RP case studies: Transfers in drawdown explained

Justin Corliss explores a set of circumstances where switching drawdown contracts may result in better client outcomes

Pension freedom and choice has had a huge impact on the income drawdown market, which continues to grow and evolve to meet client demands. However, despite the amount of product development in this market, the instance of switching between drawdown products is surprisingly low.

Someone beginning income drawdown in 2015 is likely to have changed their car once and mobile phone twice since then as technology advanced and older models become outdated, but they’re likely to still have the same drawdown contract.

The following case study explores circumstances where switching drawdown contracts may result in better outcomes for your client.

Meet Advik & Prisha

  • In 2015, they’re both 54, married and have no children.
  • Advik has a SIPP with a value of £500,000. He has a very adventurous attitude to risk (ATR).
  • Prisha on the other hand has a low-cost personal pension valued at £400,000. She has a much more cautious ATR.

At age 55 they both fully crystallise their plans, using flexi access drawdowns (FAD) attached to their existing arrangements to fund significant home improvements. However, they keep working until age 60 when they both retire and begin drawing income from their respective plans.

Only two months after they both retire in 2021, Advik dies unexpectedly. Prisha is understandably distraught, but one small mercy is the scheme administrator has chosen Prisha as the sole beneficiary of Advik’s pension plan. They have no children, and there’s no-one else the scheme administrators feel should receive any of the money.

So Prisha now has ownership of both plans which are now valued at:

  • Prisha’s FAD – Value £325,000, taxable at her marginal rate, cautious investment strategy.
  • Dependant’s FAD (previously Advik’s plan) – Value £440,000, income tax free as Advik died under age 75, adventurous investment strategy.

Prisha has approached a financial adviser for advice on the dependent’s FAD and whether remaining in the adventurous investment strategy is the right option for her. Prisha’s adviser completes a full financial review of her circumstances and highlights the following issues with the dependent’s FAD:

  • It’s not aligned to Prisha’s attitude to risk. Now in isolation, this is unlikely to necessitate switching the plan, particularly given it’s in a SIPP which you’d expect to have a broad range of investment options. A transfer in drawdown is likely to have an initial cost, so we need to prove it’s both necessary for the client and that there’s a likely long-term benefit. So a need for the investment strategy to be realigned for someone in a SIPP is unlikely to cut it. But there’s more.
  • Although Prisha needs her investment strategy re-aligned now, she’s not an active investor, so once the new portfolio has been chosen, she’s unlikely to need the functionality the SIPP provides on an ongoing basis.
  • To compound this, the SIPP product is expensive. Almost double the cost of Prisha’s existing plan. Once again, higher cost alone doesn’t automatically make a plan less suitable than a cheaper one. Some drawdown plans have higher costs than others, possibly because they have features another plan might not have, and if the client wants or needs this then it can be value for money. However, Prisha doesn’t need this functionality and therefore shouldn’t really be paying for it.
  • We should also consider target market groups from a PROD perspective. The advice firm advising Prisha has fully adopted a robust centralised investment proposition, part of which involves segmenting their client bank for at-retirement clients and identifying which target market group they’re a part of. Each target market group has not only a specific investment strategy which is considered suitable for their needs and objectives, but also a specific type of plan to be used for that target market group.
  • The target market group most suited to Prisha uses lower cost plans, generally with a range of governed solutions to keep ongoing costs down. Advik’s SIPP does not meet these criteria, so Prisha’s adviser recommends switching the dependant’s FAD plan to the same provider Prisha uses for her own plan. As income drawdown plans can’t be combined, the dependent’s FAD can’t go into the same plan as Prisha’s drawdown plan. However, Prisha’s adviser has identified that her provider calculates the ongoing AMC on the total Prisha has across all plans, so she still gets the same large fund discount she would if all funds were held in one plan.

Regular reviews of income drawdown plans enable advisers to take account of changing client circumstances and help identify when altering the plan might be in the client’s best interest. Death of a plan owner is just one instance where a transfer in drawdown may warrant consideration, but it’s an obvious one, as the plan aligns with the needs and objectives of someone who’s no longer the owner of the plan.

Justin Corliss is senior intermediary development and technical manager at Royal London