New pensions rules coming into effect next April risk triggering a rush of transfers from defined benefit (DB) to defined contribution (DC) schemes, according to Bob Campion in this month’s Pension Spotlight.
Individuals must go through mandated advice before they can complete a DB to DC transfer, although the qualifications required to advise on these transfers may be relaxed in order to make advice more readily available to the public.
The potential rush of requests for transfers could mean more work for pension specialists, leading to a take-off in the pension transfers market.
Bob Campion said, “For years, the received wisdom among regulators and pensions experts was that it is rarely in the best interests of DB members to transfer out. That principle has led to an unusually heavy-handed regulation of pension transfer advice and the transfer values that schemes offer their members.
“The art of pensions transfer advice is relatively arcane – mostly because, for many reasons, it is notoriously difficult to engineer a positive recommendation.”
The margin between the calculated value of a member’s pension as far as the overall scheme is concerned and the cash equivalent transfer value (CETV) is designed to protect the scheme, but difficult for individuals to make up the difference.
The transfer is often not recommended as the calculated investment return needed to closely match the defined benefits, known as the ‘critical yield’, is often too high.
Three scenarios in which transfers do go through make an exception to the rule. First, companies which are eager to reduce the size of their pension funds have sidestepped the critical yield problem by enhancing the CETV to the necessary level.
Second, those who do not need the extra benefits that their company scheme offers and those with severe health issues may find that the maths work in their favour, especially those who qualify for an impaired annuity.
Third, many still decide to go ahead with a transfer despite having received advice to the contrary.
Mr Campion said, “Under the new regime, the lure of instant access to pots - which can be extremely large even after the CETV calculation - may well prove too much for some pensioners.
“The typical CETV calculation is less punitive for older members (as the difference between the scheme’s conservative assumptions and their best estimate has a shorter period to play out) and that can mean even without a company enhancement the transfer quote is more likely to pass the test for a recommendation near retirement.”
The DB to DC market is set to continue to be tightly regulated, despite the fact that the requirements for recommending an occupational DC to personal DC may reduce.
Mr Campion said, “Advisers eyeing up the potential transfer market must consider that without a company enhancement, they will find it difficult to recommend a transfer even when the individual is dead set on it. That does not mean this is not going to be an attractive market for advisers – but it is one the government and regulators will be keeping a close eye on.”
