With the current trend of low interest rates producing an increase in transfer values being offered by Final Salary Occupational Pension schemes this has created a potential opportunity for transfers of deferred benefits from schemes into Money Purchase schemes. While the subject of pension transfers appears to polarise opinion in the financial advisory sector figures show that the number of transfers has increased significantly during 2016.
Traditionally, the starting position from a regulatory perspective has been that such transfers are likely to be unsuitable as members are giving up guaranteed benefits in return for benefits dependent upon unknown investment returns and annuity rates. The traditional test in terms of financial viability of a transfer is to perform a Critical Yield calculation such that the critical yield indicates the return needed, based on a number of financial assumptions, for the replacement plan to match the benefits under the ceding scheme. In this way the adviser and client may decide whether the risk involved in transferring to potentially improve the benefits is within the client’s risk tolerance.
However, the FCA has stated that firms must not rely solely on the Critical Yield on which to base a recommendation to transfer. While the Critical Yield may appear low in certain situations, it is important to recognise that the funds recommended under the replacement plan to match the client’s risk appetite must have the investment potential to beat the Critical Yield. ‘Investment potential’ would be based on reasonable assumptions about the likely returns of the underlying assets in the recommended fund(s). A prudent adviser should ensure there is sufficient potential headroom over the Critical Yield to minimise the risk of financial disadvantage to their client. Going forward in a recent consultation paper the FCA has proposed instead an Appropriate Pension Transfer Analysis (APTA), which incorporates a comparison of cash flow modelling. The consultation period ends in September 2017 and the resulting policy guidance is expected in early 2018, according to the FCA.
As mentioned earlier, the Critical Yield is a measure used to assess the financial viability of a transfer of pension benefits. This presupposes that the client’s goal is to improve their pension benefits at retirement. While it might seem obvious a client would want to do this a holistic adviser should consider what the client’s objectives are for their pension pots taking into account their other assets. Indeed there are circumstances where a transfer could be recommended where the Critical Yield exceeds reasonable investment assumptions. Examples of this might be where death benefits can be improved on transfer or where the client does not intend to personally access their pension pot preferring to leave it within an IHT efficient wrapper whilst utilising assets that would otherwise form part of their estate on death. Indeed the FCA has recognised in the new pension freedoms world that a transfer recommendation may be appropriate if a firm is able to demonstrate it is likely to best meet the client’s objectives.
Guaranteed or Partly Guaranteed?
Although Final Salary pension schemes offer guarantees these are only as strong as the balance sheet of the employer sponsoring the scheme. The Treasury has also mooted the idea that some of the benefit indexation may be watered down by schemes to assist employers meet their financial obligations under the schemes. It is important to point out that in the event of a sponsoring employer falling into financial difficulty and being wound up the Pension Protection Fund will offer a safety net but there are limits on the amount and scope of the protection they will offer. Therefore, someone with larger benefits will receive a lower proportion of benefit protection than someone with smaller benefits.
Opportunity or Threat?
In the pensions freedom world there is no doubt that pensions are being viewed differently from their traditional purpose of providing retirement benefits only. The relaxation of the compulsion to buy an annuity and also the availability of taking the fund as cash, subject to tax, means that pensions offer a more flexible planning tool nowadays. However, this increased flexibility is only available for members of funded Final Salary pension schemes where a transfer is made into a Money Purchase scheme such as a Personal Pension or a Self Invested Personal Pension, offering a wider range of investments.
While pension transfers might represent an opportunity for advisers to discuss pension planning with their client, they could also represent a potential threat to their business if it all goes wrong at a later date. If you are subject to a full regulatory review you will be expected to meet the costs of the review. There is also the risk that a complaint finding its way to an Ombudsman could be judged in favour of the client based on the view of an Ombudsman who is able to make their decision based on a wide variety of factors.
Business Planning
Empirical evidence shows that the FCA monitors spikes in the sales of financial products or areas of advice and may carry out thematic reviews to ensure that firms remain focused on giving advice likely to provide a favourable outcome for the client. The FCA website indicates that a thematic review may be required when it assesses ‘an emerging risk regarding an issue or product across a number of firms in a sector or market’. The FCA has already issued a warning earlier this year on over reliance on Critical Yield. It has also suspended some firms from advising on transfers from Final Salary schemes. Given the increase in pension transfer activity and the aforementioned events there is a real likelihood they could undertake a thematic review of pension transfers.
At Ownet we can carry out an objective check on your pension transfers to identify any potential weaknesses that might expose your business to greater risk. Pension transfers offer a potential stream of revenue for financial advisers helping to assist client’s to meet their pension, protection and IHT needs. However, firms must ensure their advice process is robust to protect themselves against claims or regulatory action. An Ownet review can assess your advice process and offer suggestions to help you protect your business. We can also review your suitability letters to help you meet FCA expectations in this area. Going forward there may be scope for automation of part of the transfer advice process using robotic advice functions and this is an area that Ownet is monitoring with a view to offering assistance to firms in the future when this becomes practicable.
