Investors need a better road map

In the last of a series on pensions, James Patterson questions the service provided by advisers

ARTICLES over the past few weeks have described the new income withdrawal facility contracts as an alternative to buying an annuity when an investor wishes to take the benefits from personal pension contracts.

One feature should be obvious - it is an extremely complex facility, with the potential for things to go sour if the investor makes the wrong choice. So what should the investor do to ensure he gets sound advice from his financial adviser, and what protection has the investor under the 1986 Financial Services Act and its regulations against poor advice?

The alternatives are buying an annuity straight away, or taking income from the contract and buying an annuity later.

Buying the annuity

Several things can go wrong, including:

q Buying the wrong type of annuity. For example, if the investor buys a level annuity and lives a long time in a period of high inflation, the real value of the annuity payments is continually eroded. This hazard has always been present when taking benefits from a personal pension, but the introduction of the income withdrawal facility has highlighted the danger.

q Buying an annuity when annuity rates are low because interest rates are low - the catalyst which brought about the income withdrawal facility. Interest rates, and consequently annuity rates, could subsequently rise, and the investor would have received a higher income had he or she waited.

q Buying an annuity from the wrong life company, when a higher annuity rate could have been obtained from another life company.

q Buying an annuity when the investor is in poor health. If the investor dies within a short time of buying the annuity, the annuity could die with him and there would then be nothing left of the pension savings to pass on to the next generation.

The potential faults are compounded because once an annuity has been bought, there is nothing the investor can do to limit the damage.

Taking income

The main potential danger here is that of depleting the fund through taking out too much income or from poor investment performance or both.

Should this happen, then the investor would be forced to limit the damage by taking much less income or buying an annuity with a depleted fund. With either course of action, the investor and dependants could face severe financial hardship.

So what can the investor do? Modern-day personal pension policies are written as a cluster of small individual contracts. The investor can take the benefits a bit at a time by cashing in a few of these contracts when required, leaving the remainder intact until later. This provides the investor with flexibility, whether buying the annuity or taking income.

An investor seeking to take benefits should not cash in all his contracts, but phase them out over a period. Above all, investors should ensure that their advisers explain the alternative options clearly and rationally:

If they are recommending buying an annuity, then the reasons should be spelt out. The Financial Services regulations require advisers to provide a "reason why" letter to clients, explaining the reasons for their advice.

Investors should note, however, that the Treasury often gets it wrong in forecasting interest rate movements, so do not expect infallibility from advisers.

Advising income withdrawal, the adviser should also set out the reasons, including the reason why not to buy an annuity at the present time.

The investor and his or her adviser should consider very carefully the amount of income to take and how to invest the remaining fund. The investor needs to check very carefully the investment advice given.

But above all, the investor should check with the adviser on the progress of the fund on various assumptions regarding investment returns and interest rate assumptions. As seen in previous articles, the level of income withdrawal is vulnerable to a fall in interest rates.

In this respect, the PIA (Personal Investment Authority), which is responsible for regulating the activities of investment advisers, whether independent or life company representatives, and of life companies, has to date only given rather general guidelines to advisers on dealing with income withdrawals. This consists of reminding advisers of the existing rules and warning them that they must highlight the dangers of depleting the fund if withdrawals are made.

However, illustrations of what can happen to benefits are still limited to the standard basis of assuming investment returns of 6, 9 and 12 per cent and using the life company's own expenses and charges.

The PIA needs to be much more specific in what it requires from members in dealing with clients - very much like its specific advice on dealing with transfers.

In particular, the investor should be provided with an illustration which shows, for a given level of income withdrawal, the investment return needed so that the fund is not depleted to the extent that income will fall later.

It is understood that the PIA is considering issuing more specific guidelines.

Start your day with The Independent, sign up for daily news emails
ebooks
ebooksAn introduction to the ground rules of British democracy
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
SPONSORED FEATURES
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Recruitment Genius: Collections Agent

£14000 - £16000 per annum: Recruitment Genius: This company was established in...

SThree: Trainee Recruitment Consultant

£20000 - £25000 per annum + OTE 40k: SThree: SThree are a global FTSE 250 busi...

SThree: Trainee Recruitment Consultant

£20000 - £25000 per annum + competitive: SThree: SThree are a global FTSE 250 ...

Reach Volunteering: Trustees with Finance, Fundraising and IT skills

Voluntary and unpaid, reasonable expenses reimbursable: Reach Volunteering: St...

Day In a Page

Isis profits from destruction of antiquities by selling relics to dealers - and then blowing up the buildings they come from to conceal the evidence of looting

How Isis profits from destruction of antiquities

Robert Fisk on the terrorist group's manipulation of the market to increase the price of artefacts
Labour leadership: Andy Burnham urges Jeremy Corbyn voters to think again in last-minute plea

'If we lose touch we’ll end up with two decades of the Tories'

In an exclusive interview, Andy Burnham urges Jeremy Corbyn voters to think again in last-minute plea
Tunisia fears its Arab Spring could be reversed as the new regime becomes as intolerant of dissent as its predecessor

The Arab Spring reversed

Tunisian protesters fear that a new law will whitewash corrupt businessmen and officials, but they are finding that the new regime is becoming as intolerant of dissent as its predecessor
King Arthur: Legendary figure was real and lived most of his life in Strathclyde, academic claims

Academic claims King Arthur was real - and reveals where he lived

Dr Andrew Breeze says the legendary figure did exist – but was a general, not a king
Who is Oliver Bonas and how has he captured middle-class hearts?

Who is Oliver Bonas?

It's the first high-street store to pay its staff the living wage, and it saw out the recession in style
Earth has 'lost more than half its trees' since humans first started cutting them down

Axe-wielding Man fells half the world’s trees – leaving us just 422 each

However, the number of trees may be eight times higher than previously thought
60 years of Scalextric: Model cars are now stuffed with as much tech as real ones

60 years of Scalextric

Model cars are now stuffed with as much tech as real ones
Theme parks continue to draw in thrill-seekers despite the risks - so why are we so addicted?

Why are we addicted to theme parks?

Now that Banksy has unveiled his own dystopian version, Christopher Beanland considers the ups and downs of our endless quest for amusement
Tourism in Iran: The country will soon be opening up again after years of isolation

Iran is opening up again to tourists

After years of isolation, Iran is reopening its embassies abroad. Soon, there'll be the chance for the adventurous to holiday there
10 best PS4 games

10 best PS4 games

Can’t wait for the new round of blockbusters due out this autumn? We played through last year’s offering
Transfer window: Ten things we learnt

Ten things we learnt from the transfer window

Record-breaking spending shows FFP restraint no longer applies
Migrant crisis: UN official Philippe Douste-Blazy reveals the harrowing sights he encountered among refugees arriving on Lampedusa

‘Can we really just turn away?’

Dead bodies, men drowning, women miscarrying – a senior UN figure on the horrors he has witnessed among migrants arriving on Lampedusa, and urges politicians not to underestimate our caring nature
Nine of Syria and Iraq's 10 world heritage sites are in danger as Isis ravages centuries of history

Nine of Syria and Iraq's 10 world heritage sites are in danger...

... and not just because of Isis vandalism
Girl on a Plane: An exclusive extract of the novelisation inspired by the 1970 Palestinian fighters hijack

Girl on a Plane

An exclusive extract of the novelisation inspired by the 1970 Palestinian fighters hijack
Why Frederick Forsyth's spying days could spell disaster for today's journalists

Why Frederick Forsyth's spying days could spell disaster for today's journalists

The author of 'The Day of the Jackal' has revealed he spied for MI6 while a foreign correspondent