The challenges of DB transfers
I began writing this article a few days ago, and shortly after starting it I found myself speaking at the Retirement Money Show in London.
The last session of the day was a chance for members of the public to pose questions to the expert panel in front of them. Perhaps not surprisingly the first pension question from the audience concerned a defined benefits transfer.
To paraphrase, the questioner had a number of pension plans, both DB and DC, and he was looking to consolidate them for retirement planning purposes and to take control of the investments. He understood that he could transfer his DC pot into a SIPP, but as his DB transfer was valued in excess of £30,000 he would have to take financial advice (at a cost) before transferring it. Why was this?
The answer from the panel was as expected – transfers from DB schemes are often not the right thing to do, and on the adviser side there is the fear of liability from insistent clients. Advisers may, therefore, not accept the business or set costs high enough to try and discourage the business, or to cover any ongoing liability if the client insisted on proceeding with the transfer.
The transfer conundrum
Let’s start by looking at what the FCA says (COBS 19.1.6G08/06/2015):
- When advising a retail client ... whether to transfer ... a firm should start by assuming that a transfer ... will not be suitable. A firm should only then consider a transfer ... if it can clearly demonstrate, on contemporary evidence, that the transfer ... is in the client's best interests. (COBS 19.1.7G08/06/2015)
- When a firm advises a retail client on a pension transfer, it should consider the client’s attitude to risk including, where relevant, in relation to the rate of investment growth that would have to be achieved to replicate the benefits being given up
- When giving a personal recommendation about a pension transfer, a firm should clearly inform the retail client about ... the consequent transfer of risk from the defined benefits pension scheme ... to the retail client
- Including the extent to which benefits may fall short of replicating those in the defined benefits pension scheme ...
- In considering whether to make a personal recommendation, a firm should not regard a rate of return which may replicate the benefits being given up from the defined benefits pension scheme or other scheme with safeguarded benefits as sufficient in itself.
So the starting point is a presumption that such a transfer is not suitable and is unlikely to be in the client’s best interests.
In my view this is very much a pre-pension freedoms presumption – we now have a retirement regime where there is no requirement to buy a guaranteed income for life and where spending the pension money is a valid option.
Against such a background, surely each case should be considered on its own merits? Pre-existing presumptions mean that the decision is already weighted against a truly independent recommendation.
I have long been of the view that each transfer should be a consideration of the quantitative aspects and the qualitative issues of the transfer, focussed by the needs of the client.
The quantitative is, in particular, a consideration of the critical yield done via TVAS.
The TVAS aims to provide the yield that would be needed to buy an annuity to match the defined benefit to be purchased at the normal retirement date of the scheme. In the new post- freedoms world this does not seem to be a logical benchmark, as annuities are not currently first choice and indeed this whole principle is currently under review by the FCA. The real issues are the non-numerical, more qualitative issues and also (to some extent) the behavioural ones.
A client’s lifestyle choices may mean that the benefits from a DB scheme do not suit their requirements pre- and post-retirement and on death. The DB scheme will offer an amount of income from a set date, possibly indexed but importantly with some form of actuarial reduction on taking the money before the retirement date or trying to take the money early, and it will probably not allow a more flexible option of when to take the money and how to take it at any time after 55.
The key qualitative factor must be the death benefits regime under DC, what with IHT planning, flexibility of beneficiaries and income tax planning opportunities. This is a difficult one to ignore.
Consider the case of the couple with a DB scheme each – do they need two spouses pensions? Would it be better to maximise income? It may be that individuals prefer to have investment control and flexibility, particularly if they have a pattern of income in mind or if they wish to utilise specific investment opportunities.
For another example, consider the client who wants to start his own company – he has some income but would like to dip into his pension for ad hoc amounts to supplement this. Health prevailing, this could go on for a good number of years.
The ongoing funding of a DB scheme can have serious consequences for a company and indeed many employers might seek to wind up schemes due to complexity and cost. This has been back in the news recently with BHS, Austin Reed and TATA Steel in the headlines, and Brexit could potentially exacerbate the issues.
This is a difficult area, particularly when it comes to advisers assessing the strength of the employer covenant.
This is an area we must not forget in the transfer transaction. When you explain to a client that his options are, for example, £40,000 p.a. for life or a transfer value of £1.3 million, what do you think the client will hear? If you were talking to non-dependent children of an ageing parent – what do you think they hear?
So all well and good? Well, no! With the advent of the pension freedoms legislation one of the big issues was the requirement to take financial advice for CETVs over £30,000.
Pension transfers have always been a controversial area from an advice perspective with regard to any residual liability there might be, particularly ‘the insistent client’ – the client who is advised not to transfer by an adviser but who does so anyway. Unfortunately, the regulator and the Ombudsman have found against advisers even in the case of insistent clients and as advisers have told me in no uncertain terms, this is reflected in their PI insurance premiums.
So, will advisers advise on DB transfers with this potential liability? If the recent figures showing a record number of advisers taking and passing the relevant examinations are anything to go by, the answer is a resounding ‘yes’.
The level of the fees and the demand for a one-off transaction rather than a full financial plan have also played their part in the discussions – some advisers are pricing to not necessarily have to do the business but as a result clients are feeling that they are paying over the odds.
Let’s look at an example; last week I presented at two pension seminars and DB transfers came up in both.
In the first one there was some vocal discussion from a number of those present (predominantly from those advisers not doing such transfers) concerning liability, PI cover, retrospective liability and fees.
The next day we had the absolute opposite – several of the advisers in the room were specialists in DB transfers and happy to do such business with an understanding of the other issues involved.
The requirement to take financial advice for certain transactions has already been on a list of common complaints received from the FOS and I would guess this is related to DB transfers.
In essence, if you believe in the principle of pension freedoms and accept that some people might spend their pension fund rather than provide a lifetime income, then why differentiate between the DC and DB regimes?
I do think we ought to reconsider the framework for advice on DB transfers, starting with the FCA presumption, investigating the adviser liability issue, revising the TVAS assumptions and even enforcing the provision that ‘insistent clients’ have received advice not to transfer and that any transaction afterwards cannot lead to liability on the adviser.
I know it all sounds a bit idealistic but an objective pension transfer regime would assist all involved and, whether or not we believe in the laissez-faire approach of pension freedoms, it should be a level playing field for all.