The right to a pension transfer has existed for many years although this often does not apply in the final year immediately before the scheme's pension age. What has changed is that the pension freedom and choice legislation means people feel a deeper sense of having the opportunity to take ownership of their retirement rights.
Previously, most scheme members thought that if they transferred out to a personal pension they would still have to buy an annuity at retirement, giving over the ownership of 75 per cent of their fund to another faceless institution. Of course, that has not been the case for many years, since pension drawdown was introduced more than 20 years ago.
However, the huge publicity surrounding the new freedoms has given far greater impetus to the idea of personal ownership of pensions than existed before. But do these changes mean it is better to transfer from a defined benefit scheme now than it was before? In short, the answer is ‘no’. But the pension changes are not the only factor in play. We now have historically low interest rates, which means transfer values have risen. Also, personal debt levels are far higher than they were when the transfer regulations were first introduced and access to pension cash for debt repayment was not a key issue.
So, we have a coalescence of factors that make pension transfers more appealing to deferred scheme members. For advisers this upsurge in demand can create a heady cocktail, but therein lies risks.
First, treating customers fairly was never about giving clients what they want. It is easy to fall into the trap of believing that just because your client wants control of their pension rights – for what may well be perfectly understandable reasons – that should be a key reason in favour of recommending a transfer. That is not to say the client’s motives should be ignored. They should form part of a wider and comprehensive assessment and given an appropriate weighting in the overall advice process depending on the needs and circumstances on a case-by-case basis.
Another external factor that has changed over the years is that, with the progressive reduction in interest rates, annuity rates have fallen. This begs the question as to whether, for the purposes of transfer advice, the standard ‘critical yield’ analysis is still as important as it was previously.
In its consultation document CP15/30, the FCA said: “Although in the past most people in DC schemes purchased an annuity, with the new pension freedoms this is less likely to be the case in the future. Those seeking to transfer out of a DB scheme are perhaps those most likely to want to take advantage of not taking their income in a predetermined pattern.
"Changing the starting point for pension transfer advice may enable advisers to take account of customers’ objectives without being unduly focused on whether the transfer is providing a lifelong income. For members who have attained the minimum retirement age, using a DB pension to access the pension freedoms, the current TVA methodology may be less appropriate.”
In its follow-up policy statement PS16-12 FCA stated: “On pension transfers specifically, some respondents argued a strong case for extending the current methodology for TVA to incorporate other options.”
The FCA has still to confirm its revised rules on this matter, but did state that when it considers the options, it will put a strong emphasis on having a process that improves the chances of delivering good outcomes for consumers and that greater focus needs to be on consumers understanding what they are giving up and the value and uncertainty attached to the alternative options on offer.
It also said communication is a key part of the pension transfer process and it considers the current TVA comparisons are “unlikely to be helping consumers to be making informed decisions because the information is so overwhelming that it is doubtful if the document is being read”.
The rules as they stand require firms to carry out a transfer analysis including the critical yield on the basis that the alternative involves buying an annuity at retirement. This assesses what rate of return would be required under an alternative plan, taking account of charges, to match the benefits being given up on a like-for-like basis.
However, the rules do not prohibit other forms of analysis being included, such as the ‘hurdle rate’, which is the rate of growth required to provide the same pension as the scheme, but without escalation, survivor’s pension or lump sum death benefits post-retirement. In my experience, this is usually comfortably attainable, while the critical yield will be attainable in fewer than half of the cases, based on realistic assumptions.
It is also useful to demonstrate, again on a reasonable growth rate assumption, how long the client’s fund would last under pension drawdown, assuming the same level of income as the scheme pension. That is not to say they would want to match the income, but it is a helpful benchmark for the client and the adviser.
While neither of these additional measures should be relied upon in isolation, they provide useful additional information on which to base the advice. For example, insuring against inflation through an escalating or index-linked annuity is expensive. In some cases, clients have other assets they can call upon if required to supplement their income as a result of a rise in living costs, while others will feel they can reasonably adjust their expenditure needs over time and so do not need to insure the inflation risk.
Equally, the need for the pension to be fully secured at the outset of retirement is not always a ‘must have’. If the pension is only a modest part of the client’s overall income in retirement it is doubtful whether buying an annuity at current rates would be right for them. Anyone going into drawdown has the option to switch to annuities later in retirement, so it is not a case of ‘never the twain shall meet’. In practice, annuities are a better deal at older ages and many investors also qualify for enhanced terms on health grounds. Ultimately annuities are an insurance against longevity (with inflation protection an optional ‘add on’) and for most people it is not so much whether to annuitise, but when.
Critical yield is still important, especially as a method of assessing whether the transfer value on offer represents good or bad value for money. The range can be considerable from low single digit to double digit returns. But CY must be viewed in the context of the client’s overall needs, circumstances and objectives. Ruling out transfer on the grounds of critical yield alone is not treating customers fairly. Advisers who do so may find themselves with a problem down the road where the report failed to consider all relevant factors.
Provided the client’s overall needs and circumstances have been taken into account, and the advice can be demonstrated to be most likely in the client’s best interests, if the client understands the risks either way, there should not be a problem. File records will be scrutinised on that premise, and everything needs to be fully documented and detailed. Advisers should never take the risk for their clients and rely solely on CY analysis.
Intelligent Pensions has decided not to implement transfers on an ‘insistent customer’ basis. This is at the option of the adviser, and there is no requirement under the rules to accommodate such cases.
Where a firm does decide to accept such business, the FCA states there are three key steps. First, you must provide advice that is suitable for the individual client and this advice must be clear to them. Second, you should be clear with the client what the risks of the alternative course of action are. Third, it should be clear to the client that their actions are against your advice.
The fact that Intelligent Pensions has decided not to accept business on an insistent customer basis does not mean there are not cases where our advice can change as result of the client coming forward with further statements or information. Indeed, we consider it to be treating customers fairly that we invite them to do so where our recommendation is against transfer.
One of the interesting things about this process is that it is often the case that, after further dialogue, many potentially insistent customers change their minds and agree, on further reflection, it was a bad idea. In other cases, we sometimes find that one or more previous responses given to specific questions were mistakenly based on a misinterpretation of the question or there had been a simple omission of a relevant fact, which might alter the previous advice. The good thing about following this extended dialogue is that the conclusion is almost always by mutual agreement, and clients leave the process feeling comfortable about the outcome.
Steve Patterson is managing director of Intelligent Pensions
Key points
The huge publicity surrounding pension freedoms has given far greater impetus to the idea of personal ownership of pensions than ever existed before.
It is easy to fall into the trap of believing that just because your client wants control of their pension rights, that should be a key reason in favour of recommending transfer.
Provided the client’s overall needs and circumstances have been taken into account and the client understands the risks, there should not be a problem with transfers.
