There is a lot of planning merit in looking at the nature of death benefits paid by an existing defined contribution scheme as part of the initial analysis process. Most schemes will typically provide the following (assuming a return of fund benefit):

  • A cash lump sum payable to the nominated beneficiaries.
  • The option of a cash lump sum or transfer to another pension provider for annuity purchase / Nominee Drawdown use.
  • All of the above.

The main disadvantages facing the client and their family from holding pension funds under the first option are:

  • A return of fund lump sum benefit would fall within the survivors’ estate. If this is the spouse there would then be pressure on ensuring this not subject to inheritance tax (and would have defeated the whole IHT efficiency of pension funds purpose).
  • Loss of tax efficiency. If the capital is not required in the short-term then the removal of funds from a tax efficient pension wrapper could result in tax payable and the inability (based on high values) to shelter the funds tax efficiently in good time.

There is however a third issue related to the Lifetime Allowance, which the following case study highlights.

Scenario

The client, aged 66, has recently put a Defined Benefit pension into payment which was initially worth £42,586 per annum plus  a lump sum of £185,000. For the Lifetime Allowance test this was calculated as being £1,036,720 (£42,586 x 20 + lump sum). The necessary Lifetime Allowance tax charge, through commutation of the pension income, has been paid.

The client now has no Lifetime Allowance remaining. There is however an uncrystallised pot worth £56,254 in place which the client is requiring advice on.

In the current format, the pension provider will only pay a benefit on death as a cash lump sum. This would be tested against the lifetime and would, as a lump sum payment, attract the tax charge of 55%. Assuming death were now, the position would be as follows:

£56,254 x 55% = £30,939.70 tax paid

£25,314.30 lump sum paid to beneficiary

The lump sum is not taxed any further as death was prior to the age of 75.

If the client moved their funds to a more flexible provider, the plan could pass to the nominated beneficiary as a nominee drawdown pension. As an income, this would be taxed at 25%:

£56,254 x 25% = £14,063.50 tax paid

£42,190.50 paid to a Nominee Drawdown Pension in the beneficiary’s name

As the client was younger than 75 on death, no further tax is payable on withdrawals made by the beneficiary in respect of their Nominee Drawdown Pension. This has a tax advantage as follows:

Tax paid under the lump sum option: £30,939.70

Tax paid under the Nominee Drawdown option: £14,063.50

Difference: £16,8m/ 76.20

Summary

Through a different pension structure, £16,876.20 less tax can be taken from the pension on death.

In the second part of the Platform Due Diligence (PDD) and Centralised Investment Proposition (CIP) we look at the ‘what’ in terms of constructing each of these.

What does a good PDD and CIP look like?

At their most fundamental, a PDD and CIP should demonstrate a researched and justified approach you aim to take with a defined bank of clients based on the following:

  • Suitability as to what your typical/subset of clients are looking to achieve
  • Financial due diligence on the platform(s)/investment provider(s)

MIFID II introduced Product Governance (PROD). As part of this, there is a formal requirement on firms to segment clients as part of the service proposition offered to them.

This requirement will work well in tandem with a formal PDD and CIP in providing justification for how clients of your firm are served as part of your ongoing proposition.

What do I need to do to construct a PDD and CIP?

Platform Due Diligence
  • You should be considering the whole market (if independent) and assessing the Platforms based on specific criteria relevant to the target clients and in how your CIP is delivered
  • You should consider the financial aspect of the Platform(s) and ensure that you have the best available knowledge in regard to your chosen option(s). Financials can and do change but as part of your annual re-fresh you will be able to account for this and make appropriate decision if required.
  • The regulator does mention cost and rather then this being seen as a ‘go for the cheapest’, you should be able to construct suitable PDD accounting for the costs the client will pay and proving that these tie in with what they expect and/or what they will receive in terms of service and proposition.
  • A PDD can never account for all clients, even with a clearly defined subset. It should therefore be constructed flexibly to account for outliers within a subset or divided further into different type of clients.
Centralised Investment Proposition
  • Again you should be considering the whole market (if appropriate) and have a defined set of parameters, based on the service you wish to offer, that you use to find a suitable investment approach.
  • Clients accumulating and clients in a decumulation phase have two very different needs and parameters to consider within your assessment. Demonstrating how your chosen CIP takes into account differing objectives is key.
  • You should be comfortable with the nature of the investment proposition and how this links to risk, particularly with how the investment is reported and monitored.
  • While not essential, an investment that links to the risk profiling tool used by the firm can provide a good and efficient way of monitoring the investments.
  • Cost versus delivery. This should be a consideration in terms of is the cost justifying what is provided, particularly against peers.

Is the passive fund(s) more expensive than equivalent funds for no justifiable reason?

Is the active fund failing to outperform peers over various measures even with higher costs?

Can the DFM justify their fees when looking at their returns?

Tools

You will need access to the following type of tools:

  • Financial assessment tools: to assess the Platform(s) in question. This could be through independent rating agencies or independent platform evaluators.
  • Product comparison tools: This will help narrow down your Platform/CIP from the whole market into options that are specific and applicable to both the proposition you want to deliver and the expectations and requirements for the client bank.
  • Investment comparison tools: This will help assess initially, and monitor later, the investment characteristics of your CIP. In the case of a DFM, this is more important as you are outsourcing the management to a third party and should have in place a way of obtaining this information from them.

Part 3

In our final part, we will try and tie together the ‘Why’ and the ‘What’ to show ‘How’ your PDD and CIP can be constructed.