Additional voluntary contributions (AVCs) may become obsolete for many existing investors if legisla...
Additional voluntary contributions (AVCs) may become obsolete for many existing investors if legislation is passed to allow concurrent membership of occupational pension schemes and the new stakeholder arrangements.
The Inland Revenue is thought to be considering concurrency for those in occupational schemes who earn up to one quarter of the earnings cap or possibly as much as twice average earnings. The cap is £91,800 in 2000-2001, so the 'quarter of earnings cap' concurrency rules would affect those who earn around £23,000 or less. If eligibility to concurrent schemes is extended on the twice average earnings basis this would open the market to those earning up to about £40,000.
The consultant Watson Wyatt, who issued the warning in its 2000 AVC survey, said the ability of stakeholder schemes to generate tax-free cash, together with the more flexible contribution and benefit rules would make these schemes more attractive than AVCs for those eligible for concurrency.
AVCs will also need to compete with alternative investments suitable for retirement planning, in particular Cat-marked individual savings accounts (Isas) and the All Employee Share Ownership Plans (Aesops). As direct equity investments Aesops, introduced in the current Finance Bill, are higher risk than AVCs and Isas, but offer valuable income tax, capital gains tax and national insurance advantages, the consultant said.
One of the problems facing the investor after April 2001 is that stakeholder schemes will be regulated by the Financial Services Authority (FSA) so trustees will be reluctant to give occupational scheme members specific advice on their choice between stakeholder and AVC arrangements. Hopefully the government will require schemes to provide generic advice and recommend independent consultation where necessary, otherwise members could end up in an AVC scheme when a stakeholder might be more appropriate.
If concurrency goes ahead, there would still be a need for AVCs for investors who will not benefit from stakeholder schemes and also for members' existing funds. However, the firm stressed, in order to remain competitive in a stakeholder environment, AVC providers will need to review their charges, particularly for low premium, short-term contracts.
The survey revealed that where an investor paid £25 per month for five years, some contracts, including those of Mercury Life, Professional life and Royal & SunAlliance, had a reduction in yield of over 5%pa. Admittedly, at higher premiums the charges for Mercury Life and Royal & SunAlliance fall much closer to the median, while Professional Life's generally higher charges may be justified by its wide range of external funds. However, there is an important point here. Trustees clearly need to look very carefully at charges across the board, otherwise a minority of low earnings members could be penalised.
Only four AVC providers met the 1% annual cap on charges required by stakeholder rules. These were Clerical Medical, Co-operative Insurance Society, Friends Provident and NPI.
The vast majority of providers do not automatically offer new charging structures to existing schemes but in the consultant's experience trustees are often able to obtain better terms for their existing and/or new AVC contributors than the original contract terms. Watson Wyatt said that the competition for new AVC business over the last few years, combined with the imminent arrival of stakeholder pensions has led many providers to reduce their AVC charges.
So when is the right time to review an AVC arrangement? Andy Parker, senior consultant at Watson Wyatt suggests, "It may be better to defer attempting to improve contract terms for the time being, instead waiting until stakeholder contract designs are known and implemented."
It is also essential to review terms for all levels of contributions and benefits. For example, while most providers surveyed provide a death before retirement benefit equal to the full value of the accumulated fund, the survey shows that there are still with-profits AVC contracts available to existing and new members which only offer a return of contributions without interest. One contract gives no return on death.
The report notes that the structure and the investment mix of the with profits is changing significantly as providers seek to improve returns. Some providers are achieving this by increasing the equity content of the fund and the proportion of the final payout represented by the discretionary terminal bonus.
The real asset (equities and property) content of with profits funds surveyed ranges from 60% to 88%, with the highest equity content at 84.9% and the lowest at 54%. Fixed interest investment ranges from 10% to 33%. The consultant noted that the historical out-performance of equities over fixed interest type investment suggests that performance is likely to suffer if a higher proportion of the fund is invested in fixed interest over the longer term.
Providers have also been reducing the guarantees on unitised with profits funds used to replace traditional contracts. Many traditional with-profits funds have been closed to new business. The new contracts offer either a reduced guaranteed rate of return or no guarantee at all, the report said.
"The last twelve months has again seen providers reducing or amending with-profits bonus guarantees and this should permit some providers to pursue a more aggressive investment strategy in the hope of producing higher returns. The responses to this year's survey show that reversionary bonuses continue to decline, with the final or terminal bonus accounting for an increasing proportion of the overall return, reflecting the perception of a lower inflation/lower return environment.
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