Jo Smith, consultant at Teamspirit, explains exactly what the pre-Budget report means for pensions ahead of A-Day as well as the implications and remedies now for both clients and intermediaries.
One week on, is the dust is beginning to settle following the chancellor’s bombshell pre-Budget announcement on pension investments?
In general, the industry seems to have a degree of sympathy over the move. But the reality is the implications stretch much further than the wealthy individuals who the chancellor has decided would be the undeserving beneficiaries.
There are dramatic implications for advisers, providers and the under-pensioned consumers out there too, particularly when we overlay this dramatic u-turn with the publication of the Pension Commission Report just a few days before.
What on earth happened?
The chancellor stated his intention to impose punitive tax charges where ‘self-directed’ pension schemes - a new definition which mainly includes sipps and ssass - invest directly in residential property or other prohibited investments such as fine wines or vintage cars after A-Day.
This will remove all tax advantages from holding these prohibited assets directly or indirectly in pension schemes, as will mean, at best, it will be no more advantageous to hold such assets in a pension scheme than to hold them personally. When you also consider the additional complications of reduced lending limits, additional costs and lack of flexibility which have always been the cautionary measures relating to pension ownership of wider asset classes, it seems clear our investment choices should remain fixed to the current pensions world.
It looks as if there will still be the opportunity to invest in commercial property, as is possible under the current rules - although with slightly more flexibility - as well as the other assets such as stocks & shares permitted under the long-standing Sipp Joint Office Memorandum 101.
These new measures could lead to tax charges of up to 70% on investments which fall within the prohibited category. There is the ultimate threat of scheme deregistration, bringing a further 40% tax charge on the total assets, where prohibited investments exceed 25% of the value. Punitive taxation levels indeed.
What the HMRC note actually says is:
If a self-directed pension scheme directly or indirectly purchases a prohibited asset the purchase will be subject to the unauthorised member payments charge in Section 208 FA 2004. This will recoup all tax relief given on the amounts used to purchase the asset.
This means that:
- the member will be subject to an income tax charge at 40% on the value of the prohibited asset
- the scheme administrator will become liable to the scheme sanction charge in Section 239 FA 2004, which will usually be a net amount of 15% of the value of the prohibited asset
- if the set limits are exceeded the cost of the asset may also be subject to the unauthorised payments surcharge in Section 209 FA 2004, which is a further charge on the scheme member of 15% of the value of the asset
- if the value of the prohibited asset exceeds 25% of the value of the pension scheme’s assets, the scheme may be de-registered under Section 157 FA 2004, which would lead to a tax charge on the scheme administrator on the value of the scheme assets at the rate of 40% under Section 242 FA 2004.
So, if a pension scheme purchased a prohibited asset costing £100, there could be total tax charges of £70 on the scheme and its member, and the scheme could risk being deregistered. If the scheme were deregistered, there would be a further 40% tax charge on the value of assets held in the scheme at the time of deregistration.
Collective or pooled investment in residential property vehicles such as the government's proposed new real estate investment trusts (REITs) will be allowed so there are a lot of happy fund managers out there.
There are, however, measures to prevent abuse via indirect investment, such as, for example, using a pension scheme to buy a controlling interest in a residential property investment company.
So is there any reprieve for those clients that have acted? Thankfully there are some small measures to protect the position of some and, as you would expect, they are complicated.
For those who bought off-plan residential properties before 5th December, there is an escape from the 40% unauthorised payment charge and 15% scheme sanction charge. But only if the property is sold immediately it receives a certificate of habitability. This window has been made as investing in off-plan property had previously been sanctioned by the Inland Revenue although was not specifically covered by the permitted investment list. This is likely to leave the seller vulnerable to those capitalising the reason and timing of the sale.
The impact of the property market looks considerable too, particularly in terms of the buy-to-let market. The Council of Market Lenders had previously estimated one in three deals after A-Day would have been sipp-related.
Who will this affect?
In terms of the industry ‘trust’ factor, this is as disaster. Promises have been broken and it will only be those cautious advisers who have held back from giving advice who will be feeling comfortable this week. Thousands of advisers now face the prospect of having to revisit the advice given and communications sent to many thousands of clients.
Providers and advisers are already feeling threatened following the proposals in the Turner Report last week. However the situation worsens when we look at consumers. They will now have read about the possibility of a State-run scheme - the National Pension Saving Scheme - bringing in compulsion, albeit in a soft form. The question they may pose now is ‘why not just wait until they are forced to save for retirement?’
There are many consumers who have already paid large sums into their pensions in preparation for making their exotic purchases from A-Day. Also there are a number of clients who, either with their advisers help or who have simply gone it alone, purchased these assets solely with a view to selling them into their pension after A-Day. These individuals will have incurred substantial professional fees and other costs in pursuing a strategy which is no longer viable.
What should you be doing?
We cannot afford to make like an ostrich on this one. There are a lot of advisers who have advised clients and are now worried about the repercussions. Even where they acted without specific recommendation from their IFA, for some customers the price of acting in an unregulated environment will be high.
Independent pensions policy adviser Ros Altmann spoke for all of us when last week she said “It's such a scandal. Will those people who have planned on the basis of the proposed rules - which have now been withdrawn - perhaps want to sue the Treasury for mis-selling?”
Also last week, that ‘bastion’ of consumerism, the Daily Mail suggested it is unlikely it will be possible to sue advisers for compensation because sipps are not regulated. However they did suggest insurers could be pressured into paying up. Only time will tell.
I have yet to see much comment from PI insurers and the lack of regulatory framework will prove complicated. What is for certain is we have not heard the last of it and in our worryingly litigious society what is certain is compensation will be sought. What is not clear, however, is where the buck will stop.
There is another view suggesting advisers could be targeted for compensation if they didn’t make it clear pensions simplification rules were not finalised. Even for unregulated products, it will be interesting to see if ‘treating customers fairly’ could be used here.
Regardless of your previous position in terms of exotic investments, the essential thing will be to keep your clients informed. Don’t wait for them to contact you as that could leave you on the defensive.
Consider the important things which will need reviewing. For example:
- Customer mailings, literature and website;
- Your company extranet, literature, website, presentations, sales aids, and factsheets.
Look back over customer files and write to clients who have previously sought post A-Day investment advice, tell them about the government’s u-turn. Surprisingly, given the vast media coverage before the pre-Budget report, there has been relatively little reporting of where we are now. It’s no longer newsworthy is it?
By taking the initiative and engaging your clients now you have the opportunity to review their post A-Day pension planning in a positive light, it could also serve as an effective way to ensure the more acquisitive among your clients do not choose to jump on the compensation wagon.
If, like me, you would rather forget about pensions for a while, at least until the landscape is more certain, just remember that given this last-minute Treasury hijacking, it seems we can no longer assume anything is cast in stone. Will more of the proposed A-Day pension legislation be suddenly withdrawn before 6th April 2006? It’s less than four months away now, but it’s suddenly looking like a long time in terms of giving advice for the before and after scenarios.
One a final piece of guidance: even once you have assessed the implications of Gordon’s change of heart on your clients and your business, don’t think it’s all over. Make sure all your advice and recommendations make it clear that we have entered a new era of government interference – and it ain’t going to be over until the fat lady truly begins to sing on A-DayIFAonline
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