Assessing suitability of pension consolidation

Mr Tilley says policy costs, investment flexibility and other features such as term assurance with tax relief, which is not available under newer contracts or guaranteed annuity rates as well as the options available at vesting, should be examined.

Taking the costs alone, Mr Tilley says this can be a hugely complex subject and includes not only headline rates, but transaction costs, fund charges and total expense ratios. Penalties on transfer will also be a critical factor.

Ultimately the key consideration of a pension consolidation assessment will really depend on the type of transfer, experts that FTAdviser spoke to point out.

When contemplating a defined contribution to another DC scheme transfer, David Brooks, technical director at Broadstone, says you should consider how much your client is paying in ongoing charges and what fund charges are like across your arrangements and how they compare.

He says it is likely that going to the one that charges the lowest sum is a good option, although the fund choices may be different there.

Fund performance is also important to consider, Mr Brooks adds, as poor performing investments within a default strategy could mean a lesser fund in the long term.

If a client is using a default strategy, Mr Brooks warns they are not all the same and how the client wishes to use the fund in retirement will determine how that default strategy should work.

He says: “One big consideration is to try and find out what you’re paying for. You may be paying a higher charge for services (switches/transactions) that you don’t utilise.

“If you are with the default strategy and are happy to let that run you may be able to get the same fund/strategy for a lower cost elsewhere.

“If your pension has any form of guarantee, some older policies provide a guaranteed annuity rate at retirement, you should understand the value of this before giving it up lightly.”

For final salary to DC transfers, Mr Brooks says your client needs to understand fully the guarantee they are giving up and all the benefits they are entitled to in the scheme as it is these they are surrendering.

Each scheme will offer transfer values on a slightly different basis depending on the relative position of the scheme and the employer. Assessing whether the final salary offer is good for the layman is nigh on impossible, Mr Brooks says.

Claire Trott, head of pensions technical at Talbot and Muir, adds there are many other reasons to transfer out of a final salary scheme even if the transfer value analysis doesn’t show a saving or better projected equivalent pension at retirement.

Ms Trott says death benefits are a very good example because the difference in what someone will receive between different schemes can be significant.

She says the return of fund or the ability to pass on tax-free income to a non-dependent under money purchase schemes versus a taxed income only payable to a spouse or civil partner could also be reason enough for some.

Adrian Mee, consultant at Mattioli Woods, says whatever the nature of the consolidation advisers should remember that a suitable pension transfer must have the following key criteria:

• no loss of benefit on transfer;

• either a lower cost structure or better anticipated future investment performance;

• increased access to capital at retirement;

• enhanced benefits available on death to beneficiaries; and

• increased investment flexibility.

He says one of the main considerations for transferring your pension pots into one would be whether the new pension contract allows for investment diversification across both in-house and external investment funds.

If the contract does not offer both in-house and external funds, he says one would question the validity of consolidating all pension pots into one as you may lack investment diversification.

If an adviser is transferring an occupational policy, not as part of a block transfer, Mr Mee says advisers should consider whether their clients will forego enhanced pension commencement lump sum rights above 25 per cent.

Accordingly, he says it may be better to draw the enhanced tax-free lump sum under the current provider, and then transfer the balance of the pension pot into either an annuity on the open market, or an income drawdown-type arrangement.

Mr Mee adds advisers should also check if the contract contains guaranteed annuity rates.

He says: “Certain pension contracts established at a time when interests rate were higher may have a guaranteed annuity rate applicable at a certain retirement date of the contract.

“Guaranteed annuity rates can be as high as 15 per cent a year, whereas the comparable open market annuity rate can be as low as 5 per cent. Consideration should also be given to whether annuity purchase is right for you.

“Careful consideration should be given to foregoing any valuable benefits, as the long-term implications may be difficult to overcome, even with better investment fund performance in the new contract.”

In terms of support for advisers when considering consolidation David Trenner, technical director of Intelligent Pensions, says an adviser should have access to systems such as SelectaPension and O&M’s Profiler, which help with the number crunching, charge comparisons, etc.

However he warns systems cannot take the place of experience.

Mr Trenner warns the biggest difficulties when assessing policies for possible transfer is the application of transfer penalties and market value adjustment factors.

“Many older policies take their charges for setting up the plan out of future growth by applying lower returns to ‘initial’ or ‘capital’ units.

“If the policy is transferred before maturity all of these future charges are taken from the transfer value.

“Although death benefits will usually be a full return of fund, the reduced transfer value simply reflects the future charges, which would be taken if the policy were not transferred.”

He added that a policy with a face value of £20,000 all in capital units with a 5 per cent a year charge and 14 years to maturity would be subject to a £10,000 ‘penalty’, but will be subject to £10,000 in charges over the next 14 years if not transferred.

“MVAs can apply when the company feels that the value of with-profits units exceeds the value of the underlying investments.

“If the policy is close to maturity then transferring would not be advisable as the MVA will fall away on that date, but where there are still several years to run and it is unlikely that the MVA will be removed, then transferring into a fund with a high equity content is likely to yield better long term returns.”

Other factors Mr Trenner recommends advisers to be aware of when picking through a pension scheme’s fine print are death benefits and ill-health benefits.