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The Scheme Pension trap

28 June 2020

Can scheme pension continue to have a place in financial planning? Stephen McPhillips, technical sales director, Dentons Pension Management Limited, considers its use in financial planning

This article was first published in the June issue of Professional Paraplanner.

When it comes to retirement benefit options within self invested pensions, paraplanners will be familiar with the most common options clients elect – flexi-access drawdown (FAD) and capped drawdown (CD). Both of these offer some flexibility around the amount and timing of income payments and, arguably, FAD offers the greatest degree of flexibility. That, of course, has to be balanced with the impact on a client’s annual allowance (AA) since accessing pension income flexibly in that way triggers the money purchase annual allowance (MPAA) (currently £4,000) and therefore would restrict tax relievable pension contributions.

Underpinning both options is the fact that it is no longer a requirement for a client to ever purchase an annuity and, thanks to the pension freedoms introduced in 2015, clients now have tremendous flexibility to cascade pension wealth down through the generations using vehicles such as these.

Occasionally, however, paraplanners might become involved in a client scenario involving a “scheme pension” within a small self administered scheme (SSAS) or, even less commonly, within a self invested personal pension (SIPP).

What is a scheme pension?

The concept of scheme pension within SSAS has been around for decades and it was a form of annuity purchase deferral. In effect, it offered a window through which to arrange for a timely disposal of (potentially illiquid) investments in preparation for the purchase of an annuity with the member’s accumulated cash fund. Ultimately, though, an annuity had to be purchased at a point in time, generally by the time the member reached age 75.

The principle behind it is sound enough; the actuary to the scheme should calculate the amount of pension income that the member’s share of the SSAS fund would be likely to sustain and the pension income would be paid from the SSAS bank account – instead of being paid by an insurance company through an annuity. In order for this income level to be calculated properly, the actuary should be taking into account factors such as:

  • the member’s age
  • the member’s health status
  • any contingent spouse or dependant pension(s) payable on death of the member
  • any increases in the pension(s) in payment (escalation) required
  • the value of the member’s share of the fund.

In effect, the member must make clear decisions about the look and shape of the pension income at the time he / she starts to take the scheme pension option – akin to the decisions which would need to be made when buying an annuity. The actuary then takes all of these factors into account when assessing and setting the level of income that the member’s fund is likely to be able to sustain, assuming all the assumptions are borne out in practice. Thereafter, it must be regularly reviewed by the actuary and adjusted if necessary.

Why use a scheme pension?

As noted above, historically, it was used within some SSASs to enable deferment of an annuity purchase and, often, to allow for timely disinvestments to create the cash necessary for annuity purchase.

More recently, however, in some cases scheme pension was seen by some as a vehicle to maximise a client’s pension income from SSAS/SIPP if the scheme pension calculation offered a higher level of income than, for example, capped drawdown figures, which are constrained by Government Actuary’s Department (GAD) rates. A higher level of income might be possible where, for instance, the member’s health is sufficiently poor to suggest shorter life expectancy than normal. In turn, a shorter life expectancy suggests that the member’s fund can be used-up more quickly through higher levels of pension income being paid – so as to exhaust their fund during their lifetime.

Clearly, for this concept to work legitimately, the member’s health status must be accurately assessed by the actuary and involve suitable medical evidence being obtained at outset (and possibly beyond for future reviews). In addition, the member should be making all the necessary decisions about contingent pensions and so on, as outlined above. If all of these are not considered fully at outset and factored into the actuary’s calculations, this calls into question the legitimacy of the operation of scheme pension in that case.

Why avoid using scheme pension?

Readers will make their own judgements about the efficacy of scheme pension – whether it is operated fully as it should be, or whether there is some side-stepping of the general principles around it, for example, little or no regard to obtaining proper medical evidence. Undoubtedly, scheme pension will have been the right option at the right time for certain clients.

Income

It can be argued that the introduction of FAD has completely negated the need for scheme pension, as it offers unlimited levels of pension income to the member. Compare this with the constrained levels of scheme pension certified by the actuary. In addition, members don’t have to make difficult “crystal-ball” type decisions around building-in any pension increases, contingent pensions and so on. The lack of need for medical evidence for FAD might, in itself, be a comfort to many clients.

Death benefits

Worthy of an article in its own right, the death benefit position under FAD is far more flexible than the death benefit position under scheme pension. As noted above, pension freedoms offer members, their nominees and successors amazing options. Unfortunately, these are not options available under scheme pension.

Restrictions on choice

Scheme pension cannot be converted to FAD, capped drawdown and so on. The only option once in scheme pension is annuity purchase. In this respect, scheme pension can be seen as a one-way street for the member.

In conclusion, whilst there may be circumstances where scheme pension was, and possibly still is, the right decision for a SSAS/SIPP member, it has largely been superseded by newer, better, options and it remains a very niche proposition which many providers choose not to offer for good reason.

 

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