I read things and then think about them. We all do that, I know, but some of the things I've read recently have led me to think that stakeholder pensions could be unsuitable investments for some people who want to pay for advice on pensions.
The strange thing is the two things I've read that led me to this conclusion were published by the PIA; Rules Notice 53 (RN53) and Regulatory Update 83 (RU83). In part, these were meant to clarify the regulatory framework within which financial advisers can continue advising their clients to invest in 'traditional' personal pension products now that a stakeholder alternative is available. This clarification was required following the expiry of Regulatory Update 64 (RU64).
RN53 has introduced a requirement that investment in a personal pension should be recommended to a client only if it would be 'at least as suitable' for them as an investment in a stakeholder pension. I've been wondering what 'at least as suitable' means in this context, particularly as it implies that stakeholder pensions are suitable. I don't know about you, but I can only get my head around these things if I can consider what goes on in real terms in real life by imagining the process that comes into play when, as in this case, say, people pay for advice.
I think it goes something like this: imagine a higher-rate taxpayer who is advised by a qualified adviser to invest in an individual pension. The agreed fee for the advice is, say, £200 and the person being advised is more than happy to pay it. (Don't get too worked up about the actual figures I'm assuming here, just go with the flow of it for a moment, it's the principle I'm trying to tease out, not the detail.) In real life how can he go about paying the £200 fee? Well, one way would be to go to his building society and draw the £200 from his savings and pay it to his adviser. That would do the trick, but he would have to draw an extra £35 from his savings account if his adviser is VAT registered and pay that on to the Inland Revenue because the fee is subject to VAT. So, he could pay the £200 he is happy to pay for the advice he has received by drawing £235 from his savings.
But, in real life there is another way he can pay the £200 fee whereby he will not be liable for the £35 VAT and, believe it or not, the Inland Revenue will also pay £80 of the fee for him. This is achieved through a much misunderstood process called 'commission'. The way it works is that instead of taking £235 from his savings to pay off his debt to his adviser, he could take £200 from his pension product through the commission system. Commissions can be thought of as 'fee-generators' in this respect. Where this is done, no VAT is due and, in this case, £35 would be saved immediately.
However, although a saving has been made, the pension product has been damaged to the tune of £200 in the process. So, what if this chap wants to repair the £200 damage to his pension, how can he do that?
Well, he could go to his building society and draw out £120 and pay it into his damaged pension as a single premium. If he does this the Inland Revenue would become obliged to immediately add a further £80 to his personal pension as tax relief, thus fully reinstating the personal pension to its previously undamaged state.
The end result in both cases is the same; the full fee has been paid to the adviser and the pension has been left unscathed. The person being advised, therefore, has the option of raiding his savings of either £235 or £120 to achieve exactly the same result, the payment of £200 for the advice given. The choice, obviously, is up to him, but, not having been born yesterday, I know which one I would choose; there seems no point in paying either 67% or 95% more than you need to. And in case you think this is a problem restricted to higher-rate taxpayers, the equivalent percentages for standard-rate taxpayers are 28% and 50%.
This seems to me to have some serious implications. If the pension product that the adviser recommended to this particular client was a stakeholder pension, then it may not be possible for the person being advised to get the Inland Revenue to help them pay their fee; the stakeholder pension may not generate enough commission capability to enable people to take advantage of the Inland Revenue's generosity, it depends on how much people are saving. This is where I got confused when I was reading RN53 and it leaves me with a number of questions that I think I must now put to the PIA and FSA.
- Where clients of advisers specifically ask for the available financial help from the Inland Revenue towards the cost of their fees, can stakeholder pensions ever be recommended investments if the amount of commission available is not sufficient to allow the full tax benefit to be achieved?
- Do clients who have already established stakeholder pensions and paid for the advice by fee have a claim against their adviser if they failed to explain the tax-efficiency of the commission system at the time of the sale?
- Should it be a requirement that whenever an individual pension is recommended following the giving of advice the adviser should be required to explain the circumstances under which people could receive substantial financial assistance from government to help pay for that advice?
- Should advisers who are remunerated by fees, particularly those who are registered for VAT, be obliged to tell their prospective stakeholder pension clients that they could be paying up to half as much again for advice as they need to if they are standard-rate taxpayers, or nearly twice as much as they need to if they are higher-rate taxpayers?
It seems to me that the answers to these questions are quite important and are urgently required before we go too far down the road if we are to avoid yet another potential scandal. So, having teased them out of my musings and written them up here I suppose the next step is for me to write to the FSA and PIA and ask them what the answers are. Once I've done that and they've replied, I'll let you know the answers in one of my future BeeLines.
This document is based on Scottish Life’s understanding of the current and proposed tax laws. These may change in the future.