SIPPs offer excellent investment choice and are undoubtedly good value for some clients, however the FSA has made it clear that the extra charges must be justified on the basis of the individual client's needs. So do clients really need SIPPs, or are they just the latest thing to have, asks Fiona Tait?
The FSA's recent review of the quality of advice on pension switching highlights some areas of concern. Overall only 16% of the advice given was deemed to be unsuitable, but there was a worrying number of firms within the sample where more than a third of the cases reviewed were deemed to be unsuitable sales.
In summary, the issues identified were:
- the switch involved extra product costs without good reason (79% of unsuitable cases)
- the fund(s) recommended were not suitable for the customer's attitude to risk and personal circumstances (40% of unsuitable cases)
- the adviser failed to explain the need for, or put in place, ongoing reviews when these are necessary (26% of unsuitable cases), and
- the switch involved loss of benefits from the ceding scheme without good reason (14% of unsuitable cases).
By far the biggest concern - over three-quarters of the files identified as containing unsuitable advice - was the transfer of clients into contracts carrying higher contract charges than the previous plans where this cost was unnecessary.
Given that most SIPPs often carry fixed annual costs, and insurance contracts are primarily charged via an annual management charge (AMC), it is possible to work out a cross over point at which a SIPP becomes more cost efficient than a personal pension (PP).
According to Defaqto, the average annual fee for a SIPP with a fund size of £100,000 is £431.45. Taking a very simple example, a SIPP with the average annual charge investing in a fund with an AMC of 0.75% versus a personal pension plan with a 0.5% AMC investing in the same fund, but with an external management charge of 0.6%, the SIPP is more expensive until the fund size reaches just over £125,000. This is the reason only 10% of SIPPs are for funds smaller than £100,000.
According to HMRC statistics, only 3% of existing personal pension and stakeholder plans are worth more than £100,000, and 7% are worth more than £50,000. The majority of clients will therefore pay more for a SIPP.
The FSA is not however saying that it is never good advice to transfer to a more expensive contract. It is saying it is not good advice if the extra costs are not justified in the context of the client's needs. If the client is likely to obtain extra benefit from the services covered by the additional costs then this provides a 'good reason' to transfer to that contract.
The major advantage of a SIPP is the increased investment flexibility. Rather than a 'limited range' of insured funds, the client has access to a much wider range of assets such as cash deposits, collectives and individual shares. This allows the client, or their adviser, to actively manage the portfolio in order to try and take advantage of changing market conditions.
The most obvious example of this is in recent months where many clients switched their investments into cash in order to try and avoid the losses being experienced in both equity and bond markets. Some are now beginning to switch back in to those markets with the aim of 'buying cheap' and maximising participation in the anticipated recovery.
Where an adviser, or their client, has the necessary expertise to run their portfolio along these lines the results may well justify any extra costs.
For many clients the extra costs are not justifiable. The above process takes time and expertise. Most clients don't have the investment capability and most IFAs simply do not have the time to do this for all their clients, particularly those with smaller and therefore probably less remunerative investments.
Pensions are, or should be for most people, long term investments. A pension portfolio is intended to deliver the fund value that is capable of providing a desired level of income at the point when the client is planning to retire and take benefits.
Similarly, the overall asset allocation is known to affect returns more than the individual funds within them. Although some providers like to refer to the 'limited range' of personal pensions, all that is really required is that the funds are able to deliver the overall asset allocation. Many clients should therefore be able to achieve their objectives without paying extra for additional investment options.
Clients may of course wish to access these options at a later date when it becomes cost effective. This can be delivered using a deferred SIPP facility, however it is important to check that there are no extra charges built into the underlying personal pensions until the facility is actually used. In this scenario the client gets the investment flexibility they need at the time when it becomes cost efficient.
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