Solicitors' pensions - time to take stock

Ian Muirhead recommends self-invested personal pension as a pensions-saving vehicle

Various research findings over recent years have lamented solicitors' lack of awareness of pensions matters.

If additional proof were needed, one need look no further than the Equitable Life debacle, of which solicitors were a notable casualty.

Should have they known better? Hindsight is a great thing, but two points stand out.

First, the over-dependence of some investors on a single product provider (too many eggs in one basket).

Second, the failure to register the fact that the Law Society's prohibition against referring clients to Equitable Life, as a tied sales organisation, might have suggested caution in relation to solicitors' dealings with the same company on their own account.

Those who might have been fortunate enough to avoid the fall-out from Equitable are unlikely to have avoided the consequences of the stock market rout of the past three years; and many will have begun to question the wisdom of saving for retirement.

But save we must if we are to avoid penury, and apocryphally the best time to invest is when the blood is flowing in the streets.

The conclusion is that we need to be more canny about the way we invest and we need also to take account of the welcome simplifications proposed in the recent pensions Green Paper and the accompanying Inland Revenue discussion document.

The revenue proposals, which are timed to come into force as early as April 2004, do away with the existing contribution regimes and permit contributions of up to 100% of current earnings, with a maximum of 200,000 annually.

However, there is a restriction of 1.4 million on the total accumulated fund which is eligible for tax relief.

It is also proposed that there should be greater flexibility in relation to the timing and form of the withdrawal of pension savings.

The pensions industry has been lobbying for several years for a relaxation of the requirement that the value of a personal pension fund should be applied to purchase an annuity by no later than age 75, but the revenue opposed this on the basis that it would lead to an unacceptable reduction in the income tax take on annuity income.

However, a concession is proposed which would build on the facility which has been available since 1995, known as pension income drawdown.

This permits the crystallisation of pension funds to be deferred after retirement and an income drawn from the investments within the fund.

Apart from the opportunity this provides to defer annuity purchase, it can also have major estate planning advantages, in that in the event of death during drawdown, the value of the fund can be returned to the estate of the policyholder, subject to a tax charge of 35%.

The problem with annuities has always been that they die with the annuitant.

Two major changes are proposed for drawdown.

First, that the current obligation to draw an income within limits prescribed by the government actuary should be removed, and funds should be permitted to roll up their investment returns subject only to a nominal 1 annual income being drawn.

Second, that drawdown can be maintained after the age of 75 - although there is an important penalty attached in that if on death after age 75 there are no survivors or dependants to whom the income can be paid - the fund will be forfeit.

For all its advantages, it has to be acknowledged that drawdown is a fairly high-risk arrangement.

It depends for its success on the pension fund maintaining its annuity-purchasing power and on annuity rates becoming more, rather than less, attractive (despite the fact that as age increases, the mortality cross-subsidy within the provider's fund will inevitably decrease).

For many investors, the alternative of phased retirement will have greater appeal - provided that they can afford to relinquish the tax-free cash attaching to their maturing policies.

This arrangement works by progressively realising segments of a pension policy or policies, purchasing an annuity with 75% of the value realised and applying the 25% tax-free cash to augment the income.

This avoids having to commit all one's funds to the annuity market at what might turn out to have been an inopportune time.

It permits account to be taken of factors which might influence the type of annuity being bought, such as the longevity of the annuitant or spouse.

And it maintains the policy in force as an asset which can be passed on to dependants.

Whichever of the three alternatives might be chosen - annuity purchase, phased retirement or income drawdown - there is a consensus among pensions commentators that investors will achieve the greatest flexibility by using the self-invested personal pension (SIPP) as their main pensions-saving vehicle.

SIPPs permit a much wider range of investments to be sheltered from tax than conventional personal pensions.

They can be used to hold individual equity shareholdings and partners' business property.

And because they separate the management of the scheme from the investment of the scheme assets, they provide transparency of charges.

Therefore, SIPPs are commonly less expensive than other personal pensions.

Holders of personal pensions need to review their existing policies in the light of these developments.

Some older types of policy have features which would now be regarded as unacceptable.

For example, on death many old policies pay out only the value of the contributions, rather than the current value of the fund.

Others allocated a proportion of premiums to so-called capital units, as a means of siphoning off extra charges.

Modern policies tend to be cheaper and more flexible, and to offer a greater range of investment options.

Therefore, there could be an advantage in consolidating pension holdings into a SIPP, subject to checking possible transfer charges.

Consideration should also be given to alternative means of saving.

Individual savings accounts provide access to similar investments but enjoy different tax characteristics, which may complement those of the personal pension.

The proceeds are exempt from income tax and capital gains tax, but the contributions do not enjoy the income tax relief granted to pensions.

So, in the same way as it pays to diversify between asset classes and product providers, so it pays also to diversify between investment vehicles.

Diversification is the key to the containment of risk.

Ian Muirhead is a member of the Law Society's financial and investment business working party and director of Solicitors for Independent Financial Advice