Professionals guide to drawdown

Transcription

1 Professionals guide to drawdown May 2017 Sponsor Accredited by

2 Contents Introduction 3 Section 1 (S1) Retirement landscape Learning objectives 6 Creating income 7 Is the source of income more important than the rate of return? Tax facts The dividend tax allowance explained 10 How pension freedoms are being used 11 The evolution of regulation 13 New in Section 2 (S2) Prudential retirement solutions Prudential in Holistic planning through one solution 53 Prudential's financial strength 54 Prudential pension plans 55 Prudential investment families 56 Prudential investment options categorised 57 PruFund guarantee options explained 58 PruFund pension and fund charges 60 Prudential support tools 62 The retirement income landscape 16 Overview of retirement options 18 Advising on drawdown 21 Comparing PPPs/SIPPs with SSASs 23 Key points to consider before taking 24 benefits from pension savings Income sustainability in retirement 25 The evolution of the MPAA 28 Turning pension savings into family money 29 Section 3 (S3) Mini guide Mini guide 65 Tax planning summary 66 Planning needs to look out for 68 Decision tree for those with savings in a pension scheme Drawdown is a continuous cycle Assessing an appropriate investment strategy 31 Overview of risks 33 Longevity risk 34 Inflation risk 35 Sequence risk 36 Summary of drawdown Example of turning pension savings into family money Benchmarking returns (evidencing suitability of returns) 38 Assessing a reasonable return from an annuity 39 Assessing a reasonable return from drawdown 40 Due diligence checklist 45 Test yourself for CPD purposes 47

3 Introduction Prudential has commissioned Defaqto to produce an annual guide packed full of the crucial facts and tips professionals need to know when advising on using defined contribution (DC) pensions to produce income through drawdown. We are now firmly into the era of pension freedoms with a few very clear indicators of the changes which are taking place. Drawdown is no longer the preserve of the high net worth client, and pension saving for many now means more than just trying to create a sustainable income. This now extends to consideration towards death benefits, ongoing contributions in some cases, and sourcing an appropriate underlying investment solution and strategy. In this, the version, we have split the guide into three sections to make navigation easier and to separate out the CPD accredited pages. Richard Hulbert Insight Analyst (Wealth and protection) rhulbert@defaqto.com Section 1 Section 2 Section 3 This section provides structured CPD, with pages to record learning and evidence it for your file How the market has evolved The practical implications for drawdown income advice The key retirement planning considerations The main investment factors to consider A deep dive into the retirement solutions and a review of the support Prudential provides to those providing advice on income in retirement A review of the new Prudential Retirement Account A look at their fund range Summary of their drawdown tools and solution supports A mini guide for advisers and paraplanners to use with their professional introducers Provides an overview of retirement options Provides the tax facts to be considered Summarises some of the main planning opportunities Contains an example of how pension savings can provide benefits across generations We hope you find this guide useful and welcome your feedback on what you would like to see in future versions. 3

4 Acronyms The most common acronyms used in this document are: ABI Association of British Insurers ISA Individual Savings Account AIM Alternative Investment Market LISA Lifetime ISA AMC Annual management charge LTA Lifetime allowance CGT Capital gains tax MAS Money Advice Service CPI Consumer prices index MPAA Money purchase annual allowance DB Defined benefit OEIC Open ended investment company DC Defined contribution ONS Office for National Statistics DFM Discretionary fund manager PCLS Pension commencement lump sum EGR Expected growth rate PPMG Prudential Portfolio Management Group FAD Flexible access drawdown PPP Personal pension plan FCA Financial Conduct Authority PRA Prudential Retirement Account FRP Flexible Retirement Plan RPI Retail prices index GAD Government Actuary s Department SIPP Self-invested personal pension GMF Guaranteed minimum fund SSAS Small self-administered scheme HMRC Her Majesty's Revenue and Customs UFPLS Uncrystallised funds pension lump sum ILC International Longevity Centre 4

5 Section 1 Retirement landscape 5

6 S1. Learning objectives This guide is written for professional financial advisers and paraplanners. Specifically, those who are involved in advising individuals on their wealth and retirement planning. This study will also be of interest to accountants and bookkeepers who are looking to provide their clients with an enhanced service through the involvement of a financial adviser in their clients wealth planning. Indeed, section 3 is designed to aid conversations and help with clients. Reading this publication will enable you to: 1 Understand how the pension freedoms are being used 2 Understand the impact of recent pension regulation changes 3 Understand the death benefit options and how they impact on advice 4 Understand the different retirement options 5 Understand the due diligence required in recommending a drawdown solution 6 Understand how to evidence the suitability of a level of income or withdrawal 7 Understand the issues in managing an effective drawdown strategy 8 Understand the risks associated with drawdown solutions If you are not a finance professional, we highly recommend that you contact Pension Wise. pensionwise.gov.uk Pension Wise is a free and impartial government service designed to help individuals understand their defined contribution pension options. Their guidance includes how to shop around and what to look out for on taxes and fees; it also includes how to avoid common pension scams. 6

7 S1. Creating income When looking at producing income in retirement, it is important to consider a client s entire financial position. Managing assets together, in many circumstances, can often produce the best overall outcome, for example, using Individual Savings Accounts (ISAs) to produce income and using wealth in a pension for inheritance tax planning. Assets to consider utilising to produce income in retirement can typically include: Cash holdings Assets in ISAs Assets in investment bonds Assets in pensions Other investment wealth Directly held shares Rental property Home (equity release) Each of the assets listed can produce income, the flow of which can be stopped and started to help maximise tax efficiency and to meet ongoing income and capital needs. This is where the skill of the professional adviser really makes a difference: being able to balance the positives and negatives of each income source, alongside their individual risks and the need for access and control, while selecting the flow of income that is appropriate from each asset and the timing of it. This needs to be reviewed on a regular basis. Taxation will also be a significant driver here. 7

8 S1. Is the source of income more important than the rate of return? When structuring the various sources of potential retirement income, it is possible, with careful structuring of income sources, for many in retirement to pay little or no tax on their income. One of the benefits of the UK s targeted taxation system is that allowances are created so that those who have a relatively small income from a specific source are not penalised. By utilising different allowances, it is possible for many to receive a significant percentage of their income entirely tax free. When we look at the tax-free income allowances, it is striking how much the system has evolved to the extent that it now clearly primarily benefits those using existing wealth to produce income. The reality is that most people are not aware that by placing their wealth in different places, the income it then produces can be received more tax efficiently. This creates a great opportunity for financial advisers, because those who can evidence that they utilise both accumulation and decumulation tax-efficient allowances will clearly be creating the greatest benefits for their clients. In the financial year, it is possible to receive up to 28,800 of tax-free income using the following combinations of income sources and allowances: Chart 1: Tax free income allowances 11,500 Personal allowance 11,300 Capital gains tax (CGT) allowance 5,000 Dividend allowance The savings income allowance will be higher for some individuals. 1,000 Savings allowance By way of comparison, if the net income of 28,800 was from employment, then a gross salary of 37,530 would be required to produce the same outcome after income tax and national insurance. 8

9 S1. Tax facts As part of the financial planning process, advisers should be considering and documenting the client s thoughts on the following key allowances available to increase tax efficiency: Growing the wealth ISA allowance 20,000 Pension annual allowance (maximum)* 40,000 Producing income Personal allowance income before tax becomes payable (up to)* 11,500 Personal savings allowance (up to)* 1,000 Dividend allowance 5,000 CGT allowance 11,300 Tax deferred income from an investment bond 5% Estate planning Investment in the Alternative Investment Market (AIM) (held for 2+ years) 100% Annual gifting allowance 3,000 Annual small gift allowance (no restriction on number) 250 Family home allowance 100,000 Inheritance Tax nil rate band 325,000 * Personal circumstances may result in a lower allowance being applicable More detail on the tax planning allowances available is shown in section 3 of this report, which is designed for you to use with your professional introducer relationships. 9

10 S1. The dividend tax allowance explained While not strictly a pension drawdown solution, clients often have other assets that they call upon for income in retirement, and it is now possible for these to produce a higher net income. On 6 April 2016, the notional 10% tax credit on dividends was abolished and replaced with a new tax-free dividend allowance The dividend allowance means that the first 5,000 of dividend income will be tax free, irrespective of other (non-dividend) income being received. 5,000 of tax-free dividend income Dividend income received in excess of 5,000 will be taxed as follows: 20% basic rate income tax payers 7.5% 40% higher rate income tax payers 32.5% 45% additional rate income tax payers 38.1% The new system will simplify matters for the majority of those in receipt of dividend income from investments, although those with significant dividend income can expect to pay more in tax than under the old system. This change will have the most impact on company directors who receive part of their remuneration package through dividend payments. Many will find that restructuring the way they are paid by their company and directing company payments into tax-efficient pensions and protection schemes may make the net tax liability at the end of the year more palatable. All dividend income is treated as taxable income and therefore counts towards an individual s adjusted net income and should be fully included in the tax computation. The amount in excess of 5,000 will be taxed according to the tax band in which the excess over the allowance falls. This could also lead to inadvertently entering a tax trap when the perception may be that no tax is due. Many company directors will benefit from advice on restructuring their remuneration package and utilising allowances STOP PRESS The government announced plans to reduce the allowance to 2,000 on 6 April 2018, however it was not included in the 2017 Finance Bill and so we wait to see what, if any, change is introduced in the future 10

11 S1. How pension freedoms are being used The obvious conclusion one can draw from these figures is that full encashment is by far the most popular choice, although exactly what people are doing with this new-found wealth has not yet been established. Chart 2: Pension freedoms usage 2% 17% 52% 29% 52% Full encashment 29% Drawdown 17% Annuities 2% UFPLS 1.1 million payments 7.65 billion paid out Source: House of Commons briefing paper SN06891, 23 November 2016 It is also interesting that annuities still hold a significant percentage of the marketplace, despite their bad press and relatively low income rates compared to just a few years ago. Notably, with one in three opting for drawdown, it shows that many are now actively involved in managing their own income in retirement and that the potential market place for advisers is becoming huge. Since the reforms came in: Annuities 4.2bn 80,000 annuities Average value 52,500 Drawdown 6.1bn 90,700 products Average value 67,500 Source: Association of British Insurers (ABI) funds invested in new products. Published 15 August

12 If clients are looking to draw income in retirement, there are a number of key questions which we feel advisers should ask their clients to consider, and then document their thoughts and findings: If a specified level of income/capital sum is taken, will this reduce my ability to save in a pension in the future? If a specified level of income/capital sum is taken, by how much will this reduce my income/ standard of living in later years? How much tax am I willing to pay to access my money? What level of fees am I willing to pay to access my money? How much tax will I be paying on this balance outside of a pension? What return will I need on my funds outside of a pension to better the return inside? What are their priority needs and aspirations? 12

13 S1. The evolution of regulation It is becoming increasingly difficult to keep abreast of the evolving market place, so we have included a brief reminder here of some of the recent key messages. Of particular note is that there have been a number of reviews of both the annuity market and drawdown, and the subject of retirement income continues to feature in the Financial Conduct Authority (FCA) annual business plan and conduct risk documents. How do you evidence value for money? In addition, the government has indicated that they would like pensions to operate in a similar way to ISAs. They issued an open consultation in July 2015 and while the government did not make changes in the March 2016 Budget, the idea has not been completely dismissed. Summary of changes and announcements May 2016 August 2016 July 2016 (Updated October 2016) November 2016 November 2016 March 2017 March 2017 April 2017 FCA business plan Explains the work the FCA will undertake in to protect consumers, enhance market integrity and promote competition this is on the back of the FCA having reviewed its regulatory requirements related to pensions and retirement income FCA updates its findings relating to the retirement income market study and details how it plans to introduce extra competition FCA published Terms of Reference for its Retirement Outcomes Review, which will assess how competition is developing in the retirement income market. This is a markets-based analysis to facilitate assessment of how the market is operating now, with a focus on the impact of the pension reforms on switching in the market FCA Consultation Paper 16/37 entitled Implementing information prompts in the annuity market aims to introduce more competition into the annuity market by requiring firms to inform consumers how much they could gain from shopping around and switching provider before a potential annuity purchase FCA Market Study interim report 15/2.2 entitled Asset management market study interim report discusses a number of weaknesses in the industry Exit fees Pension schemes (restrictions on early exit charges) being introduced with charges commonly being restricted to 1% for those aged over 55 The money purchase annual allowance (MPAA) The government had announced that the allowance for saving into a pension once benefits have been accessed would be reduced from 10,000 to 4,000 per annum with effect from 6 April 2017; however, this change was not included in the 2017 Finance Bill and so we wait to see what, if any change, is introduced in the future. Salary sacrifice The circumstances under which this can be used are being restricted, but still includes pension contributions, pensions advice, childcare vouchers, cycle-to-work schemes and cars with CO 2 emissions of up to 75g/km 13

14 While the idea of a secondary annuity market has been shelved, there are a number of planning opportunities that previously announced legislation changes have created, including: The personal savings allowance Reduction in the pension lifetime allowance to 1m Introduction of taper on the contribution annual allowance for those earning over 150,000 Changes to the way pension savings are taxed on death Reduction in the MPAA Reduction in the annual dividend allowance While we wish to avoid speculation, it would be sensible for advisers to consider the following as the government has announced an interest in them: Changes to tax relief on pension contributions Removal of the triple lock on the state pension Restricting certain types of pension transfers to combat fraud 14

15 S1. New in Pension exit fees cap These will be capped at 1% for all those over the age of 55. This is fantastic news for those who felt unable to access their savings due to high charges. This simplification could ignite a pension switching market and increase the popularity of drawdown. Lifetime ISA (LISA) LISA was introduced on 6 April 2017 to help those between 18 and 39 to save flexibly and tax efficiently for the long term. Contributions will be made from post-tax income Maximum annual allowance is 4,000 Contributions receive a 25% bonus (up to age 50) During tax year only transfers from the fund built up in a Help to Buy ISA before the introduction of the LISA will receive the government bonus and will not count towards the annual LISA contribution limit. Thereafter, transfers from Help to Buy ISAs will count against the annual LISA contribution limit. The Help to Buy ISA will now only be available until 30 November 2019 and be open to contributions up to 2029 As with ISAs, a LISA will grow free of income tax and capital gains tax and will have the same investment options as regular cash and investment ISAs Withdrawals are tax free and without penalty if they are used to buy a first home, up to the value of 450,000, with the government bonus, from 12 months after opening the LISA account Withdrawals are also penalty free if made from age 60, with the government bonus, for use in retirement All other withdrawals (except for terminal ill health) will be subject to return of the bonus element of the fund (including any interest or growth on that bonus) to the government, and will incur a 5% charge (not in ). So, individuals will have access to their savings and any interest earned on those savings minus the proposed 5% charge. The government will consider including other life events that may allow access to funds, without charge 15

16 S1. The retirement income landscape This section looks at the retirement landscape and the multitude of options and retirement solutions available to meet client needs with savings in DC pots. It is designed to set the scene before we look more closely at the practicalities of advising in this arena and factoring in the various technical and planning aspects which arise. With over two years since the launch of pension freedoms and following an average of 250+ product changes per month, the retirement income solutions landscape remains broadly unchanged. The options are: 22 annuities 56 platforms 29 PPPs 129 SIPPs 50 SSASs 63 workplace pensions 45,000 funds 63 platforms Source: Defaqto, January

17 One due diligence and research factor that has gained momentum is the need for advisers to consider some of the more recently introduced terminology and document whether they are recommending a blended or hybrid retirement solution: Blended Hybrid Combination of separate retirement solutions, facilitated through a multitude of individual product wrappers Combination of separate retirement solutions, facilitated through a single product wrapper We recommend advisers look at the full spectrum of solutions by considering a hybrid solution in their advice process because a client s circumstances will nearly always change, and if their income planning cannot evolve with them then their needs may not be met. Advisers and paraplanners should also be able to identify the overall level of risk being taken by a solution and whether it matches the client s needs and risk attitude. Below we identify the key components in the current pension landscape, including: Other assets and investments Investment risk Drawdown, without guarantees Drawdown, with guarantees Annuity and defined benefits State pension and benefits Mortality risk 17

18 S1. Overview of retirement options Now that we have looked at the current retirement landscape we will focus upon the individual components and what they all mean. The main access options available to those in DC pension schemes are: Scheme pension (if the DC scheme is occupational) Annuity purchase Uncrystallised funds pension lump sum (UFPLS) Flexi-access drawdown (FAD) Scheme pension This is a secure pension option. Available through defined benefit (DB) schemes, it is occasionally also available through older occupational DC schemes and some self-invested personal pension (SIPP) schemes in specific circumstances. It is usually provided directly by the pension scheme, or the scheme may purchase the benefits with an annuity provider. The scheme rules will determine the benefits payable. Annuity An annuity is where someone exchanges the value of their pension savings to receive a secure income for their lifetime and potentially for someone else. Drawdown rules govern fixed term annuities. While these are technically not annuities, they are often marketed as such. With term-based annuities, the period is chosen at the outset. Annuities are commonly sold as level term whole of life plans, 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: Inflation protection Joint life option Value protection Guaranteed period Where the balance of income received increases each year to reflect the general increase in the cost of living 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 The balance payable is often the same amount or a percentage of the balance that was paid to the deceased Where a lump sum is paid on the death of the annuitant. The maximum that can be paid is annuity purchase price minus the amount of annuity payments made to date of death. It is payable to the estate of the annuitant 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. Any outstanding instalments form part of the estate of the annuitant 18 It is unlikely that the annuity offered by an existing pension provider will coincidentally also be the best deal available. Indeed, the government is currently consulting on requiring providers to highlight the best deal available on the open market.

19 It is critically important that those wishing to buy an annuity shop around, as research by the ABI in 2010 found that about 50% of those retiring at age 65 were eligible for an enhanced annuity. The Money Advice Service (MAS) has a free annuity calculator which is an excellent tool to use when gaining annuity illustrations and can be found at: moneyadviceservice.org.uk/en/tools/annuities Enhanced annuities enable those with specific conditions or lifestyles that are known to shorten life expectancy to receive a greater regular income. Examples include: Overweight Smoker Diabetes High blood pressure Heart disease Each application is considered on its own merits with individual assessment/ underwriting required to identify any enhancements to income available Cancer Uncrystallised funds pension lump sum (UFPLS) UFPLS allows someone to withdraw some or all of their uncrystallised fund as lump sums without purchasing a product such as an annuity or designating to drawdown. The key facts are: Each UFPLS payment will be 25% tax free and the remainder is taxed as pension income If under the age of 75, the individual must have a lifetime allowance (LTA) remaining which 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, which is discussed in more detail later in the document An 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 There s 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 However, an UFPLS payment is only allowed up to the remaining amount of the standard LTA The default for providers is to tax UFPLS payments under an emergency income tax code, which for many individuals will result in them initially paying too much tax and needing to reclaim the excess through Her Majesty's Revenue and Customs. It is possible to take any remaining uncrystallised funds at any time and enter into FAD and/or purchase an annuity. 19

20 Flexi-access drawdown (FAD) This is the only drawdown option post 6 April 2015, unless the individual was in capped drawdown before that date. 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 an annuity Taking benefits will result in the MPAA being applied, as discussed later in the document 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 recommending taking withdrawals only a few times a year and/or on an adhoc basis should keep in mind that there is the possibility of an over-payment of tax occurring. Small pots allowance This allows those with pension pots worth up to 10,000 each to take lump sum balances without affecting their annual allowance. The allowance includes up to three non-occupational schemes and an unlimited number of occupational schemes. 20

21 S1. Advising on drawdown Drawdown is not a product for most it is a strategy to provide a sustainable income in retirement. Professional financial advisers are best placed to establish, administer and advise on drawdown arrangements. Some of the key areas their expertise will influence are: 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 Successful drawdown strategies require ongoing monitoring, review and some changing to meet evolving circumstances: Performance Income Health Products and cost Drawdown Capital preservation Estate planning Inflation Risks Annuities Flexibility The one big factor relating to drawdown is that at some point in the future, the attraction of a less risky and simpler strategy to produce a secure income for life will, for many, become an overriding need, and annuities should then be considered. Advisers should also keep in mind that if an appropriate annuity can produce the same outcome with less risk and lower costs, it may be appropriate for at least part of their retirement funds. 21

22 One of the biggest challenges with drawdown is where to invest the residual fund to achieve overall objectives and the required balance of return between growth, income and estate planning. Benefits of drawdown Matters to consider Control and flexibility in when and how much income and tax-free cash is taken Ability to benefit from any potential growth in the underlying assets Ability to control the level of income tax paid Getting it wrong may possibly result in a worse standard of living for the rest of the client s life A decrease in the value of the investment can: Reduce the capital value Reduce the income now and in the future Reduce any inheritance planning Ability to purchase an annuity at a later date with some or all of the remaining balance Ability to leave the pension savings to others as part of estate planning Drawdown is available through many UK registered pension schemes, but not all. Focusing on pensions, the three most commonplace options are a personal pension plan (PPP), a SIPP or a small self-administered scheme (SSAS). A SIPP is a more flexible version of a PPP. Table 1 on the next page illustrates and summarises the features and key factors relating to PPPs, SIPPs and SSASs. The number of PPPs, SIPPs and SSASs taken from the Defaqto database gives some idea of the choice of pension wrappers and products currently available in the pension savings marketplace, the vast majority of which provide income drawdown facilities to support the withdrawal of retirement income. 22

23 S1. Comparing PPPs/ SIPPs with SSASs Table 1: Differences between PPPs/SIPPs and SSASs PPPs and SIPPs Availability 29 PPPs and 129 SIPPs 50 SSASs 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 Governance Regulator Providers Control Investment decisions Investment options Cost Loans Pooling Available only to relevant UK individuals making contributions within the annual allowance The scheme rules are set by the provider for all members HMRC regulates the scheme. The FCA regulates the provider 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 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 individual members can make their own investment decisions within the options made available by the provider, usually in conjunction with a financial adviser SIPP providers usually offer a wide selection of investment options mostly publically available assets registered on regulated exchanges, although a number of providers do provide access to some commercial property and unregulated assets 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 Loans can be made by members to unconnected third parties, such as to buy government or corporate loan stock SIPPs can be joined together for joint investment, eg to buy a commercial property Available only to relevant UK individuals making contributions within the annual allowance Within HMRC rules, the scheme can be tailored to the individual members objectives and needs HMRC regulates the scheme. SSASs are not regulated by the FCA SSAS providers are not subject to capital adequacy rules The sponsoring employer has overall control. A scheme administrator has day-to-day responsibility for the running of the scheme The sponsoring employer has overall control. A scheme administrator has day-to-day responsibility for the running of the scheme SSAS providers offer far more flexibility in the assets held than in SIPPs, including direct commercial property ownership and investment in unregulated assets 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 As within 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 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 pension data, January

24 S1. Key points to consider when recommending contributions and transfers The general rule of thumb is that the value within a pension scheme is free of 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 into a pension and transfers to another scheme such that they are considered a chargeable lifetime transfer, and therefore taxable, if the holder dies within two years of the transaction. Ongoing contributions and transfers may make the pension value taxable on death Contributions and transfers are usually considered a lifetime transfer of value and so are excluded from the holder s estate. However, if death was the likely outcome at the time of the contribution/ transfer, the value may be considered taxable by HMRC as the benefit created by the transaction was not considered primarily for the deceased. There are a number of ongoing court cases that test this position, and while the legislation is not crystal clear, we suggest that advisers when making any form of pension recommendation, document their thoughts on their client s health and the potential for a chargeable lifetime transfer to be created. 24

25 S1. Income sustainability in retirement Without understanding a client s income needs and sources, 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 We suggest one of the best places to start this process is by simply getting your client to list their expenses within the following categories. This will provide the information you need to use different income sources to target the different income requirements. Income that is not being spent, perhaps being held in cash or invested Nice to have Emergency fund Home improvements Estate planning Income required to maintain a desired standard of living Aspirational Entertainment Holiday Lifestyle insurances Health support Income required to maintain a home and a reasonable standard of living Core Home maintenance Debt management Key insurances Transport/car/care 25

26 Spending needs in retirement From experience, we know there are very broadly four common spending experiences in retirement. How much, if any, time that we each spend in each stage is completely dependent upon our individual circumstances and needs: Stage Active Passive Assisted Supported Notes Where health and wealth allow an active lifestyle Spending starts to decrease as health begins to restrict capability Spending increases as amendments made to home to accommodate lifestyle Where ongoing and perhaps full-time care is required Ongoing research being undertaken by the International Longevity Centre (ILC), a think tank looking at longevity, ageing and population changes, indicates that the reality for many in retirement is that they spend significantly more in the active and supported stages, however they also continue to save. This creates a planning opportunity for advisers to make sure their clients' wealth is being utilised efficiently. The ILC reports make interesting and informative reading and can be found at ilcuk.org.uk 26

27 S1. Key points to consider before taking benefits from pension savings State pension From 6 April 2017, the basic state pension will be Advisers should remember that not everyone is guaranteed to receive the full amount. A minimum of 10 years of national insurance contributions is required to receive anything and 35 years to receive the full amount. Points to consider are: Individuals better off than couples Defer and get more The new state pension appears to be more attractive to single people, as married couples are likely to receive a balance similar to a couple who have retired under the old system Benefits can be deferred resulting in a larger state pension benefit entitlement in future years Additional factors to consider: Tax-free cash MPAA 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 The MPAA is a lower annual allowance which is applied when in certain circumstances benefits have been accessed This will affect many savers who have previously accessed a benefit from their savings. We discuss this in detail on page 28 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. There is a detailed explanation of the types of beneficiaries on page 29. The availability of death benefit options depends on the scheme, and not all schemes will offer full flexibility Meeting needs in later life planning We suggest that advisers have a policy for dealing with elderly clients and include factors such as: 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 and outsource decisions to third parties, such as discretionary fund managers (DFMs) and yourself Balancing the need for capital and income against placing it in investments that: are not considered realisable to immediately pay for care costs meet the needs of an attorney and/or future beneficiary rather than the owner 27

28 S1. The evolution of the MPAA The money purchase annual allowance was introduced to prevent abuse of the tax system by individuals taking pension benefits while continuing to contribute into a pension savings scheme. The MPAA affects those who have already taken benefits from their pension savings, but continue to make pension contributions , ,000 / 10,000 Those who have taken benefits from their pension savings will see their annual allowance for contributions change to the MPAA. This has the impact of reducing their allowance to 4,000 / 10,000 per tax year. As the MPAA only applies to DC pension schemes, contributions in excess of the allowance are allowable into DB schemes, subject to the overall annual allowance of 40,000. Those accruing benefits in a DB scheme having also accessed savings in a DC scheme will remain subject to the annual allowance. Many who fall foul of this legislation change will do so retrospectively as they took benefits under the old system; unfortunately no additional protection is available to these individuals. The government announced plans to reduce the MPAA to 4,000 with effect from 6 April 2017 but did not legislate for this change in the 2017 Finance Bill. With this change on hold, and a further legislation possible in the financial year advisers should advise very carefully regarding this allowance as we do not know what it will be going forward. Common events that trigger MPAA: Drawing income from a FAD strategy, including from a short-term annuity Receiving a payment through 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 which can vary in a way not allowed before 6 April 2015 Common events that do not trigger MPAA: Tax-free cash nil income in drawdown Receiving benefits under DB trivial commutation Receiving benefits under the small pots allowance Receiving a lifetime annuity that cannot go down except in prescribed circumstances The MPAA will result in many more pension holders being subject to a charge Those in capped drawdown who remain within the permitted maximum allowance 28

29 S1. Turning pension savings into family money It is unlikely that many of us will die on the day we spend our last pound. While some will experience financial ruin in later life, there are those who die with savings still in their pension plan(s). Pension freedoms included two significant changes to try to incentivise retirees to avoid financial ruin, which also created financial planning opportunities and triggers that advisers need to act on: Dependants and non-dependants can inherit pension benefits in the form of income The tax payable on the pension value depends upon the age of the holder at the date of death Pension owner aged under 75 at death 0% Pension owner aged 75 or more at death Taxed at the beneficiary s marginal rate of income tax This makes assets held within a pension fund potentially very tax efficient, and for some it may be appropriate to consider these assets for inheritance tax planning rather than solely as an income source. Should pension savings be used to produce income or for estate planning? On page 72 there is an example of pension savings creating intergenerational benefits. 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 who wish to retain some control, for example to ensure benefits go to their children rather than their former spouse s new husband or wife s beneficiaries, a spousal bypass trust can be considered. The main downsides to this route are the loss of flexibility and the fact that the value of the savings would incur a tax charge (45% as they are a non-individual) if the member was 75 or over. However, if the money is then passed onto an individual, there is a reclaimable tax credit which means the tax position can work out to be the same as an individual receiving the balance. The other disadvantages are potential periodic and exit charges and administration and trusteeship issues. 29

30 Types of beneficiary Dependant Spouse or civil partner A child of the deceased who is under 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 The following summarises the tax implications created by the death of the holder when they hold different types of pension arrangements. Existing drawdown arrangement None Uncrystallised funds (includes UFPLS) Previous holder dies aged under 75 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 Capped Income received is free of income tax No test against remaining LTA FAD Income received is free of income tax No test against remaining LTA Previous holder dies aged 75 or more Income received is taxed at the beneficiaries marginal income tax rates under PAYE No test against remaining LTA Income received is taxed at the beneficiaries marginal income tax rates under PAYE No test against remaining LTA Income received is taxed at the beneficiaries marginal income tax rates under PAYE No test against remaining LTA Providing the designation to FAD is made within the two-year window. If the designation is made outside of this time limit, the income will be taxed as the beneficiaries income under PAYE If an estate is not dealt with within two years of the date of death, this can impact on the benefits received and any tax payable. A worked example of estate planning using pension savings is shown in section 3 If a non-individual (such as a trust) receives a taxable lump sum death benefit, then a 45% special lump sum death benefit charge applies and not the marginal rate, although ultimate beneficiaries may be able to claim back some or all of this. 30

31 S1. Assessing an appropriate investment strategy The investment strategy is one of the most crucial aspects in establishing and managing a successful drawdown strategy. Often when retirees are asked what sort of investor they are, they will say balanced or medium risk, but what exactly does this mean? A suitable investment strategy is one that meets the investor s needs. For many, this is peace of mind that the right assets are held to meet their personal beliefs, needs, aspirations and risk level. The skill is to identify the right mix of assets to produce sufficient growth to offset inflation, while also producing sufficient income to meet the bulk of the income required. And all of this while keeping a watchful eye on the balance of the investments held in the acceptable asset classes and geographical locations. This is a different approach to that for clients in the accumulation only phase. Summary of factors to consider Objectives Often those entering drawdown have little idea of exactly what their objectives are other than to produce an income. A professional adviser s role is to help investors understand exactly what they are trying to achieve. It is not uncommon to find spouses have different objectives, but do not realise this until the adviser helps them to articulate what their expectations are. A good working practice is to list needs and objectives at the start of a suitability report and then again at the end, but this time also clearly summarising how the recommendations meet them. Timeframe There are two aspects to this: 1. The investment aspect not all investments require wealth to be tied up for a set period of time, but some do 2. Cash requirements it is important to understand what wealth is likely to be required and when 31

32 Capital security Everyone wants 100% capital security with the maximum balance of income and capital growth. The reality is that this is not possible as there is always a trade-off between income producing assets and capital producing ones. We recommend that before anything is invested, an appropriate cash reserve is established with sufficient access. It is not uncommon to find advisers suggesting a reserve sufficient to cover two or three years of planned expenditure. Knowledge An investor with sufficient knowledge and understanding of market volatility, cycles and returns may be willing to take greater risk than someone who is new to investing. Do not presume knowledge. Estate planning Pension savings can now be considered intergenerational planning tools and this is discussed later in the document. Total wealth The more wealth one has, the more options that are created and can be considered. A professional adviser will be able to identify those assets appropriate to use for drawdown and when, and, importantly, those that are not. Advice strategy Advisers tend to undertake the following process to select a suitable investment strategy: Attitude to risk Required return Capacity for loss Suitability Attitude to risk is usually established through the completion of a psychometric personality test. Required return can often be the most dominant assessment criteria. If the return (growth and/or income) required can be achieved by having to tolerate less overall volatility and risk, then there is no need to invest in a combination of assets beyond a particular risk level, even if the investor s attitude to risk indicates a higher level of risk would be acceptable to them. Capacity for loss was described by the FCA in March 2011 as the client s "ability to absorb falls in the value of their investment if any loss of capital would have a materially detrimental effect on their standard of living". By defining a particular level of risk to take (and thus a commensurate combination of assets), one can assess whether the individual s financial situation can withstand the impact of a worstcase outcome, or a near worst-case scenario, based upon a given percentage probability of an event occurring. 32

33 S1. Overview of risks Drawdown is always 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: Longevity risk Inflation risk Sequence risk Commitment risk Financial ruin risk Diversification risk Insurer credit and counterparty risk Legislative and regulatory risk Timing risk Interest rate risk Investment risk Risk of living too long Risk of inflation eroding the buying power of the income produced 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 Risk of selecting a solution and not being able to change the product choice, benefit shape, income level or death benefits Risk of exhausting the capital and income while still alive and having a lower standard of living for the remaining years Risk of putting all your eggs in one basket, or too many baskets Risk of default by a provider of all or part of the solution Risk that a change in legislation and/or regulations will impact on the net income received (also known as political risk) Risk of securing the level of income required at the time required Risk that interest rate movements may adversely affect annuity style products and guaranteed or protected funds/solutions Risk of poor market returns that reduce capital sums and by association the level of income produced: Systemic market risk the risk of an event impacting on a specific market or asset class Specific risk the risk of a specific investment underperforming the market or its peers Health risk Risk that deteriorating health will bring about the need to access retirement capital or income to cover non-insured medical expenses and healthcare There are many factors retirees need to consider both initially and ongoing, and we will focus the next few pages on looking at the first three risks in the list above. Different risks apply to different solutions 33

34 S1. Longevity risk If we all knew how our health will evolve and the exact date on which we were going to die, it would make retirement planning so much easier. Financial ruin Spend too much and/or invest poorly and see pension savings used up, resulting in financial hardship for the rest of your life Under spend Having not used pension savings to the maximum during your lifetime Chart 3 shows the average healthy life expectancy, life expectancy, proportion of life spent in 'Good' health and ranks for males and females at birth by region. Chart 3: Life expectancy in England South East South West East of England London East Midlands West Midlands Yorkshire and 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 average life expectancy in England for men is 86 and 89 for women. Remember, only a handful of people will experience the average outcomes the majority will experience an outcome either side of the average. Facts to consider: Poor health will impact many before they reach the state pension age The average time spent in ill health before death will impact on the spending habits of those affected: for men it is 16.1 years and for women 19.2 years Both healthy life and life expectancies are higher in the South Those in the North East not only experience the lowest average life expectancy but also the lowest healthy life expectancy, which means they suffer poor health for longer before they die The Office for National Statistics (ONS) has an excellent webpage entitled, How long will my pension need to last. We suggest advisers use it with their clients to focus attention on the risk of longevity 34 visual.ons.gov.uk/how-long-will-my-pension-need-to-last/

35 S1. Inflation risk To 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 the rate of inflation each year. UK inflation is commonly measured by one of two indices: Retail prices index (RPI) Consumer prices index (CPI) The actual rate of inflation experienced very much depends upon what each of us spends our money on (in other words, our personal shopping basket). Phrases such as pensioner inflation and silver RPI rate are likely to resonate well with clients. Looking at some common costs we all incur, especially those that affect pensioners, we can see some significant differences in Chart 4: Chart 4: RPI indices from 1987 to RPI Year RPI: Housing: Council tax and rates RPI: Food RPI: Fuel and light RPI (exc mortgages) Source: ONS data released 14 March 2017 Irrespective of the method by which pension savings are accessed, when inflation is considered, it is clear that, for most, some form of protection against inflation in retirement will be critically important to avoid a decrease in the standard of living. Housing and fuel costs have consistently increased by more than the general RPI rate 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. 35

36 S1. Sequence risk Sequence risk or Sequence of returns risk is a significant issue for those living off income. Retirees become more vulnerable to investment volatility because, as they withdraw income from their savings, they can find themselves locking in investment losses. The full implications of sequence risk are not always displayed in a way that fully illustrates the dangers. Therefore, in the tables and charts below, we have plotted the capital value of 100,000 invested over a 10 year term, where the total net return is 40% over the term: Table 2: Sequencing risk example Sequence of Value growth rates each year return Simple total Positive start +30% +25% +20% +15% +10% 5% 7.5% 10% 15% 22.5% 40% Linear +4% +4% +4% +4% +4% +4% +4% +4% +4% +4% 40% Negative start 22.5% 15% 10% 7.5% 5% +10% +15% +20% +25% +30% 40% Chart 5A: Sequencing risk with no withdrawals 300,000 Conclusion Capital value in 250, , , ,000 Where no withdrawals are taken, the net return is the same for the positive and negative starts, although the compounding effect on a linear return creates additional growth: Positive start 147,242 50,000 Linear 149, Years Negative start 147, Positive start Linear Negative start

37 Chart 5B: Sequencing risk with withdrawals of 4,000pa ( pm) 300,000 Conclusion Capital value in 250, , ,000 Where withdrawals of 4,000 pa are taken, the total net return is significantly affected by the sequence of return: Positive start 116, ,000 50,000 Linear 100, Years Negative start 65,615 Positive start Linear Negative start As shown, the sequence of the return can significantly affect the capital value and therefore the potential future level of sensible withdrawal (income) that can be produced and that is available to take. It is worth noting that increasing the volatility of returns also increases the potential damage caused by sequence risk. The impact of sequence risk on income Using the values realised on the previous page, 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. 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: Table 3: Indicative potential annuity income Sequence of return Value available Monthly Annualised 10 years Positive start 116,563 Linear 100,000 Negative start 65, ,946 59, ,104 51, ,339 33,390 Source: Money Advice Service annuity, 24 March 2017 Conclusion A poor sequence of the return can significantly affect the capital value and therefore the potential future withdrawals (income) that are available. Using investments with a linear type return and/or absolute guarantee can help to mitigate the potential damage caused to capital and long-term income by a poor sequence of returns. 37

38 S1. Benchmarking returns (evidencing suitability of returns) We previously mentioned that financial ruin, exhausting the savings and having no income later in life are real possibilities for those in drawdown. One way to evidence that the level of income being taken is suitable and sustainable is to, at least annually, take the capital balance of the remaining savings and the income being taken and test it against one of the following benchmarks: Critical yields GAD rates Annuity (enhanced) It may also be helpful to ascertain sustainability and test drawdown income against estimated life expectancy to try and gain a clear view of any safe withdrawal rate, subject of course to realistic evidence-based assumptions. It is acknowledged that this specific benchmarking no longer forms part of any compliant regulatory process, but rather still exists as good practice to evidence suitability and enhance the client s experience. WARNING Advisers and paraplanners should consider carefully and document the implications of the loss of any existing attractive benefits held, ie: Guaranteed/ protected growth rates Guaranteed/ protected annuity rates To prove that advice is in the client s best interest, advisers should be able to evidence how the return meets the client s needs and expectations, both initially and on an ongoing basis 38

39 S1. Assessing a reasonable return from an annuity Evidencing a reasonable drawdown strategy in retirement is difficult. There are a number of tools available that allow a pictorial view of the solution to be created which can prove very useful in helping retirees to understand the implications of the decisions they are taking. Using the Defaqto Engage At retirement modelling tool, we have taken as an example an individual turning 65 next year with a pension pot of 100,000 available to provide them with an income for the rest of their life. We have assumed that a minimum of 250 per month ( 3,000 per annum) is required to meet their combined core and lifestyle income needs. Projections are intended as an illustration only to aid discussion around the benefits and risks associated with each product type to help advisers agree a retirement strategy with their clients. They are not a guarantee of investment performance and do not take account of a client s taxation position. Annuity Looking at a standard annuity with no guaranteed periods and no widow/er s option, but with the income set to increase with inflation, the following return is likely: Chart 6: Projection of annuity Average 10k 7.5k Age 100 Index to flags: Poor Strong There are two likely boundaries between poor and strong performance Income 5k Average Indicates a likely outcome in an average performing market 2.5k 0k Age 100 Indicates when client will turn Years Income needs Annuity Source: Defaqto Conclusion The income requirement is being more than met and the income will last as long as the individual does. For those clients looking for a secure income for life that provides a good level of protection against inflation, an annuity can be a possible solution, at least in part. However, there are drawbacks to annuity purchase and one of those could be that the annuity ends at the end of the annuitant s (or their dependant or nominee s) life. 39

40 S1. Assessing a reasonable return from drawdown For those clients who feel an annuity is not for them, or at least not the only solution to meet their retirement income needs, then we now look at the likely outcome of producing 5,000 per year ( per month) from a 100,000 initial investment. We have done this using the Defaqto Risk Profiles 3, 5 and 7, taken from a scale of 1 to 10, with 1 being the lowest level of risk and 10 being the highest level of risk. The examples to follow are purely illustrative, but look to paint the picture as to how retirement income can be modelled using Defaqto Engage 'At Retirement' and how the future income and capital position of a client is impacted by the selected withdrawal levels and asset allocation. Projections are calculated using the following principles: Non-invested savings grow by an assumed rate, while invested savings use the investment risk level selected to project the likely growth based on weak, average and strong investment performance Property values grow by an assumed rate each year Income needs rise each year by CPI. When the retirement date is reached, only then are investments, pensions or savings used to drawdown from or to purchase products Assessing how to produce 5,000 per annum When projecting the likely outcome of the selected retirement strategy, a number of assumptions have been made, namely: Description Value assumed Starting age 65 General savings growth rate 2.1% Property value growth rate 4.2% Reduction in yield (RIY) for income funds 1.5% CPI 2.7% Illustrations are provided to age 100 Each drawdown illustration contains flags indicating when the fund would be exhausted if the underlying investment performance is poor, average or strong in comparison to the chosen risk profile. 40

41 Risk Profile 3 Cautious Defaqto description Cautious investors tend to regard themselves as quite cautious people and are inclined to view risk negatively rather than as a source of opportunity. They typically have limited experience of investments and do not find financial matters easy to understand. They can take a fairly long time to make investment decisions and can be somewhat anxious about investment decisions they have made. They will likely suffer from regret when their decisions turn out badly. Cautious investors are inclined to look for safer investments rather than seeking higher returns, though may be persuaded to take a limited amount of risk in exchange for a modest return. They aim for some capital preservation above the rate of inflation. They tend to prefer bank deposits to riskier investments, are averse to volatility and are not particularly comfortable about investing in the stock market. Objective To produce 5,000 pa ( 417 pm) Chart 7: Risk level 3 with income withdrawals of 5,000 pa Age 100 Index to flags: Income 14k 12k 10k 8k 6k Poor Average Strong Poor Strong Average There are two likely boundaries between poor and strong performance Indicates a likely outcome in an average performing market 4k Age 100 Indicates when client will turn 100 2k 0k Year Source: Defaqto Conclusion for Risk Profile 3 Drawdown Shortfall The average expectation is that the income requirement will be met until around age 86. However, as the flags indicate, in poor market conditions the wealth could be exhausted at around age 83 and in strong conditions at around age

42 Risk Profile 5 Balanced Defaqto description Balanced investors do not particularly regard themselves as cautious people and have no strong positive or negative associations with the notion of taking risk. They will typically have some experience of investments and a degree of understanding of financial matters. They will usually make investment decisions reasonably quickly and don t tend to be particularly anxious about investment decisions they have made. They may suffer from feelings of regret when their decisions turn out badly. Balanced investors can be inclined to look for safer investments rather than higher returns, but understand that investment risk may be required to meet their investment goals. While they will take investment risk, they are still not particularly comfortable with investing their whole portfolio in the stock market and get some comfort from a balance of bank deposits in addition to riskier investments. Objective To produce 5,000 pa ( 417 pm) Chart 8: Risk level 5 with income withdrawals of 5,000 pa 14k Poor Average Age k 10k Income 8k 6k 4k 2k 0k Year Drawdown Shortfall Source: Defaqto Conclusion for Risk Profile 5 The average expectation is that the income requirement will be met until around age 91. However, as the yellow flag indicates, in poor market conditions the wealth could be exhausted at around age 82, however in strong conditions it should continue past age

43 Risk Profile 7 Growth Defaqto description Growth investors do not typically regard themselves as cautious people and are inclined to view risk as a source of opportunity rather than as a threat. They generally have experience of investments and find financial matters fairly easy to understand. They tend to make investment decisions relatively quickly and are not usually particularly anxious about the investment decisions they have made. While they can suffer from regret when their decisions turn out badly, they are usually able to accept that occasional poor outcomes are a necessary part of long-term investment. Growth investors typically look for higher returns rather than safer investments, and will occasionally take gambles where they see the potential rewards as being attractive. They are reasonably comfortable about investing in the stock market and typically prefer riskier, but higher returning, investments to keeping money in bank deposits. Objective To produce 5,000 pa ( 417 pm) Chart 9: Risk level 7 with income withdrawals of 5,000 pa Age k Poor Average 12k 10k Income 8k 6k 4k 2k 0k Year Drawdown Shortfall Source: Defaqto Conclusion for Risk Profile 7 The average expectation is that the income requirement will be met until around age 95. However, as the yellow flag indicates, in poor market conditions the wealth could be exhausted at around age 83, however in strong conditions it should continue past age

44 Overall conclusion on producing 5,000 per annum from a drawdown arrangement From the evidence on the previous pages we can draw the following conclusions: The data from the ONS previously discussed tell us that the average life expectancy is 86 for men and 89 for women. The truth is many clients will live beyond these ages and so advisers must take care to consider these facts in their calculations and recommendations Increasing the level of investment risk through asset allocation can increase the likelihood of the savings producing the income for a longer period of time, but not significantly. However, it also increases (at a greater rate) capital value volatility and the likelihood of the value of the savings being exhausted even earlier in life resulting in financial ruin We suggest drawing an income close to the natural yield and taking a low to medium level of investment risk as both steps can help to increase the potential of a drawdown solution lasting a lifetime. 44

45 S1. Due diligence checklist The most important factor when making recommendations is to meet the individual s needs and objectives. It is good practice to consider, at least, the following items in your research: Provider strengths and capabilities Product strengths and weaknesses The application process Payment capabilities Cost (advice, product, investment and administration) Quality of communications Quality of service Any extras (such as online tools and technical help) Establish needs and objectives What cash is required to meet core income needs? 3 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 Establish health and longevity factors What should happen, the order it should happen and dates if known? Assess health and life expectancy Sense check this against the level of income and risk indicated Establish noninvestment risks Establish client s risk profile Document, evaluate and address 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 timescales Establish death benefits Agree clear timings for when objectives need to be met What does the scheme allow in relation to death benefits? Who do they want death benefits passed on to? Are death benefits more important than retirement income? Ensure an expression of wishes form is completed Cont. 45

46 Establish cash reserve requirements Liquidity needs Future liabilities/expenses Establish an investment strategy Establish benchmark(s) Ring-fence sufficient to cover next three years of cash payments or a suitable period as assessed as appropriate for a specific client Evidence how this meets the client s circumstances and needs 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 needs and objectives Be sure to meet regulatory requirements as well Establish a drawdown strategy Detail balances expected from each source (gross and net) and when Set out the immediate and longer-term tax implications Review Set periodic reviews of the solutions as all circumstances evolve 46

47 S1. Test yourself for CPD purposes To assess your knowledge following completion of this section, why not work your way through the following questions? All the answers can be found within the content of section 1. 1 What percentage of the income taken through an UFPLS arrangement is taxable? 2 In 2010 did the ABI report that around 25%, 50% or 75% of those retiring at age 65 were eligible for an enhanced annuity? 3 Name the three types of beneficiary who can receive pension savings after death of the holder? 4 Looking at the contributions, how (if at all) does the taking of income under FAD affect an individual's future annual allowance? 5 What are the four common stages to spending in retirement? 6 In drawdown, what are the signs of the risk of financial ruin to look out for? 47

48 7 What is sequence risk? 8 What is longevity risk? This publication is accredited by the CII/PFS and CISI for up to 60 minutes of structured continuing professional development (CPD). Name Signature Date CPD time recorded 48

49 About Defaqto Defaqto is a financial information business, helping financial institutions and consumers make better informed decisions. Our independent fund and product information helps banks, insurers and fund managers with designing and promoting their propositions. We analyse more than 41,000 financial products in the UK. These products change on a daily basis, and our customers need help with keeping track. We have been doing this for over 20 years, and we have 60 analysts spending 400 hours a day monitoring the market. They ensure that the information we provide is accurate and up to date. Our experts have done all the hard work so that financial institutions and consumers can make better informed decisions. Defaqto Engage Manage your financial planning process, all in one place, from the most trusted source of fund and product information in the market. Licensing Engage provides you with a simple financial planning solution to help you efficiently and flexibly meet all your clients needs, following your preferred financial planning process. Panel support We provide a one stop shop solution to support advisory businesses panel construction and maintenance requirements based on our uniquely large and broad base of in-house knowledge and expertise and marketleading data (supported by Engage). We help strengthen your client adviser proposition by creating a panel to meet your business requirements (no matter how niche) and help you manage regulatory risk through developing repeatable processes to maximise your control over the advice process. Our approach also creates cost and time savings by enabling efficient distribution of your panel across your business via Engage giving advisers a solution they can use with clients easily and quickly. For more information, visit defaqto.com/ advisers/solutions/panel-support/ Engage at a glance: Over 5,500 advisers use Engage Stochastic risk profiling based on industry-standard scoring and Moody s projections compatible with Oxford Risk, Finametrica and A2Risk questionnaires More than 300 risk rated funds Accumulation and decumulation workflows to meet differing clients needs Choice of investment solutions: handpick, use risk rated funds, target asset allocation or DFM MPS depending on investment size and strategy Unique, three-way, dynamic research to aid selection of investments, products and platform For more information, or to arrange a free trial, visit defaqto.com/advisers/solutions/engage 49

50 50 Section 2 Prudential retirement solutions

51 I want to help reduce the impact of market volatility for my drawdown clients. Our PruFund funds aim to grow your clients money while providing them with a smoother investment journey. TIMETOTALK - RETIREMENT PLANS - When it s time to talk drawdown, we have a wealth of support from tools and calculators to expert technical help all backed up by our dedicated account team. We re here to help you get the most out of your retirement planning conversations. For adviser use only not approved for use with clients. Prudential is a trading name of the Prudential Assurance Company Limited which is registered in England and Wales. This name is used by other companies within the Prudential Group. Registered office at Laurence Pountney Hill, London EC4R 0HH. Registered number Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority.

52 S2. Prudential in 2017 Introduction to Prudential s proposition In this section we take a look at the support that Prudential provides advisers on drawdown solutions. We shine a light on Prudential's product and fund solutions and also look at the support tools and educational material they provide. We look specifically at: How Prudential can help provide holistic planning through one solution Financial strength of Prudential Prudential pension plans, comparing them side by side Prudential investment families Prudential investment options PruFund guarantee options PruFund pension and fund charges Prudential support tools 52

53 S2. Holistic planning through one solution One of the aspects of using Prudential as a drawdown solution provider is that they have a comprehensive family of products and funds to meet many of the evolving needs of investors. 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. Pensions Directly held ISAs International bonds Onshore bonds The PruFund range also provide options for: Capital protection A minimum income guarantee 53

54 S2. Prudential's financial strength As part of a due diligence process it is good practice to assess the stability and strength of the institution providing any drawdown solution, and as part of this approach the AKG financial strength ratings tend to be the most commonly used benchmark. AKG is an independent organisation specialising in the provision of assessment, ratings, information and consultancy to the financial services industry. On 1 March 2017 AKG published financial strength ratings for the different elements of Prudential as follows: Table 4: AKG Ratings, 1 March 2017 Tax wrapper Prudential product Relevant rating ISA Prudential ISA (offered through pension division) A Pension Prudential Flexible Retirement Plan 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+ 54

55 S2. Prudential pension plans Prudential offers a range of pension plans to accommodate most retirement drawdown needs, which can be summarised as: Table 5: Prudential pension plans Product Flexible Retirement Plan Fund SIPP Flexible Retirement Plan Full SIPP Prudential Retirement Account Maximum age at entry Capped drawdown yes yes yes FAD yes yes yes UFPLS yes yes yes Investment options PruFund range available FTSE shares x 3 3 AIM shares x 3 3 Fixed interest securities x 3 3 Permanent interest bearing shares x 3 3 Unit trust/oeics links Insured unit linked funds Offshore mutual funds x 3 x Overseas stocks and shares x 3 x Unlisted/unquoted shares x x x Investment trust links x 3 3 Exchange traded funds x 3 3 Real estate investment trusts Futures and options x x x Hedge funds x 3 x Structured products x 3 x Commercial property x 3 x Open market DFM x 3 x 55

56 S2. Prudential investment families Investment solutions provided by Prudential are carefully managed. Their range of funds is constructed, monitored and reviewed by Prudential Portfolio Management Group (PPMG), which controls 170 billion of Prudential s investments (October 2016). Prudential offers two investment families: PruFund (with optional protection) Prudential Dynamic Portfolio funds The table below seeks to demonstrate where the different Prudential funds sit in comparison to each other and on the Defaqto risk assessment tool. Once the individual s attitude to risk, capacity for loss and required return have been considered, the agreed risk level tends to be most commonly graduated somewhere between levels 3 and 7. This is broadly the range and area of the market within which Prudential s funds, as listed below, are positioned in try and match investor needs. Table 6: Risk levels of Prudential's funds High Risk Defaqto risk level R I S K 10 DEFAQTO M A P P I N G PruFunds Dynamic Portfolio funds R I S K 9 DEFAQTO M A P P I N G R I S K 8 DEFAQTO M A P P I N G R I S K 7 DEFAQTO M A P P I N G Dynamic R I S K R I S K R I S K R I S K 6 DEFAQTO M A P P I N G 5 DEFAQTO M A P P I N G 4 DEFAQTO M A P P I N G 3 DEFAQTO M A P P I N G PruFund Dynamic PruFund PruFund Growth and PruFund Protected Growth Dynamic PruFund Dynamic PruFund 0-30 PruFund Cautious and PruFund Protected Cautious Dynamic 0-30 Low Risk R I S K R I S K 2 DEFAQTO M A P P I N G 1 DEFAQTO M A P P I N G Source: Defaqto, March

57 S2. Prudential investment options categorised Over the following pages, we will look at the PruFund range in more detail as the funds are available through both the: Prudential Flexible Retirement Plan (FRP) Prudential Retirement Account (PRA) The Dynamic Portfolio funds are produced in association with Morningstar, who select and recommend to the PPMG funds they believe should be bought, held and sold, based on their research and regular reviews. Defaqto has written separate question and answer documents on using the PruFund range in different tax wrappers. These provide more detail and can be found at pruadviser.co.uk The key facts to consider about the PruFund range are: Uses the same multi-asset allocation process as the long-established Prudential With-Profits Fund, which has existed since the 1950s Individual funds have been risk profiled with asset allocation so advisers can match a fund to a client s agreed risk profile Uses unit pricing which is smoothed daily using a quarterly expected growth rate (EGR) Options include protections designed to provide a minimum income guarantee and a minimum portfolio value It is risk managed, ie designed with different levels of investment risk and with specific equity exposure parameters All funds contain equitybased investments and are therefore only suitable for long-term investment strategies The chart below details the high-level asset allocation weightings across the PruFund range: Chart 10: High level asset allocation used in the PruFund range 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% PruFund 0-30 PruFund PruFund PruFund PruFund Cautious PruFund Growth Cash Fixed interest Property Equity UK Equity overseas Other assets Source: Prudential, 20 March

58 S2. PruFund guarantee options explained The protected PruFund range forms an investment option under a number of the investment product ranges offered by Prudential, and we will now take a closer look at the details of the protected range and how it can be accessed. Capital protection Minimum income guarantee Capital protection The PruFund Cautious and PruFund Growth strategies both provide the opportunity for investors to buy capital protection. The options currently available are: Table 7: Capital protection costs PruFund Term Annual guarantee charge PruFund Protected Cautious Fund 10 years 1.00% PruFund Protected Growth Fund 10 years 1.50% Source: Prudential 30 March 2017 The annual guarantee charge is in addition to the standard PruFund version annual management charge (AMC). The PruFund protected funds use a Guaranteed minimum fund (GMF) value that is designed to provide peace of mind that if the investment value has fallen below the GMF on the guarantee anniversary date, the lost value will be replaced. The GMF is equal to a percentage (usually 100%) of the amount invested in the relevant PruFund account, reduced proportionately for any switches, withdrawals or adviser charges taken out of the fund. 58

59 Minimum income guarantees The minimum income guarantee is available through the PruFund Cautious and PruFund Growth funds held within the Prudential Pension Income Account. The guarantee can be switched off when needs change. The guarantees are available to those aged over 55 at the following rates: Table 8: Minimum income guarantees Age Rate 2.90% 2.95% 3.05% 3.10% 3.15% 3.25% 3.35% 3.40% 3.50% 3.60% 3.70% Age Rate 3.80% 3.90% 4.05% 4.15% 4.30% 4.45% 4.60% 4.75% 4.90% 5.10% Source: Prudential 2 May 2017 The rates shown were correct at 2 May 2017 and are subject to change. Please refer to Prudential for further information and the current rates available. This minimum income guarantee does carry an additional charge of 0.95% per annum and can be switched off when needs change. Once switched off, this facility cannot be switched back on again within 12 months. It is possible to have different protections on different segments of a client s pension savings, for example where pots with different normal retirement dates are held. The protected funds are not available in all tax wrappers and there are restrictions on their availability, including: Table 9: Tax wrapper availability Tax wrapper Prudential product Notes Bonds Investment Plan PruFund Protected Cautious fund and PruFund Protected Growth fund are only available at inception of the bond Only one Protected PruFund can be selected at a time Pensions Flexible Retirement Plan Retirement Account All PruFund funds can be selected for investment at any time Only one Protected PruFund can be selected at a time If your client has previously been invested in a Protected PruFund and switches out before the guarantee date they cannot reinvest in a Protected PruFund fund for 12 months MIG is only available on the Retirement Account 59

60 S2. PruFund pension and fund charges It is important for investors to understand the costs involved for the level of advice, platform(s), tax wrapper(s) and investment solutions and then to calculate the potential impact of these on returns. Table 10: Adviser charging terms across Prudential pensions Charge Flexible Retirement Plan Retirement Account Set up charges (single premiums) Set up charges (regular premiums) Ongoing charges Ad hoc charges Can be paid as a percentage or as a specified monetary amount Can be paid as a percentage of each gross regular premium paid Can be paid as a percentage or a specified monetary amount on a monthly or yearly basis Can be paid as a percentage or a specified monetary amount Can be paid as a percentage or as a specified monetary amount Can be paid as a percentage of each gross regular premium paid Can be paid as a percentage or a specified monetary amount on a monthly or yearly basis Can be paid as a percentage or a specified monetary amount 60

61 Fund and pension wrapper charges It is important to appraise the charges levied on the fund and/or investment solution under consideration and to gauge the potential impact on returns. If a product wrapper and/or platform are being utilised, these charging structures should also be appraised. If a PruFund is used within Prudential s pension plans on a nil adviser fee basis, the charging structure would be as follows: Table 11: Prudential pension plan charging structure Charge Flexible Retirement Plan Retirement Account Product annual Zero Value Cost charge < 25, % 25,000 49, % 50,000 99, % 100, , % 250, , % 500, , % 750, , % 1m % Fund AMC 1.45% 0.65% (known as investment charge) AMC fund size Fund value AMC discount Not applicable discount 0 24, % (only applies to 25,000 49, % Prudential insured funds) 50,000 99, % 100, , % 250, % Loyalty discount Elapsed time AMC discount Not applicable years 0.00% years 0.05% years 0.10% years 0.20% 20 years % Additional fee Yes Yes payable for a guarantee Allocation rate 100% 100% Note: Other charges may be payable, including for fund switches The total cost experience and individual terms and conditions, and charges involved in accessing the PruFund range may vary when used within other Prudential product wrappers 61

62 S2. Prudential support tools Prudential has a suite of solutions and tools that are suitable for consideration for the accumulation and decumulation phases of retirement planning. These can be found at pruadviser.co.uk As part of any long-term financial plan, it is usually good practice to both model and project forward any income/withdrawal requirement and also any capital needs and flexibility required. By using an appropriate planning tool to do this, it is possible to explain and assess what can be a very complex subject and evidence suitability. Looking specifically at the Prudential tool kit, we have listed below the component parts: Solutions and tools Drawdown through the Prudential Flexible Retirement Plan and Prudential Retirement Account Drawdown client guide A guide to retirement income options Using With-Profits and the PruFund range in retirement planning Fund reporting tool Fund factsheets Knowledge centre Checklists to help meet client and regulatory needs Retirement modeller Fund guides The retirement modeller tool enables very complicated and common questions to be answered in just a few seconds, including: Accumulation I want to know my fund value at preferred retirement age I want to know how much I need to save to achieve my desired fund at retirement Decumulation I want to know how long my fund will last I want to know the maximum income I can take in my first period of retirement I want to know the growth rate needed to achieve my income goals Accumulation and decumulation I want to know how much of my fund I need to allocate to provide my planned income I want to know how much I need to save to achieve my planned income 62

63 Prudential retirement modeller The chart below is from Prudential s modelling tool and explains a very complex subject in one graph: Chart 11: Prudential modelling tool example k 50k 100% 9 450k 45k 90% 8 400k 40k 80% 7 350k 35k 70% Contributions ( ) Fund value (at end of year) ( ) 300k 250k 200k 30k 25k 20k Income ( ) 60% 50% 40% Survival probability 3 150k 15k 30% 2 100k 10k 20% 1 50k 5k 10% 0 0k k 0% The policy anniversary during the age displayed Other income Income Fund value Survival probability Contributions The chart shows: 25% PCLS taken at 57 Starting fund is 250,000 Income of around 9,000 is being taken from aged 58 Income is increased to 11,000 from age 61 Various lump sums are being taken at ages 60, 70 and 75 Income is reduced by around 7,000 at age 67 to reflect the inception of state pension The client has other escalating income (DB pension and state pension) from 61 and 67 respectively The income being drawn reflects the Prudential EGRs (PruFund Growth) The capital value is maintained at around 300,000 for estate planning purposes, the fund withdrawal rate being reduced at 70 accordingly The survival probability is also illustrated 63

64 64 Section 3 Mini guide

65 S3. Mini guide This mini guide to financial planning is designed to be used by advisers with their professional introducers to help identify financial planning opportunities. Over the following pages, we highlight the important factors advisers should be aware of when discussing drawdown with their clients. This includes the key tax allowances and planning factors, including a worked example of pension savings benefiting three generations. Creating income in retirement from existing wealth is collectively known as drawdown and, while this is generally a phrase used with pensions, it relates to all assets irrespective of any tax wrappers that have been used. The following pyramid illustrates the different sources of income from the variety of investment-based solutions that should be considered. Conventional annuity Imparied Life annuity Enhanced annuity Postcode annuity Capped drawdown Blended drawdown Hybrid drawdown Investments With-profits annuity Investment backed annuity Fixed-term annuity Unit linked guaranteed products If you have a client aged over 50 who declines to take professional financial advice, to help them avoid a costly mistake always suggest they discuss their retirement options with the independent and free Pension Wise service: pensionwise.gov.uk

66 S3. Tax planning summary Drawdown is always a balancing act between mitigating risk, receiving returns and retaining some flexibility. The timing of drawing benefits from individual assets and tax wrappers can be critically important. However, some of the greatest benefits can be achieved by planning in advance and utilising annual allowances to maximise tax efficiency in retirement. The trick for retirement planning going forward is to hold assets in the most appropriate tax wrappers, products and investments. Of equal importance is the timing of taking the benefits to maximise tax efficiency and also to help protect the fund over the owner s lifetime and the lifetime of future generations, if required. 0% savings band rate For those receiving income of less than the personal income tax allowance ( 11,500 in ), the first 5,000 of their income from savings will be taxed at 0% Dividend income The first 5,000 of dividend income received each year is free, irrespective of any other income received First 5,000 of dividend income 0.0% Dividend income over 5,000 received by basic rate taxpayer Dividend income over 5,000 received by higher rate taxpayer Dividend income over 5,000 received by additional rate taxpayer 7.5% 32.5% 38.1% CGT Realise capital gains of up to 11,300 (in ) free of tax ISA allowance No personal tax relief on investment Growth is free of income tax and CGT Annual ISA savings allowance 20,000 Benefits paid tax free Investment bonds No personal tax relief on investment Growth can be tax efficient using both onshore and offshore variants 5% of the original balance invested can be withdrawn per annum with income tax deferred as it is considered to be a capital distribution rather than income Pension Tax relief on contributions up to 40,000 per annum ( 4,000 / 10,000 if benefits have been taken due to MPAA) Growth usually free of income tax, CGT and inheritance tax for those aged under 75 A restriction on the value of lifetime savings in pension schemes of 1m that attract tax benefits Restrictions on how benefits can be taken, with up to 25% tax free available from age 55 66

67 Scheduling Effective retirement planning can result in your clients paying less tax or even no tax. Allowances to consider include: Accumulation phase ISA annual allowance 20,000 Pension annual allowance 40,000 Decumulation phase Personal income tax allowance 11,500 0% savings band rate 1,000 Dividend income 5,000 CGT allowance 11,300 Investment bonds tax deferred income 5% Planning through death Targeting of resources and having a professionally written Will can make a significant difference to wealth planning: Tax-free estate 325,000 Assets held in AIM stocks for 2+ years 0% Remainder of estate 40% or, remainder of estate if 10%+ left to charity Pension value income 36% 0% or beneficiary s marginal income tax rate Family home allowance (from April 2017) 100,000 Family home allowance (from April 2018) 125,000 Family home allowance (from April 2019) 150,000 Family home allowance (from April 2020) 175,000 The family home allowance will gradually be withdrawn for estates valued at more than 2m Summary Efficient use of the allowances shown above can greatly improve the financial security and standard of living for current and future generations. 67

68 S3. Planning needs to look out for For business owners, the change in dividend taxation should fundamentally change how they draw income and places more importance on the distribution of remuneration between dividends, salary and pension contributions Restrictions on contributions for additional rate taxpayers may limit the attraction of making future pension contributions Restrictions on the annual and lifetime allowances may make pension savings options less attractive for committed long-term investing by high earners Pension input periods are now fixed in line with the UK financial year (6 April to 5 April) this limits the ability to utilise an extra year s annual allowance The increasing popularity of continuing in work and earning while drawing pension benefits has tax implications, but the way in which those benefits are taken may have an impact on the ability to make further pension contributions, so care should be taken in planning exit routes Changes to death benefits in pensions may mean legacy planning is most efficiently achieved via pension wrappers, rather than using them to produce income in retirement, although this depends on the rules of the scheme While many will continue to see the ISA as an attractive and increasingly generous investment vehicle, pensions may begin to shake off their reputation for being inflexible, costly and hard to access. They can also be seen as considerably more attractive, especially for those close to age 55 when pension access could be comparable to ISA access Tax-free income from ISAs and dividends, combined with the gradual or phased withdrawal of tax-free cash through UFPLS or FAD, could boost income dramatically. In addition, tax deferred withdrawals from investment bonds and planned encashments making use of CGT allowances (or losses where relevant) could further increase the level of household income simply through efficient tax planning Holistic financial planning generous investment and taxation allowances are available for spouses with a linked approach to family finances. These facilitate the allocation of investments in the accumulation phase and also facilitate the efficient drawing of income in the decumulation phase When considering the various sources of potential retirement income, it is possible, with careful structuring of income sources, for many in retirement to pay little or no tax on their income 68

69 S3. Decision tree for those with savings in a pension scheme What to do with accumulated and invested pension savings Is the expression of wishes form up to date and meeting aspirations? Yes Yes/No Wish to take benefits and aged over 55? Check investment strategy is appropriate No Is tax-free cash needed? Yes No Are you sure? There could be a more efficient way to access your savings Consider taking some or all of the tax-free cash available (max 25% of value) Yes Is income and/or capital required? No Consider small pot allowance Consider annuity Consider UFPLS Consider FAD Periodically re-evaluate: Should the expression of wishes form be changed? Is the level of income appropriate? Is the investment strategy appropriate? Would an annuity be more appropriate? 69

70 S3. Drawdown is a continuous cycle Professional financial advisers are best placed to establish, administer and advise on drawdown arrangements. Some of the key areas their expertise will influence are: 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 Successful drawdown strategies require ongoing monitoring, review and some changing to meet evolving circumstances. Understanding wealth, health and individual needs and philosophies Monitoring the suitability of alternatives, such as moving to (enhanced) annuity Understanding initial and ongoing income needs and assess their ability Drawdown Monitoring the suitability and influence of any inheritance planning Monitoring the suitability and sustainability of income being produced and taken Monitoring the ongoing suitability of underlying products and assets, including capability, service, costs and performance 70

71 S3. Summary of drawdown Importantly, drawdown is not something to take advice on once or even periodically. It requires ongoing monitoring to ensure the evolving needs of the client are met and that evolving markets, inflation and legislation (including taxation) are included in that review. Benefits Control and flexibility in when and how much income and tax-free cash is taken Ability to benefit from any potential growth in the underlying assets Ability to control the level of income tax paid Issues Getting it wrong will probably result in a worse standard of living for the rest of the client s life A decrease in the value of the investment can: Reduce the capital value Reduce the income now and in the future Reduce any inheritance planning Ability to purchase an annuity at a later date with some or all of the remaining balance Ability to leave the pension savings to others as part of estate planning One of the biggest challenges with drawdown is where to invest the residual fund to achieve the required balance of return between: Capital preservation Income Growth Estate planning The one big factor relating to drawdown is that at some point in the future the attraction of a less risky and simpler strategy to produce a secure income for life will, for many, become an overriding need and annuities should be considered. Professionals should keep in mind that if an appropriate annuity can produce the same outcome with less risk and lower costs, it may be appropriate for at least part of their clients' retirement funds. 71

72 S3. Example of turning pension savings into family money Introducing the family of Ben Smith Ben Smith Alison Smith (Spouse) Gill Smith (Daughter) Andrew Smith (Grandson) Ben retires with accumulated pension savings of over 100,000 and the following summarises how the capital and income is passed through the generations until ultimately his grandson elects to take the full balance after 52 years. Assumptions: 6% net growth per annum and 4% net income per annum. Chart 12: Capital value provided by pension savings Income per annum 10,000 9,000 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1, Years since Ben retired Ben Alison Gill Source: Defaqto 72

73 Chart 13: Income provided by pension savings 250, ,000 Capital value 150, ,000 50, Years since Ben retired Ben Alison Gill Andrew Source: Defaqto Full description Ben can retire with accumulated pension savings of 100,000. He does not retire straight away, then in the next financial year he stops working, becomes a basic rate taxpayer and starts to draw 4% (net) as an annual income. After 10 years, aged under 75, he dies leaving the fund to his wife Alison. Alison receives the death benefit of 129,213 and elects to continue with drawdown. The capital and income is tax free as Ben died aged under 75. After 20 years, aged over 75, she dies leaving the fund to her daughter Gill. Gill receives the death benefits from her mum of 192,004; however, as Alison died aged over 75 the income being created is now taxable at Gill s marginal rate of income tax, which is the standard 20% leaving her with 156,675, After 20 years, aged over 75, she dies leaving the fund to her son Andrew. Andrew receives the death benefits from his mum of 228,246; however, as Gill died aged over 75, the balance is taxable at Andrew s marginal rate of income tax, which is the higher 40%, leaving him with 136,948. Andrew decides to pay off his mortgage and without taking advice elects to take the entire balance as cash which is taxed in full. This example illustrates how capital and income can be efficiently cascaded down the generations under drawdown rules and just how the investment and tax planning options can be used to preserve remaining pension wealth post pension freedoms to the benefit of multiple generations of a family. 73

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