Flexi-access drawdown has become significantly more popular following the 2015 pension freedom reforms. It’s easy to see the attractions.
A money purchase pension scheme member avoids locking into an annuity when rates are historically low. A flexible income suits many retirement lifestyles better than a fixed income. And the death benefit options allow funds to flow down the generations.
However, clients need to actively engage with investment choices on an ongoing basis to maintain a sustainable income, understanding the significance of volatility and pound/cost ravaging.
Managing drawdown may not seem that onerous at the outset, but we all face the risk of losing cognitive capacity as we get older. Clients who fully engage with their advisers can benefit from ongoing support to keep their drawdown on track to provide a sustainable income.
Most people will retain the mental capacity to deal with their financial affairs. They’ll understand the need for changes to income levels, whether a lump sum withdrawal strategy is more suitable, and alterations to the underlying investments.
However, consideration should also be given to what happens if a client becomes much less or completely unable to handle their own financial affairs.
This may be a slowly developing problem, as with some forms of dementia. Or there could be sudden significant brain damage following a stroke or heart attack. And as pension drawdown is an individually owned product, loss of capacity for one spouse or partner could cause significant financial difficulties in the short term for the other.
If there’s no suitable power of attorney in place when someone loses the mental capacity to deal with their own affairs, someone has to apply to the courts for the legal authority to take over.
In England and Wales this involves a deputyship order. Scotland uses intervention and guardianship orders. A controller needs to be appointed in Northern Ireland. The process is normally lengthy – six months is not unusual and the client’s financial affairs are in limbo in the meantime.
What does that mean? Regular income sources – whether from an annuity or ongoing drawdown – can continue to be paid into the member’s bank account. But until a court order is in place, no-one has the authority to vary existing or set up new expenditure.
It won’t be possible to arrange for any new lump sum pension withdrawals. Nor will anyone have the authority to vary any arrangements already in place for managing drawdown investments.
It might not matter too much if markets are stable, the investments remain suitable, or there’s still a valid discretionary mandate. But if there’s a stock market crash, or other factors trigger a review, corrective action could be significantly delayed.
In England and Wales, clients should normally consider a lasting power of attorney: property and financial affairs – although existing enduring powers of attorney set up before 1 October 2007 are still valid. Continuing or combined powers of attorney are used in Scotland, and enduring powers of attorney are still used in Northern Ireland.
Ideally, clients set up the lasting power of attorney or equivalent while they’re fully in control of their own affairs. They can then carefully consider who will make a suitable attorney – putting them less at risk of exploitation while vulnerable. They can think about who has the capacity to deal with potentially more complex planning including the ongoing management of their drawdown in liaison with their adviser. And take the time to resolve any issues generated by family dynamics.
The modern concept of mental capacity treats it as a continuum. So, for example, someone who creates an LPA can be reassured that they’ll have the legal right to be involved in decision making so far as they are able, even after they start to lose the mental capacity to fully look after their own affairs.
Legal protections aim to ensure that funds are used for the client’s own benefit. For example, there are significant restrictions on gifting arranged by the attorneys.
With a lasting power of attorney or equivalent in place, a client’s attorneys will have the legal authority to work with their adviser to consider how best to use flexi access drawdown funds and other assets. There’ll be no barriers to ongoing reviews to ensure this resource is best used for the client’s benefit even in the face of significantly changed circumstances.
A client’s income and capital will be taken into account if they need residential long term care. The rules vary for each of England, Wales, Scotland and Northern Ireland. Age UK, Age Cymru, Age Scotland and Age NI provide factsheets and other support covering each jurisdiction.
However, it’s worth mentioning how pension funds are treated. Uncrystallised funds and funds designated for drawdown are treated as an actual or potential income source – rather than as capital. The member is treated as receiving the higher of the actual income they’re withdrawing, or the amount of annuity the funds could purchase.
Lump sum withdrawals become treated as capital. Withdrawing and giving funds away isn’t a solution to means testing, because of the deliberate deprivation of assets provisions.
For more detailed information on the treatment of pensions post freedom and choice, see the Care & Support Statutory Guidance – annexes B & C.
Bernadette Lewis is financial planning manager at Scottish Widows