Final salary transfers – 7 key areas of focus
23 November 2017
The ‘right’ decision on a DB pension transfer could be different with 20 or 30 years’ hindsight, which means how adviser firms approach each case now is crucial, says Andrew Tully, pensions technical director, Retirement Advantage.
The numbers of people considering transferring their final salary benefit is currently one of the most talked about aspects of pensions. As a result the FCA launched a consultation looking at potential changes to the process. And 32 firms chose (with some influence from the FCA) to stop offering pension transfer advice or limit their pension transfer activity since the start of 2016. While the recent interest rate rise could knock transfer values slightly, it seems clear final salary transfers will remain one of the most discussed and emotive aspects of pensions for some time to come.
It’s worth putting the situation into context. The Pensions Regulator estimates 80,000 transfers were made in the year to 1 March 2017, which is roughly 2% of those who have deferred final salary pensions. While that is undoubtedly an increase on previous years, it is still a relatively rare occurrence – despite potential transfers being the talk of some workplaces around the country.
It’s easy to understand why consumers are attracted by a transfer. Many are being offered transfer values which mean their pension is comfortably their greatest asset, despite some of them not recognising that fact until recently.
There are, of course, many financial reasons why people should retain the certainty of the income for life offered by the final salary benefit, which traditionally comes with hugely undervalued inflation-proofing, as well as benefits for partners following the member’s death.
Equally, there can be good reasons to transfer, especially at the point of taking benefits. People who are single can re-shape death benefits to suit their individual circumstances which is preferable to an irrelevant benefit automatically provided by the scheme. Final salary schemes also lack flexibility, so a transfer can give income flexibility and tax planning opportunities. And the ability for family to inherit the remaining pension fund is a strong driver for many, compared to the often poor level of death benefits available in the scheme.
The difficulty here of course is that the ‘right’ decision can often only be ascertained with hindsight in 20 or 30 years’ time. There are, of course, probabilities which can point to the better outcome. And there are a variety of risks for clients, whether they transfer or remain in the scheme.
How can firms help customers understand the various inter-linked and often complex issues involved? Alongside the normal work of understanding the scheme benefits, considering the wider tax issues and analysing the client’s retirement income needs, the following are some suggestions of key areas of focus. Although, as always, it will depend on the specifics of the case.
1. Documentation, documentation, documentation! The FCA has been monitoring the FS transfer business of 22 firms over the past two years. It found that the advice given was suitable in only 47% of cases. Advice was unsuitable for 17%, while it was unclear whether or not the advice was suitable in the remaining 36% of cases. While this was a very small sample it does highlight the importance of ensuring comprehensive and meticulous files are kept in all cases.
2. Cash flow modelling. Many adviser firms use cash flow modelling and that can help demonstrate what the future may hold. In particular, including the impact of a significant market fall can help clients work out their capacity for loss.
3. In your own words? It may be useful to ask a customer to write down or talk through their reasons for wanting to transfer, and what they see are the benefits and risks. This can help ensure these specific issues are covered, any misunderstandings are cleared up, while helping clients focus on what they see as their key goals.
4. Consideration of alternative options. A customer’s specific reasons for transferring may be able to be achieved without transferring the final salary benefits. For example, if death benefits are a key aim then consider and document the costs of a suitable protection policy. Or demonstrate the desired flexibility can be achieved through the use of other assets. This helps customers and shows the regulator the firm is considering all options.
5. Use guarantees after transfer. While some people will be attracted by the benefits of transferring, they may still want some certainty of income. That’s where new hybrid solutions offering annuities and drawdown in one wrapper can help. The annuity element can produce a guaranteed income personalised to the client’s circumstances and take into account their health and lifestyle, with any excess money invested in the drawdown element. This can give a combination of flexibility and certainty.
6. Partial transfer. Some schemes offer the option of a partial transfer and, if available, that may be a suitable option for some customers. This can combine the flexibility of drawdown while at the same time leaving a bedrock of certain income in the final salary scheme. However, given offering a partial transfer is more problematic from a scheme perspective it seems unlikely they will become a mainstream solution any time soon.
7. Analysis of sustainability of income. The benefit of a final salary scheme in this situation can’t be overstated with a certain income for life, together with some degree of inflation-proofing. However, it can often be underestimated by clients. Comparing that to the risks involved with a transfer where customers take on longevity risk, investment risk and sequence of returns risk is crucial so a customer is making an informed decision. A transfer can provide a solution which suits the customer’s needs better, but it can provide a significantly worse outcome.
Final salary transfers are a high profile area of the market given the sizeable transfer values involved, alongside regulatory scrutiny which has the backdrop of a potential future regulatory review. Meanwhile there are many strident views on both sides which suggest the pendulum has swung too far, or that people’s freedom is key.
In the midst of this background noise, adviser firms need to continue to work to help clients achieve the best possible outcome, and ensure advice is suitably documented.
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