Scheme Pensions aren’t the magic bullet -yet

There seems to be irrational exuberance among some parts of the IFA community that a new solution is round the corner to what are seen to be the poor “at retirement” options presented by conventional annuities or the new drawdown (under the latest GAD guidelines. If this sounds technical it is!

Take this example (full text via the link)

However, there is a little known but important alternative to capped drawdown for retirees seeking to generate the maximum from their pension funds. A handful of specialist self-invested personal pension (Sipp) providers – generally those that offer the full range of Sipp investment options including commercial property – offer this third option, called ‘scheme pension’. Under scheme pension, the maximum income that can be drawn from your pension pot is calculated by an actuary with regard to your individual life expectancy. It can generate 18 per cent more income than via capped drawdown for a 65-year-old man.

There follow some detailed financial analysis that makes a pretty conclusive case for Scheme Pensions. An actuary will wave the magic wand and whoosh – you are 18% richer in retirement.

There’s a general rule in life that’s worth requoting for the umpteenth millionth time

If it looks too good to be true – it almost certainly is too good to be true.

This from our actuarial technical team…

Under drawdown the amount of income that can be drawn depends on annuity rates set by the Government Actuary’s Department. Those rates reflect gilt yields (rounded down to nearest ¼%) and whether member is male or female and are appropriate to a single life level annuity.

Under money purchase arrangements can be used to provide a scheme pension or a lifetime annuity. The scheme pension is calculated by an actuary (appointed by the scheme if the benefits are payable by the scheme or the insurance company actuary if the scheme pension is paid by an insurance company.). The annuity rates the actuary uses may therefore take into account the actual circumstances of the member – good health etc. They may also use different investments backing the scheme pension. This way it may be possible for the member to receive a higher pension via the scheme.

But there are rules about the scheme pension – it is fixed at the outset – it may increase but it cannot decrease.

http://www.hmrc.gov.uk/manuals/rpsmmanual/rpsm09101460.htm

http://www.hmrc.gov.uk/manuals/rpsmmanual/rpsm09101440.htm

Also if the funds are used to provide a scheme pension, the member effectively loses the benefit of the investment of those funds. So although the initial level of pension may be higher under a scheme pension, I am not convinced that this will be the case in future year. (If drawdown is used, then the funds remain invested and if there is good investment performance the member will benefit when it comes to reviewing the amount that can be paid via drawdown (every 3 years). )

If an occupational money purchase scheme pays scheme pensions then there is the concern that this is in effect a defined benefit and the associated requirements relating to funding then apply. However, the article is referring to SIPPS which are deemed to be personal pension schemes and hence falls outside of the funding legislation.

Lurking in that final paragraph is the problem – the provider of the Scheme Pension is effectively insuring the income stream for life – not for average life expectancy of the nation, or a sub-section of the nation, but for an individual who could drop dead the day after the pension went into payment or live for another sixty years.

This is the take on this from my friend Mark Rowlinson

we just don’t understand how higher pensions can be provided. Who is taking the risk of the pension costing more than Joe Bloggs actuary certifying? Wendy’s immediate reaction was that it may unwittingly be the SIPP provider who is effectively underwriting the liabilities. If so do a) they understand this and b) the government realise this loophole exists. If this isn’t the case then the key question still remains….

What we have here is a lot of unjoined up thinking. The HMRC are slamming stable doors but this stable has never had horses in it. Scheme Pensions cannot be paid by SIPPs because there is no counter-party on whom the “person” in the “personal pension” can off lay longevity risk. The same goes for SSAS schemes – unless they convert into occupational schemes (which for these purposes seem to be defined as schemes where there are 20 or more pensions in payment).

The DWP and The Pensions Regulator are busy chasing other rainbows – principally in auto-ernolment. But as I endlessly repeat, the biggest problem facing “work and pensions” right now is that annuities aren’t working, drawdown isn’t working and Scheme Pensions- which are being touted as the next big thing – are merely a chimera because they have no proper sponsorship.

The Government needs to take a long hard look at taking this risk – Scheme Pensions could become a reality and could provide the backing for scheme pensions that could provide a cheaper alternative to annuities. But to do so they are going to need counterparty insurance – either from the capital market (swaps) or from national insurance or from risk-pooling (the Pension Protection Fund)

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About henry tapper

Founder of the Pension PlayPen, Director of First Actuarial, partner of Stella, father of Olly . I am the Pension Plowman
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