Transfers from defined benefit (DB) schemes to defined contribution (DC) plans remains one of the hot topics in pension planning today and a key area of focus for the FCA.
Two sources of information from the FCA help financial advisers and planners who work in this area to both develop and review their processes:
- Policy Statement PS20/6; and
- Final Guidance FG21/03.
This article summarises the main points for financial advisers to consider.
Getting ready to give advice
Firms must hold adequate personal indemnity (PI) insurance to give DB pension transfer advice. If firms are offered PI that contains exclusions or limitations, they need to consider if these unreasonably limit the cover.
The FCA expects firms to have good systems, controls, and records, and to gather management information to inform decisions on the type of business they accept, and to fine tune their processes.
Firms must create a training and competence scheme. Alongside their usual CPD requirements to remain a regulated adviser, pension transfer specialists (PTS) must undertake an additional 15 hours each year specifically on DB transfer advice. Five hours must be provided by an external source.
As the FCA believes working with introducers could be an area of high risk, it asks advisers to be very clear with clients who is responsible for what part of the process.
Initial client contact
Adviser charging structures
Advisers and planners must disclose charges to clients before they give advice. Charges must be personalised and based on the transfer value.
Advisers cannot apply contingent charging – where the fee is only paid if the transfer goes ahead – except in certain situations (if the consumer is in serious ill health or serious financial difficulty). Advisers must charge the same for investment advice on a DB transfer as they would for any other similar sized investment. This is to stop some advisers from backloading the charges from the transfer to the investment.
Providing a triage service isn’t mandatory. But if advisers do offer this then triage should give the consumer enough information to help them decide whether to proceed to advice. The adviser cannot give any personalised advice or steer the consumer towards a specific choice. Advisers might want to give consumers written information to read or a web-based education tool, devised by themselves or a third-party triage service. This way the adviser might find it easier to stay distant, and not get drawn into a personal discussion.
Decision trees or RAG-rated questionnaires cannot be used as part of the triage process. The FCA believes that, as advisers can only make a binary recommendation – to either transfer or not transfer – then these tools carry too high a risk of crossing the advice boundary.
Triage services should give a balanced and unbiased description of the features of both DB and DC schemes, and how the risks and benefits of both compare.
Information gathering and abridged advice
The adviser must collect enough and the right type of information to know their client. The information must be personal and complete enough to assess suitability; if there are material gaps, the adviser cannot make a recommendation.
It may be worthwhile for advisers to spend time reviewing processes to ask the right open questions to gather the required detail and depth of information regarding the consumer, and FG21/3 has examples of what the FCA sees as good practice.
The FCA wants to see full records detailing consumers’ responses to these questions. It is concerned many advisers’ records are showing information gaps.
Assessing attitude to risk
Advisers need to assess consumers’ attitudes to both transfer risk and investment risk specifically in the context of a DB transfer and giving up safeguarded benefits. Advisers should focus on the consumer’s willingness and ability to take on risk, as well as exploring their capacity for loss.
Using more than just a standard risk profile questionnaire will help advisers understand the client’s behavioural and emotional response. Advisers need to assess if a safeguarded benefit or a flexible benefit scheme is best suited to the client – for example, asking a client how they manage money may help inform if the client would be likely to access flexible benefits in an unplanned way.
Objectives and needs
Through the information-gathering process, the adviser should understand the consumer’s priorities, plans and what motivates them. The FCA is expecting advisers to challenge any false expectations.
Advisers also need to understand their clients’ essential income needs and how the DB pension could meet these compared to other assets. They need to assess how a transfer could result in a shortfall or increase in income.
The client’s needs could be split into essential, lifestyle and discretionary. The FCA encourages advisers to challenge consumers’ stated needs, using open questions, to explore if they – or their spouse – have any additional expenditure. This assessment should also cover known future events – for example paying for a child’s wedding. FG21/3 has examples of good practice, highlighting the need for detailed personalised information.
It is the adviser’s role to help the client balance their needs and objectives.
This is a short-form advice process which is more affordable than full advice:
- the adviser can give a personal recommendation that the client should not transfer; or
- the adviser can tell the consumer it is unclear whether they would benefit from a pension transfer and check if the consumer wants to continue to full advice.
If the client decides to continue to full advice, the adviser must offset the cost of the abridged advice against the cost of the full advice. Before the adviser can implement any transfer, the client must have gone through the full advice process.
If the personal recommendation is not to transfer, then the process usually stops. The client could go on to seek full advice, but the FCA would expect in most cases the outcome from full advice would be a recommendation to not transfer.
Advisers do not have to offer abridged advice, but if they do it has to be carried out or checked by a pension transfer specialist.
The guidance states firms should consider the risks of staying in the scheme and the risks of transferring and losing benefits. It can use an estimated transfer value. However, a transfer value comparator (TVC) or an appropriate pension transfer analysis (APTA) (see below) cannot be included, and the firm cannot consider the consumer’s proposed receiving scheme.
Full advice process – research and analysis
Advisers need to provide both a TVC and an APTA as part of their full advice process.
The TVC compares the transfer value to the cost of buying DB scheme benefits in a DC scheme. It must be prepared and explained so the consumer understands the inherent value in the DB scheme.
The APTA is the research and analysis used to determine a suitable course of action. It cannot be generic – it must demonstrate the client’s personal circumstances. The FCA makes clear it does not expect generic reasons for transferring, such as greater flexibility or better death benefits, to be the drivers for a transfer. It should also consider alternatives to transfer.
Firms may want to include cashflow modelling as part of the APTA looking at specific income and spending plans. It should probably go beyond average life expectancy – for example up to 100 years old.
The APTA can cover scheme solvency, but firms are warned not to misrepresent the PPF benefits, and generally not to use scheme deficits as a reason to transfer.
Death benefits comparison can be included in the APTA but should be compared in priority against the client’s other objectives (for example a guaranteed income), and should be shown on a like-for-like basis, rather than, for example, one option showing a lump sum and one showing an income.
The APTA could explore early retirement, but the FCA warns advisers to challenge a consumer’s objective to retire early if it’s not realistic.
Comparison with workplace pensions
The FCA believes ongoing advice charges create a conflict of interest, as an adviser may have a strong monetary incentive to recommend one course of advice over another. It also believes many consumers, especially those further away from taking benefits, would not benefit from ongoing advice as their circumstances are unlikely to change significantly from year to year.
It therefore states that transferring to an individual arrangement must be more suitable than a workplace pension scheme (either deferred or active). The APTA must include a comparison with the workplace scheme looking at fund choice, charges, and ongoing advice.
In most cases, people transfer around the time they retire and do not have a current workplace pension scheme, or it may not be suitable to provide the desired retirement income. However, the rules state the adviser may choose to take any previous workplace pension scheme into consideration if appropriate.
Even if the client is only months away from retirement, if they have a current workplace pension scheme, this has to be considered and included within the APTA analysis, even if it may be apparent why the workplace pension scheme is not appropriate (for example, it does not offer flexi-access drawdown).
Firms must produce an initial one-page summary to the suitability report. This must include the following.
- PENSION TRANSFER SUMMARY – including the anticipated first year charges in pounds and pence in the receiving scheme, compared to the costs to the client in the DB scheme and the revalued monthly income they could receive from the DB scheme, as well as any workplace pension scheme charges. It must also show the initial transfer advice cost, and how many months of income from the DB scheme would be needed to pay it.
- PENSION TRANSFER RISK WARNING – laying out the risks associated with pension transfer. The client must sign to indicate they accept these.
- MY ADVISER’S RECOMMENDATION – a summary of the personal recommendation, with a link to the full recommendation. The client must sign to indicate they intend to follow the transfer advice.
- ONGOING MANAGEMENT ADVICE – information about ongoing services, including the cost in pounds and pence. The client must be told they are not required to take these services and can cancel them at any time. The client must sign to indicate they accept the ongoing management advice.
The suitability report must be provided in good time before a transaction is undertaken.
This article was previously published by FT Adviser
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