Product Specific Guidance - Investments

Annuities

Product Suitability

NB: Since April 2011 there is no longer a requirement to purchase an annuity by age 75 as this upper age limit has been removed. This means that annuity purchase can be postponed indefinitely or avoided completely in suitable circumstances although annuity purchase at some point will remain the appropriate route in the majority of cases.

From December 2012 annuity providers are no longer allowed to differentiate between genders when calculating annuity rates. This is likely to have a detrimental effect on some annuity rates (particularly for males or where joint life annuities are purchased).

When a client is accessing benefits from a pension arrangement the following are essentially the main options:

  1. Leave the existing pension fund with the current provider. Then, if appropriate, take a tax free cash sum (Pension Commencement Lump Sum) and utilise that provider’s annuity rates to purchase a conventional compulsory purchase annuity, which guarantees a lifetime income.
  1. Exercise a transfer of the whole value of the pension fund to another provider which currently offers the best conventional annuity rate (known as exercising the open market option).
  1. Use the whole of the pension fund, after TFC, to purchase a 'with-profits' annuity with the existing or another provider.
  1. Use the whole of the pension fund, after TFC, to purchase a unit linked annuity with the existing or another provider.
  1. Transfer the whole value of the pension fund into drawdown pension. This allows future income levels to be varied to fit in with the client’s overall financial plan.
  1. Transfer the pension fund to a provider offering a flexible annuity (sometimes referred to as a ‘third way’ annuity) which attempts to combine the certainty of an annuity with the prospect of investment growth seen with drawdown pensions.
  1. Convert the retirement fund in stages, over a number of years, into income (staggered vesting/phased retirement) by transferring into a personal pension plan (if the client does not already have a suitable plan).
  1. Transfer the pension fund to a provider offering a scheme pension (usually only available with defined benefit pension schemes). This allows for income levels to be actuarially determined based on personal circumstances.
  1. Use the value of the pension fund to utilise a combination of the above options.
  1. If certain conditions are met, it may be possible for the entire pension fund to be taken as a lump sum (known as a trivial commutation lump sum). The conditions include being aged over 60 and the total value of pension rights from all registered pension schemes being £18,000 or less. Under separate rules introduced on 6 April 2012 small personal pension pots of £2,000 or less can be commuted (up to two per person) if aged over 60 – these rules are in addition to the standard £18,000 triviality rule.

Compulsory Purchase Annuity

This type of annuity pays an income for life with the amount payable depending on such factors as:

  1. Age of annuitant (from Dec 2012, the annuitant’s sex can no longer be a determining factor).
  1. Amount of the pension fund.
  1. Level or escalating pension.
  1. Level of spouse/dependants’ pensions (if any).
  1. Income frequency.
  1. Whether paid in advance or arrears.
  1. Whether with or without proportion/overlap.
  1. Whether guaranteed annuity rates are available with existing provider.
  1. Whether capital protection (known as annuity protection) is selected.
  1. Choice of guarantee period.
  1. Availability of Impaired life/Enhanced annuity rates (often available to those with particular medical conditions and/or smokers, those who are overweight, those who have had certain occupations or live in particular locations).
Advantages
  1. Guaranteed level of gross income for life.
  1. Spouse/dependant(s) can enjoy a guaranteed level of gross income, in the event of annuitant’s death (if applicable).
  1. Pension can be payable for a guaranteed period of time (e.g. 5 or 10 years).
  1. Access tax free cash lump sum immediately, (although with a lower pension), to spend or invest as client wishes.
Disadvantages
  1. Level of income is fixed at outset and cannot respond to changing personal financial circumstances.
  1. The level of income is fixed at outset and will depend upon the level of annuity rates available at that time.
  1. The income will not keep pace with inflation (unless the annuity is set up to increase each year and the increase rate matches or exceeds inflation).
  1. There is no possibility of benefiting from future investment growth on the pension fund, although an implicit rate of investment growth has been assumed when setting the annuity rate to provide the income.
  1. In the event of death, depending upon the type of annuity purchased, benefits to dependants could be lower than those enjoyed under some of the other retirement options available.
  1. Once the annuity has started it is not possible to amend the basis chosen or the provider selected.
  1. No surrender value.
  1. Payments cease on death unless an option to continue for a spouse/dependant has been selected.

Investment linked – With Profits Annuities

These provide an income linked to the investment returns of an insurance company’s with profits fund. Income payable can go down as well as up in the future. With profit annuities do however provide smoothed investment returns. Typically, income is made up of a minimum starting income set at a low level (unless investment conditions are very poor, it would be usual to receive at least this much income. Some with-profits annuities guarantee this level of income) plus bonuses. At outset, with a with profits annuity, an anticipated bonus rate (ABR) is normally chosen in the approximate range of 0% to 5% and once selected cannot usually be changed (although some products do allow this). Depending on the actual bonus rate declared by the insurance company, income may stay the same, increase or decrease.

Some providers allow conversion to a standard annuity with them at given points in the future.

Advantages
  1. Minimum guaranteed level of gross income for life.
  1. Spouse can enjoy a semi or minimum guaranteed level of gross income, in the event of annuitant’s death (if applicable).
  1. Pension can be payable for a guaranteed period of time (e.g. 5 or 10 years).
  1. Immediate access to TFC.
  1. Income may rise above guaranteed levels if the with profits fund performs well.
Disadvantages
  1. Initial income and anticipated bonus rate (ABR) are fixed at outset and cannot normally respond to changing personal financial circumstances.
  1. Although an implicit rate of investment growth has been assumed when setting the annuity rate to provide the income there is no guarantee that investment returns will exceed or even match the rate assumed - income could, therefore, fall or fail to increase.
  1. In the event of death, depending on the type of annuity purchased, dependants’ benefits could be lower than those available under some of the other retirement options.

Investment linked - Unit Linked Annuities

Income is linked directly to the value of an underlying fund of investments. Generally, there is a wide range of funds to choose from catering for most risk profiles including, fixed interest/deposits, property, equity and tracker funds. The more risky the underlying fund, the more income may vary – both up and down. Some unit-linked annuities work in a similar way to with-profits annuities.

Starting income is based on an assumed growth rate and if the fund grows at that assumed rate, income stays the same with increases/decreases to income if fund growth is higher/lower than assumed A few unit-linked annuities allow investment in a ‘protected fund’ which limits the fall in income. Most unit-linked annuities do not guarantee any minimum income.

Advantages
  1. Income fully reflects the movements in the value of underlying assets.
  1. Spouse can enjoy an income, in the event of annuitant’s death (if applicable).
  1. Pension can be payable for a guaranteed period of time (e.g. 5 or 10 years).
  1. Immediate access to TFC.
  1. Income may rise above chosen assumed growth rate.
Disadvantages
  1. Income may fall even if a 0% assumed growth rate has been selected.
  1. In the event of death, depending upon the type of annuity purchased, dependants’ benefits could be lower than those available under some of the other retirement options.

Investment linked - Flexible (third way) Annuities

Up until recently the UK retirement market has been dominated by providers of traditional annuities and drawdown pension plans but new plans are increasingly emerging which attempt to combine the certainty of an annuity with the prospect of investment growth seen with drawdown pension i.e. the best of both worlds. Generally speaking these flexible annuities fall into three main categories;

  1. Annuities with flexibility - these are similar to traditional annuities i.e. payable throughout lifetime but with a degree of income and/or investment flexibility.
  1. Fixed term annuities – these provide a guaranteed income for a set period of time with a guaranteed or reviewable maturity value. These plans may incorporate a maximum expiry age.
  1. Drawdown pension with income guarantees – these are basically drawdown pension plans but with some level of underpinning income guarantee which will continue no matter how the underlying investment performs. Some plans provide an income for life whilst others may incorporate a maximum expiry age.

Product Options

Types

  • Phased retirement (using annuities and/or drawdown)
  • Drawdown pension (capped or flexible)
  • Occupational drawdown
  • Conventional annuity
  • With Profits annuity
  • Unit linked annuity
  • Flexible (third way) annuity
  • Impaired life/enhanced annuity

Options

  • Single or joint annuity
  • Level or escalating annuity
  • Capital protected annuity (annuity protection)
  • Guaranteed period
  • Income frequency
  • Advance or arrears
  • With/without proportion
  • With/without overlap

Special Considerations

Open market option

Consideration should always be given to the open market option where available.

Impaired life/enhanced annuity rates

The availability of impaired life or enhanced annuity rates should always be investigated.

General questions regarding the client’s health such as:

  1. Do they smoke?
  2. Are they currently taking any prescribed medication?
  3. Have they ever been hospitalised?

should be obtained to help identify where enhanced rates are likely to be available.

Guaranteed annuity rates

It is important to check whether guaranteed annuity rates are included within the client’s existing plan? These are often only available at specific ages and/or if benefits are taken in a specific form. Always check availability prior to recommending a move to a different plan.

Replacement Policies

The adviser should obtain from the provider of the existing pension arrangement, an Illustration confirming current fund and transfer values, and annuity illustrations on the required bases. In some cases, there may be a charge for moving funds elsewhere in order to achieve a better annuity rate (i.e. exercising the open market option).

By obtaining this data, the adviser can undertake a like for like comparison of the amount of annuity available from the existing contract with any new product recommended taking into account any costs for moving the funds.

The adviser should only proceed with the replacement of an existing contract, if the client is likely to benefit from the transaction. For example, if the transfer from the ceding scheme is more expensive then there should be valid grounds to justify the extra cost.

For any cases where the client may suffer a loss we recommend that these are referred to your Compliance Oversight function prior to making any formal recommendation.

Any guaranteed annuity rates available on the existing policy should be considered carefully. These are more commonly found on old retirement annuity contracts although occasionally on other pension types.

Clients may have transferred their occupational pension scheme to a personal pension previously and this may restrict the benefits payable in some cases.

Clients with scheme specific tax free cash protection (i.e. tax free cash under an occupational pension scheme that was greater than 25% of the fund/benefits at A day) will normally lose this protection if a transfer takes place, leading to a reduced tax free cash sum.

We recommend that a replacement policy form is completed and signed by the client. This should detail a full comparison of costs, performance, charges, disadvantages and any guarantees given up. This should outline a balanced view and not involve the adviser leading the client toward a pre-determined course of action.

To assist you a Replacement Policy Form – Pensionsis available.

Additionally the suitability report should confirm:

  1. The client’s personal and financial circumstances and objectives; highlighting and justifying specific investment objectives: consolidation; reduction in charges; improved performance etc
  1. Why it is considered appropriate to replace the existing contract rather than recommend annuity purchase with the existing provider (particularly if costs are involved)
  1. Any exit penalties or investment loss which might be incurred on moving the funds to a new provider
  1. Why the provider selected is likely to prove better than the existing provider, accompanied by a statement confirming that there is no guarantee that better performance will be achieved (where a with profits/unit linked annuity is being recommended)
  1. Whether any guaranteed annuity rates were available and any other benefits given up

Suitability Report

The suitability report for pension annuity purchase should address the following as a minimum:

  1. The client’s objectives.
  1. Confirmation of the client’s assets or ‘net worth’.
  1. The client’s attitude to risk.
  1. Any impaired life/enhanced annuities available (if applicable).
  1. Any existing guaranteed terms available (if applicable).
  1. That an open market option has been researched (if applicable).
  1. If the total value of all pension benefits exceeds the client’s ‘lifetime allowance’ they will be subject to a tax charge of up to 55% on the excess. In tax year 2012/13 the lifetime allowance is £1.5 million unless transitional or fixed protection is in place.
  1. The reason for choosing that product.
  1. The reason for choosing that provider.
  1. Reference to key features document and illustration
  1. Where appropriate, replacement policy, limited advice and non-disclosure warnings.
  1. If a unit linked annuity – warning that ‘unit prices can fall as well as rise’.
  1. If a with profits annuity – warning that ‘the past is not necessarily a guide to future performance. Bonuses come from profits to be earned and are not guaranteed’.

To assist you, a range of Suitability Reports are available on our website.

Bonds

Product Suitability - Bonds

In assessing the suitability of a bond, the adviser should consider the following:

  1. The client’s tax status (both income tax and CGT), and whether this is likely to change in the future.
  1. The client’s attitude to risk and how this relates to their expectations in terms of investment return.
  1. Whether the client wishes to take an active role in the investment strategy i.e. is there a preference for advisory or discretionary management.
  1. The client’s time horizons and the flexibility of their arrangements.
  1. The client’s need for access to capital.
  1. The ability of any contract to maximise the surrender value of the contract in the event that it is surrendered or discontinued prior to ‘maturity’.
  1. The client’s requirement for ‘income’ during the investment term.
  1. Whether the contract is to be held subject to a trust.

Product Options – Bonds

Types of investment bond

  • With profit bond
  • Unitised with Profit bond
  • Unit linked bond
  • Distribution bond
  • Hybrid bond
  • Stockmarket bond

Types of guaranteed bonds

  • Guaranteed growth bond
  • Guaranteed income bond
  • Guaranteed equity bond

Basis

  • Single life
  • Joint life first death
  • Joint life second death

Withdrawing Capital to Meet Income Needs

The adviser should generally advise clients to retain sufficient capital on deposit to meet their additional income needs over the following twelve months, prior to making any withdrawals from investment contracts recommended.

When recommending the withdrawal of income (or capital) from an investment contract the adviser should ensure that the level of withdrawal does not exceed, on an annual basis, 5% of the capital originally invested. In all cases, the adviser must give due consideration to the effect of income withdrawals on the capital value of the investment, and warn the client with regard to the potential for capital erosion.

In all cases, where the withdrawal of income is recommended this should be clearly demonstrated within the client specific illustration.

In addition, the suitability report should state:

  1. The level and frequency of withdrawal being made, and how this relates to the client’s income needs; and
  1. That the withdrawal of capital to provide income, at whatever level, may have a negative effect and ultimately erode the client’s capital investment if the contract’s growth does not at least match the level of income generated by the contract; and
  1. How the ‘income’ is to be taken – as regular withdrawals across all policies within the bond or as a series of encashments of individual policies?

In any cases where the adviser wishes to recommend a withdrawal of over 5% pa in the first twelve months of investment, we recommend that the case be referred to the Compliance Oversight function for approval prior to a formal recommendation being presented to the client.

Income Distributions

In cases where the client receives ‘normal’ distributions, in the form of a dividend for example, the suitability report should state:

  1. That the objective of the investment contract recommended is to provide income, and that this may well be reflected in the capital performance of the investment;
  1. That the income provided by the investment contract will vary according to the income generated by the underlying investments, and may fall as well as rise.

Special Considerations - Bonds