Avoiding TAP traps
With all the hype associated with the launch of term allocated pensions (TAPs), it could be easy for advisers to miss the downside.
Apart from the obvious disadvantages of TAPs — such as their non-commutability and lack of payment flexibility — there are also a number of other dangers advisers need to be aware of.
First of all a TAP is designed to run out, so there is always the risk a retiree will outlive their pension — especially if the markets don’t do well.
There is an in-built safeguard for retirees; they will be able to choose how long their TAP will go for — either their life expectancy or their life expectancy plus an extra five years.
But even though choosing the longer life expectancy option will give retirees a bit more peace of mind, their tax situation could be worse.
Each year, retirees who have purchased a TAP will receive a deductible amount that is a tax-free return of capital.
ING technical services manager Andrew Lowe says clients choosing the shorter term will get a higher deductible amount and hence a higher tax-free return.
“It’s a question of laying out the consequence of going for a shorter term and longer term in front of the client so the client can make an informed decision.”
For those who are still worried about outliving their TAP and don’t care about the increased taxation they will face by selecting a longer period, there is another option.
They can base the length of their pension on their spouse’s life expectancy.
This might be an advantage for someone who wants to take out a TAP with a younger partner.
But there is a catch.
Using a spouse’s life expectancy will mean having to choose automatic reversion of the TAP on death.
This means the TAP will revert to the spouse, but will continue to be paid as a pension with the 50 per cent asset test exemption. The spouse will lose the option of taking the rest of the TAP out as a lump sum death benefit.
BT technical services manager Sue Merriman thinks advisers should avoid recommending clients use their spouse’s life expectancy.
“I think it’s the safer option because there’s a ‘get-out-of-jail’ card there,” she says.
“But if the client wants automatic reversion — provided the adviser has made sure that they fully understand the pitfalls — it will still be an option for those concerned about outliving their TAP.”
However, according to most technical advisers, the biggest mistake investors can make is not seeking out financial advice on the investment options they choose within a TAP.
If they are too conservative in their choices, there might not be much point in taking out a TAP. If they are too aggressive, investors could end up suffering in a bear market.
“Advisers need to be targeting higher returns to make a TAP worthwhile, so they need the client to understand the risks involved in targeting that sort of return,” Merriman says.
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