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Efficient and well-designed income solutions are currently the “biggest gap” in the retirement market, according to an institutional investment platform.
But Hugh Cutler, chief commercial officer at Mobius Life, says an expected increase in demand for retirement income as a result of inheritance tax on pensions will lead to more sophisticated decumulation strategies.
The upcoming IHT measure, the commercial chief says, will encourage savers with high value pots to take an income from their pension and utilise their basic rate of income tax, as well as possibly their higher rate.
“If they don’t take the money, it’s going to get taxed at 40 per cent when they die; and then still, their dependants might have to pay income tax on it. And so I think there’s going to be a lot more demand for income solutions,” Cutler says.
A consultation from HM Revenue & Customs says in recent years pension schemes have been “increasingly used and marketed as a tax planning tool to transfer wealth without an IHT charge, rather than for their intended purpose of funding retirement”.
From the 2027-28 tax year, most unused pension funds and death benefits will be included within the value of an estate for IHT purposes.
While the measure is expected to increase demand for retirement income, Cutler says income solutions today are usually not very sophisticated, such as those based on model portfolios of Ucits funds.
“Those Ucits funds are limited in what they can do in terms of asset classes, and they pay withholding tax,” he says. “If you’ve got income solutions and you’re paying withholding tax, that’s sort of suboptimal.
“And so we would anticipate there to be a growing demand for more sophisticated income solutions, including a wider range of assets that are lower cost, more tax efficient, to support income generation.”
In terms of creating high-quality decumulation solutions, [IHT is] another thing that’s going to accelerate that.
Cutler cites asset classes such as private debt, and debt supported by infrastructure or real estate, for their tendency to produce “attractive and stable” levels of income.
“You also see asset classes like asset-backed securities or structured credit that pay high income with stable values. You’d also see strategies like structured or guaranteed equity products where you maintain participation in the equity market, but you protect against extreme downside losses.
“When you’re designing decumulation or income strategies, you have the issue of sequencing risk. So you want to create portfolios of assets that produce high levels of income and have low price variability; these sorts of assets become critical to that.”
Besides a wider range of assets, Cutler says another source for potential innovation is mortality pooling, similar to collective defined contribution schemes. “There’s a cross-subsidy between people who die and people who live, which means that those who live get a higher income for life.
“That’s another area of product development that has not really happened to a massive extent to date; but I think that increasing demand for income solutions may lead to more interest.
“However, I don’t think IHT is really going to drive that, because the people for whom IHT is an issue probably have enough money that they will still leave an inheritance. I certainly think those sorts of solutions will become more prevalent; but it’s less obvious to me that it’s really a result of the IHT change.”
Indeed, designing products with the aim of mitigating IHT would likely face challenge from HMRC, says Julie Hammerton, head of Hymans Robertson Personal Wealth. But she also says that innovation could come in the form of collective defined contribution schemes.
“Given the vast majority of people won’t have adequate savings for retirement, pension product innovation is more likely to focus more on helping retirees maximise the income they can take in retirement through risk sharing and pooling, for example in vehicles such as CDC schemes,” Hammerton says.
Andy O’Regan, chief client strategy officer at TPT Retirement Solutions, a workplace pensions provider, likewise says that innovation in the pensions industry, including products like CDC schemes, will have to consider their design carefully from an IHT perspective if they are to become an attractive alternative to current pension saving methods.
“With the introduction of [IHT] changes landing in the same year as we’re likely to see the first multi-employer CDC scheme going live, a suitable alternative benefit structure could be arriving at just the right time,” he adds.
Indeed, while IHT on pensions may not become a main driver of innovation, Cutler at Mobius Life says it is accelerating interest in new retirement solutions.
“I haven’t heard someone say, ‘Because of IHT, we now must do this’. It’s more, ‘We’ve been thinking about decumulation anyway; regulators are telling us we have to think about it.’ In terms of creating high-quality decumulation solutions, [IHT is] another thing that’s going to accelerate that.
“When we talk to our clients on the wealth management and institutional DC side, if you go back 12 or 18 months, a lot of the conversations were around, ‘How do we include private markets? How do we get higher growth in accumulation?’
“Now, every conversation is about decumulation, like ‘How do we build decumulation solutions?’ And IHT is pouring fuel on that fire; it’s front and centre for everyone now.”
There may be some innovation to finally deliver the blended solution.
Annuities are also expected to be a main beneficiary of IHT being imposed on pensions, says Mike Ambery, retirement savings director at Standard Life. “The higher rates now on offer provide a guaranteed income that can be gifted within allowances as required, while also reducing the value of your estate,” he says.
But the type of pension solutions and products that are in the market are not technically designed to facilitate IHT planning, says Kareline Daguer, a director in Deloitte’s EMEA Centre for Regulatory Strategy.
“When pensions become subject to IHT, I don’t think current solutions on the market could really meet the objectives of people who are using their pension pot in that particular way.”
Daguer adds: “The main reason why annuities weren’t very attractive is because at death, you generally don’t have anything to leave to anyone. I think pensions becoming subject to IHT could very well drive greater interest in annuities.
“IHT is not the only driver of a potential increase in interest in annuities, but I think there could be more of a point for firms to offer other types of annuities. However, in order to really foster more innovation in the market, I believe that you need potentially more profound changes than just IHT.”
As the industry awaits the government to publish its consultation response, and carry out a further technical consultation on draft legislation, “the devil will be in the detail” before annuity companies decide how to innovate their product features, says Mark Ormston, director of propositions and corporate partnerships at Retirement Line, an annuity broker.
“We still need to go through the consultation process and clarify the details. However on first look, it seems that the government is hoping to capture not just unused pension pots, that is, the capital value of funds, but also any guaranteed income payments.
“This therefore currently will include annuity income payments covered by guarantee periods, currently up to 30 years. It is not known exactly how the government will assess a capital value on these future income payments.”
The HMRC consultation also alludes to potential behavioural changes as a result of pensions becoming subject to IHT, such as individuals drawing down pension funds at a faster rate.
Ormston says he agrees with this, but believes this will be achieved by more people choosing an annuity, rather than remaining in drawdown.
“If they will take more income in the future, then people generally prefer certainty over volatility, and therefore we will see more people choosing an annuity over drawdown,” Ormston says.
“There may be some innovation here to finally deliver what some in the industry have been predicting for a long time: the blended solution. There is only one solution which allows you to blend an annuity [style solution] within a drawdown plan on the market at the moment, which is from Just.”
In 2019 the retirement specialist launched ‘Secure Lifetime Income’, a guaranteed income trustee investment plan purchased with crystallised funds. Risk is pooled and shared with other retirees.
Payments can be paid out as taxable income, in whole or in part with other self-invested personal pension investment distributions and encashments; remain within a cash account; or be reinvested into other assets.
A cash-in option also enables clients to exchange their entitlement to future income payments and a death benefit for a one-off lump sum, if their circumstances change significantly during the cash-in value period.
“We may see other annuity providers create these trustee investment plan structures within the drawdown wrapper to provide guaranteed income in drawdown,” Ormston says.
“There are still many roads to travel until we get clarity on what the [IHT] rule changes will be, before we can guess at the potential changes this will bring in retirement planning. But I think we can reasonably predict that there will be changes, and the likelihood is that the dominance of drawdown as a solution will be challenged.”
Chloe Cheung is a senior features writer at FT Adviser
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