Pensions in jeopardy

On the launch of Money World a year ago this weekend we reported that many independent financial advisers believed the plans had the potential to become another mis-selling scandal.

Income drawdown allows early access to the tax free lump sum and a regular income, within limits, from your pension fund instead of having to buy an annuity. The plans have been promoted as an alternative to settling for rock-bottom annuity rates. They can also earn salesmen or IFAs commission of up to 6% on six-figure funds.

But for those who die before 75 the plan can represent a tax liability, as can bonds or investments which some buyers are offered as a convenient home for their 'tax-free' lump sum or any spare income. In any event an annuity must be bought by the age of 75 - and rates are still falling.

Meanwhile the remaining 75% of the pension fund will have had to grow by at least 17% a year since 1995 to have the same annuity buying power now that it had then. If the fund was invested in an underperforming sector it will not have achieved what the Personal Investment Authority has identified as the 'critical yield'.

To make things worse falling gilt yields have additionally meant that the actuarial limit (set by the Government) for the amount of income that can be withdrawn from the fund has anyway fallen steeply. A 60-year old man with a #100,000 fund who withdrew the maximum #860 a month in October, 1995, saw his income cut to #720 - a drop of 16.5% - on October 1, 1998.

In the worst case scenario, a 60-year-old man who bought an income drawdown plan last July, and had his #100,000 fund invested in the average managed fund or UK general pension fund, would have seen his fund fall to around #80,000 by October 19. His #700 a month income would then be more than 20% higher than the actuarial limit for withdrawal of income. And his fund would have to grow by 16.1% in a managed fund or 17.6% in a UK equity general fund between October, 1998, and October, 2001, for even his #700 a month income to be maintained thereafter. The figures were calculated by investment group M & G.

By far the biggest player in the market is Equitable Life, which is currently arguing in court that it does not have to pay out as promised on its past 'guaranteed annuities'.

The mutual insurer with the reputation for low charges, which uses its own sales force, had sold more than #1.35bn of income drawdown plans to almost 11,600 people by November 1, 1998, according to industry figures published by Money Management.

That is almost twice the #752m sold by Scottish Equitable, which sells through independent financial advisers, and more than four times the industry average (among 17 companies) of #243m of income drawdown business.

Equitable Life is also unusual in that 95% of its drawdown money is invested in a with profits fund.

The fund would be the obvious source of cash if the company were to lose its court battle over guaranteed annuities, in which it claims only #50m is at stake. Other companies privately claim the figure must be far higher and could be anything up to #1bn.

Equitable Life is also one of only seven companies in the market which have had to carry out the first batch of statutory three-yearly reviews of plans. Of its 1810 three-yearly reviews carried out, 1280 schemes had their income from the plan reduced, or 71%, compared with 49% for Scottish Equitable.

Equitable Life, however, has less than 13% of its plan-holders taking maximum income, compared with 15% for Winterthur Life and 22.5% for Scottish Equitable.

Money World reported last September that brokers in the south of England had identified Scottish Equitable income drawdown plan holders with falls in income of up to 40%, though the company said it was not aware of such figures.

But the almost complete use of with-profits investment for income drawdown has been criticised by other companies. Winterthur Life, where 80% of the funds are in self-invested pensions, says with-profits is 'increasingly inappropriate as returns reduce, particularly if income is required to be taken at anything approaching maximum levels'.

At Scottish Equitable, where funds are evenly spread with only 26% in with-profits, Stewart Ritchie comments: ''Individuals have different risk profiles. You have to assess their attitude to risk at the outset and keep revising it according to changing circumstances and what the individual is trying to achieve.''

He adds: ''The kind of area where it should not be sold is where the individual cannot afford any downside....I don't think there is any room for complacency, but I do think there is no substantive evidence of widespread mis-selling of income drawdown.''

IFA Alan Steel says: ''I still believe income drawdown is not the product that people are led to believe it is, I still believe it is dangerous and from a tax point of view it is very dangerous. The PIA have not come down on it as they ought to have done and there are a lot of people still being attracted into it who really don't appreciate they are losing a lot of tax benefits - and are still being affected by falling annuity rates. People should be looking at alternatives and taking their time about it.''

Alastair Dunbar at Equitable Life said: "Because we are selling directly we can be confident about the advice that is being given, because it is our advice." On why almost all clients chose the with-profits fund, he said: "The investment choice is up to the customer. It may be that to some extent there is selection because people know us more as a with-profits office."

Over the past three years, rising markets had been positive for unit-linked funds, but the with-profits fund would smooth out volatility.

On the fall in planholders' income, Dunbar said Equitable Life's figures might not be on the same basis as those for other companies quoted in Money Management's survey.