The safe way to do DB transfers

There are two immediate issues with this question. The first is it might indicate that the client has already made up their mind to transfer and the second is that the timing cannot be known to be good or bad without the benefit of considerable hindsight.

Xafinity Group publishes a Transfer Value Index based on the transfer value that would be provided to a scheme member aged 64 who is currently entitled to a pension of £10,000 each year starting at age 65 (increasing each year in line with inflation).

While the chart as at 31 January 2017 indicated a small drop since December 2016, and the peak early in October 2016, it would be foolish to try to predict the next move, especially given economic uncertainties and the different approaches trustees might take to the valuation of the preserved benefits.

There is also the matter of inflation. Most schemes provide some form of inflation protection (for example, CPI or RPI on non-guaranteed minimum pension benefits, which could be subject to section 21 orders). While inflation has not been an issue in recent years, the last set of figures puts RPI at 2.3 per cent and many financial planners would assume between 2.5 per cent and 5 per cent as part of any long-term planning.

Transfer values are higher than they have been in the past as a result of record low long bond yields, which schemes use to value liabilities, but making a recommendation on the basis that a valuation of, for example, 27 times the prospective income, is considered to be a good deal will not save you. The advice must stand up on the fundamental issues of suitability.

A higher transfer value will help with the critical yield (the return required to match the estimated scheme benefits), but the FCA’s rules in Conduct of Business (COBS) 19.1 still assume that an annuity will be purchased. Post pension freedoms, recent data seems to show that most clients with personal pension pots use some form of drawdown.  

The FCA has reminded firms that to base a recommendation solely on a critical yield being deemed generally achievable does not make this automatically suitable. The advice must take into account the returns that might reasonably be expected from the client’s underlying investments and, of course, there will be fees and charges to consider that are otherwise borne by the scheme.

Further, the FCA states (in COBS 19.1.6G) that a firm should start by assuming that the transfer is not suitable and that one should only be considered if it can demonstrate and show evidence that it is in the client’s best interests to do so, taking into account their circumstances, attitude to risk and capacity for loss.  

The client must also be in an informed position about any risks as a result of the transfer, such as potential investment losses and that they might receive benefits less than their scheme would have provided. Clients making a transfer will also be taking the longevity risk (the risk of out-living their money) and the responsibility to manage the investment (albeit potentially with the aid of an adviser). For a client in poor health, this may well be a factor that supports a transfer, but most people cannot predict their date of death.

The FCA rules are under review, but they have published a guidance consultation on the redress for unsuitable transfer advice, which would see the compensation amount rise by between 5 per cent and 30 per cent, depending on the term to retirement.  

This amounts to the cart being placed before the horse, but has been done because the FCA is more concerned about current compensation for historic advice than the adequacy of current rules in the light of pension freedoms.

However, the FCA is reviewing the quality of current advice in this area to inform what, if any, changes will be made to COBS 19.

In the meantime, a good reference point is the Personal Finance Society (PFS) Good Practice Guide, which highlights points to focus on under the following headings:

1.    Understand the scheme.

2.    Fully assess hard and soft facts.

3.    Consider the wider tax issues with the client.

4.    Ensure DB transfer matches client’s attitude to risk.

5.    Analysis of client’s retirement income needs.

6.    Analysis of sustainability of income.

7.    Clear capital requirements.

The full text includes some good examples, but I would highlight the following practical steps advisers can take to help clients reach the right outcomes and protect themselves:

•    Use lifetime cash flow analysis, using reasoned and reasonable assumptions, to demonstrate how the invested funds will or will not meet the client’s expenditure requirements.  Ideally this should include stress testing of the investment strategy to incorporate the sequencing risk of returns, as well as absolute returns.

•    If a key driver for the transfer is death benefits or other inheritance tax planning, consider whether additional life assurance might meet the need while preserving the ‘secure’ income benefits.

•    Confirm whether or not a partial transfer is possible and, if so, consider this in the model.

•    Consider carefully the investment policy with the client at outset. This might include the possibility of annuitisation of some or all of the remaining pot.

•    Avoid contingent fees to mitigate potential transaction bias. DB transfer business is complex, high risk and irreversible, so fees should reflect the work done rather than the outcome.

•    Above all, ensure that you understand the client's objectives and what a good retirement looks like for them, then work with their available assets – that is, not just the pension – to ensure their money works to support this. Remember that the single-tier state pension will take account of contracting out, so the client may not be entitled to the full amount.

In summary, advice on a transfer at any time must balance risk, value for money and the client objectives in order to arrive at a good outcome. There is something of a sale mentality stimulated by the current level of transfer values, but like a jumper you might have bought on Boxing Day, it is only a bargain if you like it, need it and it fits.

Finally, while the main risk is often considered to be the risk of transferring, not recommending a transfer when it would have been in the client’s best interests carries equal risk. Whatever your recommendation, your file should adequately demonstrate how you reached your conclusion and stand up to scrutiny in the distant future. If ultimately the client insists on an alternative course of action, check the client has understood the potential disadvantages and follow the FCA guidance on insistent clients.

Simon Thomas is head of policy of Tenet Group

Key points

A question about transferring is an indication that a client has already made up their mind.

Transfer values are higher than they have been in the past.

The client must also put be in an informed position about any risks.