There are few areas of regulated advice that carry more risk to an adviser than a prospective client asking: “Is now a good time to transfer my defined benefit pension?”
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.
