Speaking at the European fee-based advisory network’s conference in Dublin, Lean raised the issue of the use of insurance bonds and wrappers within a pension at the point clients are starting to transition from accumulation to decumulation.
Products such as funds, ETFs and collectives can provide a natural income with a reduced requirement to encash any capital units, the chartered financial planner argued.
This creates flexibility and is tax efficient within a pension product, meaning a variable or fixed income stream can be paid out.
In contrast, insurance bonds, even where they hold the same assets, have to encash units or surrender segments leading to potential short-term surrender penalties.
Structured notes
In addition to insurance bonds and wrappers, Lean highlighted the unsuitability of structured notes within insurance bonds, which he says can exacerbate the problem as the coupons may be dependent on the underlying assets.
If the underlying assets do not reach certain prescribed levels, then there is no income received and potential loss of capital.
In the long term, he said, structured notes are simply a return of capital.
This is compounded by the risk that if a structured product has failed to qualify, there are short-term liquidity issues or further surrender penalties, he added.
Regulatory viewpoint
The UK’s Financial Conduct Authority, and recently the Malta Financial Services Authority, have stipulated that a maximum of 30% of any fund, after the pension commencement lump sum (PCLS) has been assessed, should be considered for structured products.
The watchdogs regard them as complex investment structures that only Mifid-based advisers should be advising on, Lean said.
This is due to the complexity of any risk being taken, which the regulators believe both retail clients and trustees are unlikely to understand.
Fees versus commission
James Pearcy-Caldwell, chief executive of OpesFidelio, highlighted the difference that fees and commissions, even when identical figures, can make.
He said that, even at low levels of commission, insurance bonds or structured products will have early access penalties. This means that those taking a PCLS or income in the early years face one of two alternatives:
- Take encashment through surrender and incur penalties; or,
- Withdraw funds BUT the remaining value continues to accrue charges at the greater of the current value or the original investment value.
Pearcy-Caldwell offered a case study to illustrate the second option.
A client with a bond valued at £100,000 ($135,372, €113,346) makes a £5,000 withdrawal in year one.
The bond grows at 5% (minus charges), meaning it is now worth around £95,500.
However, initial charges linked to a commission bond remain based on the greater of initial value or current value – which means that some charges are based on the sum of £100,000 and not £95,500.
The escalation of this can lead to a downward spiral of fund value, he warned.
The general consensus among the OpesFidelio members attending the second annual conference was that platforms provide a better decumulation solution to those planning to take an income within five years.
