Sipps provided by insurance-based companies offer FSCS protection but do not have the investment flexibility of trust-based Sipps
For many years we have seen major growth in the self invested personal pension (Sipp) market, culminating in massive investments in Sipps both pre and post A-Day.
The vast majority of Sipps available on the market are operated under a trust arrangement where all of a client's assets are held within a trust created by the administrator/provider.
However, there has for many years been a lesser known alternative that is equally flexible but has some distinct advantages for the discerning investor. This alternative is an insured Sipp, which can only be purchased through a life company and is operated under a more traditional policy-based structure.
With the majority of new providers entering the market under a trust-based regime, thereby challenging the stranglehold larger insurance companies previously held over the pension market. Consequently the insurance based Sipp was, for some time, largely ignored.
It is important to note that insurance based does not describe the range of investments available to the investor under an arrangement. It refers to how the Sipp is legally constituted. Insured Sipps are already fully regulated under the FSA and therefore will be largely unaffected by the impending regulation in April.
Confusion often occurs when insurance companies offer Sipps that are actually trust based arrangements. Most insurance providers launching new Sipps have elected to do this under the trust based arrangement. It is important that an adviser/investor understands the differences between the two plans and considers the advantages and disadvantages of both.
Under an insured Sipp, the insurance company creates a personal managed fund as a separate fund, unique to each investor, which holds the range of investments selected by the client. These investments, governed by the same HM Revenue & Customs rules that apply to all Sipps, may include equities, collectives and commercial property. The only difference is that all assets must comply with the FSA's permitted linking rules for insurance companies. Crucially, the investor is not limited to the insurance company's range of funds. The FSA's permitted linking rules have been somewhat restrictive in the past but have now been relaxed to allow non-Ucits retail schemes to be held as unit linked investments. It is hoped that further flexibility will arise as a result of the FSA's forthcoming consultation into the permitted linking rules.
Commentators frequently refer to trust-based Sipps as pure or fully self invested when they are typically comparing trust based Sipps to insurance company Sipps, frequently trust based arrangements, offering their own range of insured funds. The personal managed fund option is frequently ignored.
In December 2005, the Department of Work and Pensions (DWP) clearly stated that 'the only type of contracted out personal pension scheme that can offer Sipp style choices for protected rights is an insured product offered by an insurance company'.
It subsequently confirmed: 'Personal managed fund plans - which, as insurance products, are subject to additional regulatory requirements by the FSA - can continue to hold protected rights. Trust based Sipps will continue to be restricted to holding non protected rights only.'
It appears that it is the DWP's intention to maintain the status quo that has so far led to complaints over a u-turn by trust-based providers. However the DWP's current position is unequivocal and no promises were ever made to change this.
Protected Rights funds have been building up since 1988 and could be backdated from April 1987. In 2007 such a fund could give an individual a substantial amount of money to self invest.
Since 1997, final salary schemes have also been accruing S92B rights which, when moved to a personal pension, become protected rights. These funds can be very sizeable and discretionary managed but, where a client is considering a commercial property purchase, he or she can also be added to the non protected rights funds thereby substantially increasing the available purchasing power. The ability to invest this money directly into equities has long been of interest to more sophisticated investors, and particularly those unwilling to be restricted to insurance based funds.
Indeed, it is not unusual for an individual to accumulate protected rights worth £30,000 or considerably more. For example, for three business partners considering using a Sipp to purchase new business premises, the ability to self invest three times £30,000 of protected rights can significantly increase the potential purchasing power. This can be further enhanced by the ability to borrow up to 50% of the value of the fund to purchase a property.
Under an insured scheme clients are able to include protected rights funds and gear them to increase their purchasing power.
For example: three investors with £200,000 in pension funds, of which £90,000 is protected rights money, are looking to maximise purchasing power so they can invest in commercial property.
In a trust based arrangement the available funds, including borrowing, would be £165,000, ie, £200,000 - £90,000 = £110,000 plus 50% borrowing. The remaining £90,000 would have to be invested in other permitted assets.
However, insurance based Sipps could take the whole pension value, which would increase the purchasing power to £300,000 which equates to a 40% plus increase in available funds - £200,000 available pension + 50% borrowing of £100,000. This type of arrangement is little recognised but is an important planning tool when investing client Sipp capital.
Protected rights self investment is an important consideration for investors, but insured schemes have another significant advantage - the client has a unit-linked fund under a life policy. Because of this, investors holding commercial property in an insured Sipp would normally be eligible to receive compensation under the insurance element of the Financial Services Compensation Scheme (FSCS). If the provider was unable to meet its liabilities, clients would receive 90% of the value of their fund, with no upper limit.
The position regarding the FSCS compensation on assets other than property held by trustee based Sipps is complex. What can be determined is that commercial property is not covered by the FSCS if held in a trustee based Sipp.
One argument against insurance based Sipps is that they are subject to additional regulatory requirements under the FSA's permitted linking rules. These rules are intended to provide additional protection for clients by preventing insurance companies from investing in assets that are unlikely to be readily realisable and are difficult to value. In practice, however, insurance based Sipps can cater for the majority of investments in which clients and their advisers wish to invest.
With the impending regulation of trustee based Sipps providers will need to comply with the FSA's requirements regarding Treating Customers Fairly and Conduct of Business rules. This includes issuing communications that are clear, fair and not misleading. Equally importantly, independent advisers will need, as always, to consider all options available to them.
Far from a u-turn, the DWP has maintained the status quo, and in doing so has reignited a debate on whether investors should be able to fully self invest protected rights monies. A number of providers have already started to establish insurance based Sipps to help investors - it will be interesting to see how the provider market tackles this advisory issue in the coming months. KEYPOINTS
l Insured Sipps follow the same HM Revenue & Customs rules that apply to all Sipps, but unlike other Sipps assets must comply with the FSA's permitted linking rules for insurance companies, offering consumers more protection than trustee based ones.
l Investors in insured Sipps have a unit-linked fund under a life policy so those holding commercial property can receive compensation under the insurance element of the FSCS.
l But insurance based Sipps are subject to additional regulatory requirements, which prevent insurance companies from investing in assets that are unlikely to be readily realisable and are difficult to value.