Demand to transfer out of defined benefit pensions is hitting new highs. While the reasons for this are clear, are clients truly aware of the risks involved, asks Justin Rourke
The topic of defined benefit (DB) pension transfers has hit national headlines. What do you need to know if your client wishes to transfer away from a DB pension scheme?
The most important point to make is that anyone considering a transfer from a DB pension must be referred to a qualified and authorised financial adviser. This is vital, as it is not possible to transfer out of a DB pension scheme valued at more than £30,000 without the individual concerned having received regulated financial advice.
Some of the sums involved are of Lottery-win magnitude
In March, the Financial Conduct Authority (FCA) published new rules on pension transfer advice, and recently held a consultation on additional changes, including adviser charging structures (a policy statement is due in the autumn). The aim is to improve the quality of pension transfer advice to help consumers make informed decisions tailored to their individual circumstances.
The rules require ‘transfer advice to be provided as a personal recommendation that takes account of a consumer’s individual circumstances’. They also replace the transfer value analysis with the need to undertake a personalised analysis of the consumer’s options and a comparison to show the value of the benefits being given up.
But why have DB transfer requests become so popular? The main driver is undoubtedly the introduction of pension freedoms in April 2015, as people have become increasingly aware that they now have significantly more choices than before.
Freedom and choice
The 2015 rule changes allowed those aged 55 and over full access to their pension savings, but this only applied to those with defined contribution (money purchase) pension schemes. Purchase of an annuity was no longer a compulsory requirement (though still an option) and those accessing their pensions now had the choice of new flexi-access drawdown (FAD) and uncrystallised funds pension lump sum (UFPLS) arrangements, or any combination, including access to one lump-sum payment. The only way DB scheme members are allowed these same flexibilities is to transfer out of their scheme and forego the guarantees that these arrangements convey.
The legislation also created opportunities to bequeath pension wealth in a tax-efficient way, as new rules created new options. Not only can dependants benefit, but any nominated successor can now also do so. This is attractive for those involved in estate planning, and in particular for individuals who are unmarried or without dependant children.
High-profile pension scheme failings
Public confidence in employer pension schemes has taken a significant downturn, with high-profile scheme failures such as BHS, Carillion and the well-publicised issues with the British Steel Pension Scheme. Pension scheme members have increasingly felt that their savings and future income are under threat, and some have felt that they may be better transferring out and taking control, often unaware of the risks. Knee-jerk decisions based on a lack of information could see people unwittingly taking an inappropriate route which impacts the remainder their lifetime, and possibly beyond.
Many of those obtaining transfer values from DB arrangements have seen figures comfortably in excess of the value of the average house price in the UK, making it their largest asset. Some of the sums involved are of Lottery-win magnitude.
Knee-jerk decisions could see people unwittingly taking an inappropriate route which impacts the remainder their lifetime
DB pension schemes take all the risk, yet a transfer out means the risk is passed from the employer (who is funding the scheme and the future income) to the individual. At a time when the value could fall as well as rise, such a decision needs the fullest consideration. With many potential transferees having little investment experience, the potential for future issues is high.
There will inevitably be scenarios whereby a transfer out of a DB pension scheme will be right. Indeed, in some scenarios, retention of the DB scheme may even be disadvantageous, but in all cases, each individual’s circumstances need consideration. An assessment must take full account of their needs and objectives, their investment experience and, of course, their risk outlook and ability to withstand loss.
The FCA and the government are keeping tabs on this area and have raised concerns. One is ‘factory gating’, a term that emerged after it appeared that certain advisers were specifically targeting the British Steel workforce, although this is not unique to British Steel. The concern is that employees are targeted because of the scheme they are in, or employees spread the word to go and see a certain adviser, based on the assumption that a transfer is suitable for everyone. Given that each individual’s circumstances will differ, this is unlikely to be the case. If you are concerned that a client is being targeted in such a way, refer them to an IFA, the FCA or the Pensions Regulator.