Following the introduction of pension freedoms by George Osborne in the 2014 Budget the upsurge in requests from deferred scheme members to transfer their final salary pension rights to a personal pension has been marked.
The demand has been further fuelled by concerns raised about the security of DB schemes by the well-publicised problems of the Tata (British Steel) and BHS schemes.
The right to a pension transfer has existed for many years although this often doesn't apply in the final year immediately before the scheme pension age. What has changed is that the pension freedom and choice legislation means people feel a far deeper sense of having the opportunity to take ownership of their retirement rights. Previously, most scheme members thought that if they transferred out to a personal pension they would still have to buy an annuity at retirement, giving over the ownership of 75% of their fund to another faceless institution. Of course, that hasn't been the case for many years, since pension drawdown was introduced over 20 years ago.
However, the huge publicity surrounding pension freedoms has given far greater impetus to the idea of personal ownership of pensions than ever existed before.
But do these changes mean that it's better to transfer from a defined benefit scheme now than it was before? In short, the answer is 'no'. But the pension changes aren't the only factor in play. We now have historically low interest rates which means transfer values have risen significantly. Furthermore, personal debt levels are far higher than they were when the transfer regulations were first introduced and access to pension cash for debt repayment was not a key issue.
So in reality we have a coalescence of factors that make pension transfers far more appealing to deferred scheme members than they were before. For advisers this upsurge in demand can create a heady cocktail but therein lie some significant risks.
Treating Customers Fairly
First and foremost, treating customers fairly was never about giving clients what they want. It's easy to fall into the trap of believing that just because your client wants control of their pension rights, and for what may well be perfectly understandable reasons, somehow that should not be a key reason in favour of recommending transfer. That's not to say the client's motives should be ignored, simply that they should form part of a wider and comprehensive assessment and given an appropriate weighting in the overall advice process depending on the needs and circumstances on a case by case basis.
Another external factor that has changed over the years is that with the progressive reduction in interest rates annuity rates have also fallen significantly. This begs the question as to whether, for the purposes of transfer advice, the standard 'critical yield' analysis is still as important as it was previously.
In the FCA consultation document CP15/30: Pension reforms – proposed changes to our rules and guidance they set out the expectations as to how existing rules operate in the new pension environment. The FCA said "Although in the past most people in DC schemes purchased an annuity, with the new pension freedoms this is less likely to be the case in the future. Those seeking to transfer out of a DB scheme are perhaps those most likely to want to take advantage of not taking their income in a predetermined pattern. Changing the starting point for pension transfer advice may enable advisers to take account of customers' objectives without being unduly focused on whether the transfer is providing a lifelong income. For members who have attained the minimum retirement age, using a DB pension to access the pension freedoms, the current transfer value analysis (TVA) methodology may be less appropriate."
In its follow up policy statement PS16-12 FCA stated: "On pension transfers specifically, some respondents argued a strong case for extending the current methodology for TVA to incorporate other options." The FCA are due to publish revised rules later this year but have stated they will put a strong emphasis on having a process which improves the chances of delivering good outcomes for consumers and that greater focus needs to be on consumers understanding what they are giving up and the value and uncertainty attached to the alternative options on offer.
They also said that communication is a key part of the pension transfer process and they consider the current TVA comparisons are "unlikely to be helping consumers to be making informed decisions because the information is so overwhelming that it is doubtful if the document is being read".
So how does this leave advisers in the meantime?
The rules as they stand require firms to carry out a transfer analysis including the critical yield, on the basis that the alternative involves buying an annuity at retirement. This assesses what rate of return would be required under an alternative plan, taking account of charges, to match the benefits being given up on a 'like for like' basis.
However, the rules do not prohibit other forms of analysis to be included, such as the 'hurdle rate' which is the rate of growth required each year to provide the same pension as the scheme, but without payment escalation, a survivor's pension or lump sum death benefits post retirement. In our experience this is usually comfortably attainable, while the critical yield will be attainable in less than half of the cases, based on realistic assumptions. It is also useful to demonstrate, again on a reasonable growth rate assumption, how long the client's fund would last under pension drawdown, assuming the same level of income as the scheme pension. That's not to say they would in reality want to match the income, but it's a helpful benchmark for both the client and the adviser.
While neither of these additional measures should ever be relied upon in isolation, they do provide useful additional information on which to base the advice. For example, insuring against inflation through an escalating or index linked annuity is expensive. In some cases, clients have other assets which they can call upon if required to supplement their income as a result of a rise in living costs, while others will feel they can reasonably adjust their expenditure needs over time and therefore don't need to insure the inflation risk.
Equally, the need for the pension to be fully secured at the outset of retirement is not always a 'must have' and if the pension is only a modest part of the client's overall income in retirement it is doubtful whether buying an annuity at current rates would be right for them in any event. Anyone going into drawdown has the option to switch to annuities later in retirement so it's never a case of 'never the twain shall meet'. In practice annuities are a better deal at older ages and many investors also qualify for enhanced terms on health grounds. Ultimately annuities are an insurance against longevity (with inflation protection an optional 'add on') and for most people it's not so much whether ... but when to annuitise.
In a note recently issued by the FCA to advisers detailing their expectations when giving pension transfer advice, one of the key messages was that advisers should not rely solely on the critical yield analysis when making recommendations and must consider a number of other factors, such as the likely returns of the assets in which the client's funds will be invested relative to the critical yield, the personal circumstances of the client and taking into account specific other factors that might apply to the client. They also said that advisers must ensure there is a consistency between the assumed investment returns in the transfer analysis and the likely expected returns of the assets in which the client's funds will be invested as well as the specific receiving scheme.
As a company we have taken the decision not to implement transfers on an 'insistent customer' basis. This is at the option of the adviser, and there's no requirement under the rules to accommodate such cases. Where a firm does decide to accept such business the FCA states there are 3 key steps: You must provide advice that is suitable for the individual client and this advice must be clear to the client; you should be clear with the client what the risks of the alternative course of action are; and it should be clear to the client that their actions are against your advice.
The fact that we have decided not to accept business on an insistent customer basis doesn't mean that there are not cases where our advice can change as result of the client coming forward with further statements or information. Indeed, we consider it to be treating customers fairly that we invite them to do so where our recommendation is against transfer.
One of the interesting things about this process is that it is often the case that after further dialogue, many 'would be' insistent customers actually change their mind and agree that, on further reflection, it was a bad idea. In other cases, we sometimes find that one or more previous responses given to specific questions were mistakenly based on a misinterpretation of the question or there had been a simple omission of a relevant fact, which of course might or might not alter the previous advice. The good thing about following this extended dialogue is that the conclusion is almost always by mutual agreement, and clients leave the process feeling comfortable about the outcome.
Steve Patterson, Managing Director, Intelligent Pensions
After studying engineering at Glasgow University Steve decided a career in financial services offered the best opportunity to apply his creative technical skills. Having established his own IFA business in 1984 Steve and his team had built up a wealth of experience in pensions and investment planning.
After developing specialist retirement analysis software he launched Intelligent Pensions in 1998 to provide flexible bespoke retirement solutions for their clients. From an early stage a growing proportion of the company's clients were being introduced by other professional advisers reflecting the exceptional calibre of services and expertise on offer in this complex area of financial planning.