says.

This year promises to provide the biggest shake-up to the retirement options market since income drawdown was introduced in 1995. I estimate that there are more than 250,000 investors currently using income drawdown – or Unsecured Pension (USP) as it is currently known – with a few thousand investors over age 75 using Alternatively Secured Pensions (ASPs).

That suggests a market today of about £30bn. This market was set to grow through demographic change, but it has now been given an additional boost as result of the legislative changes confirmed by the Treasury at the end of last year.

The changes are dramatic and could have a significant effect on the way in which advisers approach retirement planning, particularly for their wealthier clients. I will discuss that in more detail later, but first, here is a brief summary of the major elements of the new regime. It comes into effect on 6 April 2011, with the necessary legislative amendments being included in the Finance Act 2011.

The return of drawdown

The good news is that under this new regime we revert to the terminology of ‘drawdown’, rather than the contrived labels of USP and ASP. In future, there will be two types of ‘drawdown’.

• Capped drawdown, which will effectively replace USP
• Flexible drawdown, which is new and can only be used by those satisfying a Minimum Income Requirement (MIR).

ASP is abolished, with existing ASPs being converted into capped drawdown. In future, drawdown (both capped and flexible) can continue beyond the age of 75 and can start at any point from the age of 55.

The maximum annual income under capped drawdown will be limited to 100% of the relevant annuity using Government Actuary’s Department (GAD) tables. This compares with the current maximum under USP of 120%. The GAD tables will be extended to beyond age 75.

Reviews of the maximum income under capped drawdown will be required to take place every three years before the age of 75 (rather than five years, which is the case at present under USP); and annually beyond the age of 75 (as currently applies to ASP).

There are transitional arrangements for current users of USP with their first capped drawdown review to take place on the earliest of the following events after 5 April 2011:

• The fifth anniversary of the most recent review
  
• Following a 75th birthday: the first ­anniversary of the most recent review
  
• Following a transfer to another drawdown provider: the first anniversary of the most recent review.
  

Pension Commencement Lump Sums (PCLS) – often referred to as tax-free cash – can be paid at any time after the age of 55 (including after the age of 75), without any requirement to take income.

Minimum requirement

If an individual can satisfy the new MIR, they may use flexible drawdown, under which any level of income may be taken. The MIR is set initially at £20,000. This limit will be subject to review by the Treasury at least every five years.

Importantly, the MIR is a ‘once-only’ test, no matter how often flexible drawdown is subsequently used.

MIR can be made up of any or all of the following:

• State pensions
  
• Lifetime annuities from a registered pension scheme
  
• A member’s or dependant’s scheme pension.
  

Drawdown payments cannot satisfy the MIR. Importantly, once flexible drawdown is used, no further tax-relievable pension contributions can be made to any pension scheme A recovery tax charge on death of 55% will apply to all funds where some income or PCLS has been taken.

There will continue to be no tax charge on death for undrawn funds until the age of 75, at which point the recovery charge of 55% will apply unless there are no dependants. It is paid to a nominated charity (this also applies pre-age 75).

This is only a summary of the main provisions of the new regime. As ever the devil will be in the detail of the legislation. Also in its announcement, the Treasury made it clear that the FSA will be consulting on the necessary changes to their Conduct of Business Sourcebook (COBS) to take account of this new regime properly. It said the FSA will ensure that the relevant changes to its rules are in place for 6 April 2011 implementation. Obviously, this is an enormously demanding timeline, bearing in mind that changes as a minimum are likely to be needed to:

• COBS 9: ‘suitability’
  
• COBS 13: ‘product information’ –key features, projections
  
• COBS 16: ‘reporting to clients’.
  

In its impact assessment, the Treasury estimated that about 50,000 individuals currently using USP/ASP could initially benefit from flexible drawdown. In addition, it suggested that a further 12,000 individuals a year may access flexible drawdown. I believe those may be under-estimates.

Pressure on providers and IFAs

What is clear is the impact for providers and advisers is potentially very significant. The pressure on providers to meet what are extremely demanding timelines are enormous. Already some providers have made it clear that they will not be able to offer flexible drawdown from 6 April. I suspect a lot more risk managers will reach the same conclusion. What is more, these changes are not just about flexible drawdown; the changes to capped drawdown are also important.

For advisers, the challenges are potentially even greater. Every client currently using USP/ASP will need to be reviewed between now and 6 April.

In addition, potential new users of drawdown need to be identified – including clients who are currently members of occupational schemes – particularly defined benefit schemes. New guidance from the FSA will need to be accommodated, including the already contentious area of suitability, along with new projection requirements and potentially a new framework for client reviews.

Most important, the strategy and tactical approach to investment management for clients using flexible drawdown will need to be determined – not to mention the implications of the tax and IHT changes. Of course, advisers will also have to review their preferred providers particularly if those providers are unable to accommodate the new regime immediately.

The Treasury argues that delaying introduction of flexible drawdown beyond April next year “would create further uncertainty, which would make it more difficult for providers to adapt to the changes”. Interestingly, it emphasised that: “It will be important that individuals take appropriate advice before entering a capped drawdown arrangement.”

This suggests that they are all too aware of the risks of making the wrong choice. However, on this occasion, I wonder whether the Treasury has made the wrong choice by not delaying. I fear that the risks of pressing ahead in just over 100 days have been drastically underestimated.