Investors need a better road map
In the last of a series on pensions, James Patterson questions the service provided by advisers
Sunday 17 September 1995
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.
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.
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