Andy Zanelli discusses the potential issues surrounding the abolition of protected rights.
It is a well-known fact that from 6 April this year it will no longer be possible to contract out of the state pension system using a defined contribution pension scheme. This practice has declined in recent years but there are significant assets held by many clients who were possibly incentivised to do it in the past. These assets in the fund would have been held separately as protected rights (PR) benefits due to the specific legislation governing the benefits that had to be paid in different circumstances. As with all changes the facts are quite simple to understand, however there are some potential outcomes which a client may need to consider; and this will be an ideal time for the proactive adviser to add real value.
1. Review death benefits
Many policies would have been written with an irrevocable ‘expression of wish' which may or may not refer specifically to the PR portion, due to potential inheritance tax (IHT) issues. This document may no longer be valid after 6 April. Imagine a £100,000 fund which today is split 50:50 non-protected rights (NPR) and PR. The expression of wish could direct the NPR portion to the spouse and the PR to the children. If it is no longer valid the question must be: what will happen to the ex-PR funds? Will it all go to the spouse with potential IHT consequences? Will the kids now get nothing, which was not the original intention? Will the ex-PR funds become subject to the discretion of the trustees which could significantly delay payment as they fulfil their duty around discovery of potential beneficiaries? The best thing to do is to engage with the client and revisit the situation.
2. Separate arrangements
Some schemes may be set up with NPR and PR benefits held in separate arrangements or even separate schemes. It is worth understanding any consequences of this; for example are the separate funds considered as a whole for drawdown minimums? Are the charges considered across the whole value? Are all the options available due to the size of each arrangement? Does this allow a smooth transition to drawdown in the future or will the client get multiple sets of paperwork and different review dates?
If the client is considering drawdown in the future then action now could avoid possible problems. If vested separately and then it is decided to try and consolidate for ease of administration, this will not be possible. When vested, a ‘drawdown to drawdown' transfer has to be to a new arrangement.
A straightforward and obvious reason why some clients may consider action is to continue the trend of recent years of consolidating their various pension funds. Many of the earlier style ‘rebate only' schemes had higher charges than the client would expect to be paying now. There could also be benefits in ease of administration and things like increased investment choice, access to additional flexibility and other options not traditionally available in the older policy structures.
4. Members of occupational schemes
Some occupational pension schemes were contracted in, for example contracted in money purchase schemes, executive pension plans and small self administered schemes (SSAS), so did not or could not accept rebate payments. A common option was to run a ‘rebate only' pension scheme as a separate scheme. No restrictions should exist now so why not bring the benefits together? I know that some SSAS practitioners are looking at this as an opportunity to grow assets in their schemes.
5. Review the client's expectations
For clients whose plans use the illustrative figures within their review documents each year it may be worth another look if they were targeting a specific level of income in retirement. Illustrations for PR pots had to take into account a 50% spouse's pension and a level of escalation. Is this the right benefit for the circumstances? Is the client single? Has their spouse provided an adequate pension of their own or should it be reviewed?
6. Unisex annuity rates
For some there may be a small window of opportunity when looking at the benefits that could be provided from their PR fund as they will no longer have to be based on unisex annuity rates. There is no need to use them anymore but beware of any ‘Test Achats' implications after December.
7. Money purchase scheme pensions can now be used for old PR pots
Taking benefits via a money purchase scheme pension has been an option that many thinking of retirement must consider with their adviser. For those where this is a suitable strategy, they can now use their PR funds as part of this moving forward where previously this was not allowed.
8. A secured pension can now be phased
Some of the specific restrictions around PR falling away will bring additional flexibility for clients. One area where this is true is around those that want to phase their pension benefits. Previously clients had to phase and use drawdown for the crystallised funds. Now they can consider using a secured pension for these tranches.
9. Any lifetime allowance excess is now available as a lump sum less 55%
After April if the ex-PR fund is in excess of the lifetime allowance it could now be paid as a lump sum less the 55% tax charge. Prior to April it may have to have been paid as an income with a 25% tax charge and taxed in the hands of the individual. There had been some question where HM Revenue & Customs and Department for Work and Pensions legislation appeared to differ on this point.
10. Review potential Section 32 (S32) transfers to personal pensions
Many advisers will still have a number of long standing clients who retain S32 policies. There were many good reasons for the transfer of benefits to a S32 rather than a personal pension with death benefits being one of them. If the client affected the transfer to a S32 because of the way the death benefits would be paid rather than have them emerge from the personal pension as PR funds, then it may be worth a review as the restrictions have dropped away.
I cannot help but think that this is symptomatic of many of the changes to pension legislation recently. On the face of it very straightforward but as you sit and consider different, and some very small, groups of clients there are many reasons to engage. Sometimes it could only apply to one or two clients but as they all deserve the same level of care and advice, making them aware of all possible implications is essential.
Andy Zanelli is head of technical sales at AXA Wealth
Head of UK intermediary distribution
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