I welcome the move from the Financial Conduct Authority (FCA) to publish a video helping those considering transferring out of Defined Benefit/Final Salary Pension Schemes.
The video highlights the process which financial advisers should follow when providing advice on your pension. It provides a guide to the information an adviser should provide you with and the questions they should ask you in order to understand your situation fully.
I encourage you to take a look on the following link
Since the dawn of pension freedoms and the ability for those in defined benefit schemes to transfer their funds into a defined contribution arrangement, a record number of transfers have occurred.
Taking the decision to move out of a guaranteed income scheme to one which is reliant on stock market performance isn’t a decision to be taken lightly.
However, if the advice is to transfer, as it will meet your objectives better, the next step is to find a home for the funds.
If you’ve taken advice to transfer (transfer value above £30,000) your adviser will have taken you through a risk profiling exercise. There are no right or wrong answers with where you fit on this risk scale, but your situation should be able to tolerate the resulting volatility.
Recent data from Selectapension (adviser transfer software provider), provides an insight into where the majority of these funds have been placed, since pension freedoms began.
At the top of the list is PruFunds provided by Prudential. The two main funds are PruFund Growth and PruFund Cautious, with a risk level of around 4 and 3 out of 10 respectively. These are cautious/balanced funds by nature and have given consistent performance for the last 10 years.
A reason these may be popular is because of their ‘smoothed’ returns. So, while a standard fund will move in tandem with the stock market rising and falling ever day, the PruFunds aim to smooth out this volatility by providing a more consistent return.
When markets increase significantly, this rise isn’t added to the underlying fund performance. Instead some of the profits are held back so when the market dips, this additional growth held back can be put back on, creating a more consistent return.
In total, around 13,500 defined benefit members have used PruFunds since the pension freedoms. It seems people are looking for a more consistent return in retirement, in order to manage income, than chasing larger returns, which comes with more volatility.
PruFund currently has around $40 billion of assets and it seems will continue to grow given its consistent performance. PruFund Growth has delivered 33.97% whilst PruFund Cautious has delivered 19.75% since pension freedoms began.
Other funds which are popular include Vanguard, who provide lower-cost passive funds. There has been a definite shift from traditional actively managed funds to passives given the management charge cost saving. This has been helped by passive funds, which replicate an index as a whole, outperforming many actively managed funds. The view is why pay more in management charges when the performance doesn’t justify it.
In terms of sector specific funds, the US has been the stand out region. Schroders US mid Cap, Merian North America and Vanguard US Equity Index have shown returns or 50%, 62.95% and 59.14% respectively since pension freedoms began.
As always, past performance is not guide to future performance and the above popular funds may not continue to perform in the future. This isn’t a recommendation.
Are you considering transferring your defined benefit scheme? Ask me a question.
Guaranteed Minimum Pensions (GMP) came about when employees opted their employers out of the State Earnings Related Pensions Scheme (SERPS) between 1978 and 1997. The common pension vehicle for this was Defined Benefit/Final Salary Schemes, where benefits were built up alongside employee benefits.
In 1990, it became law that all UK pension schemes should allow an equal retirement date for both men and women. Before this date, it wasn’t uncommon for UK occupational scheme to have unequal retirement ages for example 65 for men and 60 for women. This echoed the state pension retirement ages at the time and so was deemed to be fair and consistent.
The law was changed when Mr Barber took his previous employers pension scheme, Guardian Royal Exchange to the highest European court. He argued that in was unfair for him to wait to receive his pension (he was 52), as if he were a women, he would be able to receive his pension immediately.
The European Court of Justice ruled in his favour after a lengthy process involving complaints to the Employment Tribunal, Employment Appeal Tribunal and the House of Lords.
The result was an equalisation of retirement ages for both men and women.
The problem regarding GMP was that, even though the state pension ages for women are being graduated to be the same age as men, GMP benefit calculations were never altered. The calculation to equalise benefits were so complex that when calculating transfer values, these were largely ignored.
The result of not including GMP equalisation into the transfer value of those who wished to move out of defined benefit scheme has meant that, up until the recent ruling, millions of pounds have been missed of member transfer values.
The recent judgement, involving Lloyds Banking Group, has now detailed the specific calculation for schemes to do in order to offer a fair and fully GMP inclusive transfer value.
The problem for those who have already transferred is that they’ve missed out on the uplifted transfer value. There is now a huge piece of work for scheme to recalculate already transferred pension and forward on any owed pension fund monies. They may need to recalculate the past 28 years transfers.
Any new request for a cash equivalent transfer value will now include the specified GMP equalisation uplift.
- Aged 55
- Outgoing of £1600 per month
- No loans or mortgage debt
- Good Health
- 3 Children but not dependent
I received a contact request through this website for a man who had just received his transfer value. He was surprised at the figure and immediately thought he needed to transfer this into his own name so it was ‘safe’.
After speaking to him at length, it became apparent that his main objective was to pass any unused funds onto his wife and children on his death.
This was his only and main pension income and he planned to work for another 10 years. His thought process was that if he died early, his estate would lose the value of the transferable fund. Only his wife would benefit from the 50% spouses pension meaning she would receive half the income he was on, on his death.
His pension was forecast to provide him £17,450 at age 65, and together with his wifes £5,200 NHS pension income, this was more than enough to cover his forecasted £16,000 per annum outgoing. Two years after he retired he would also receive a full state pension, increasing his guaranteed income further.
He didn’t have any investment experience or indeed need any more income or flexibility in retirement, his main concern was just to pass some funds onto his children as he had no savings.
Now, one thing I reiterate to people who have this thought process is that pensions are primarily there to ensure you and/or your spouse/partner have enough income in retirement. Anything that left is a bonus. It shouldn’t be the main driver to pass money on when the pension is an absolute need for you whilst you’re alive.
I brought to his attention that if I could offer a solution where he could keep his guaranteed income, together with providing a cash lump sum to his children on death, would this be preferable.
He hadn’t thought about other possible solutions to passing money on but after a further discussion, I suggested a Whole of Life plan. Whole of life plans are a life cover policy that provides protection for as long as you live, whether this be to 65 or 95.
For a monthly premium which was affordable to him and one that was guaranteed not to increase, he was to meet the objective of passing some funds onto his estate without putting at risk his own retirement lifestyle.
Don’t get me wrong, I have recommended clients transfer away from schemes to pass funds onto their estate in many other instances, but there have been other overriding factors which deemed it to be in their best interest in their personal situation.
The advice you receive is personal to you and will be based on your circumstances and objectives. I always have your best interests at heart and if there is a way I can help you meet your objectives without giving up your pension, i’ll always discuss this with you first.
We are currently in a period where defined benefit schemes are being transferred in record numbers. Low long term gilt yields are fueling an unprecedented demand to forego the safeguarded benefits within such schemes for more flexible access to a pension pot.
Just last week, one of the largest pension administrators, JLT Employee Benefits, said it was transferring £750,000 per hour which equates to £100m a month.
For those who ask for a Cash Equivalent Transfer Value from their scheme, there is often a surprise how large the offer is compared to previous years. This has lead to a feeling of ‘transfer now while the going is good’ from many scheme members.
Reasons cited by those looking to transfer include protecting benefits for non-dependent children (not currently covered by the scheme pension), flexibility to access the pension pot as needed (rather than taking a pre-defined inflation proofed income), and access to a larger tax-free cash pot.
What many don’t realise, are the risks involved in giving up the guaranteed income, transferring to a pension which is reliant on stock market performance has no future guarantee of certainty.
An alternative to transferring the full benefits could be a partial transfer. Many treat the offer as an ‘all or nothing’ decision. A partial transfer could cover the requirements whilst retaining a level of guaranteed benefits.
From my own experience, many schemes still aren’t offering this feature, however Standard Life have recently come out and called for the FCA to make it a mandatory requirement in the upcoming Defined Benefit regulations.
“The FCA consultation is an important exercise in reaffirming good practice which we absolutely welcome. We would like to see it go that bit further and use the opportunity to embed the value of partial transfers in the regulations, so that a partial transfer must always be considered as an option for consumers during the advice process.” Said Alastair Black, Standard Life financial planning propositions head.
I would always recommend discussing this option with your advisor. Establish your need and see if they can be met without foregoing all the valuable benefits a defined benefit scheme offers.
- Age 62
- Married, no dependents
- Current Pension & Investment income £20,000
- Outgoings £18,000
- Buy to Let Property with £45,000 mortgage
- Residential mortgage with £40,000 mortgage
I was approached by a client who had a Defined Benefit Scheme from employment many years ago. The scheme had written to him and disclosed a potential Cash Equivalent Transfer Value (CETV) of £140,000 or an annual income in 3 years of £5,800. Until this point, my client hadn’t realised there was a cash value to his benefits and was therefore surprised at its value. He wanted to understand if he could somehow use the pension, to help fund the building of an additional room on a buy to let property.
He wasn’t interested in the income as he already had enough pension income between himself and his wife to cover their outgoings. They were also due to start receiving a state pension in a few years, which would provide even more guaranteed income. His main objective was to access the pension to use for renovation and use any remaining fund to pay off his mortgages.
To analyse any case where someone wishes to give up safeguarded benefits, I need to consider a number of factors, some of which are:
- What benefits are being given up and could the CETV being offered, be used to replicate those benefits in the future (potentially through buying an annuity)?
- What are the client main priorities for considering a transfer?
- What position would the client be left in financially if the CETV was taken and the markets had a downturn?
- Can the clients’ objectives be met by some other method?
This particular client didn’t have any savings and didn’t wish to take on any more loans for the renovations. His only accessible asset was the DB scheme.
He didn’t need the income from the scheme and therefore it wouldn’t be detrimental if it wasn’t there. For all intense purposes, the pension income was surplus to his needs.
By renovating the buy to let property, it was estimated to increase the property value by around £50,000 and increase the rental income by around £5,000 per annum.
All factors considered, I gave the client a positive recommendation to move the scheme.
The usual vehicle for this type of transfer is a flexi-access drawdown product, which keeps the fund invested and allows unrestricted access. On this occasion though this didn’t suit the clients objectives or risk. He wanted to withdraw the fund, in the quickest time possible, without breaching the higher rate tax threshold.
As his current taxable income was around £20,000, he had a further £25,000 available per year, in the 20% tax band.
Additionally the client state he didn’t want any investment risk. Given the timeframe he was looking to withdraw the fund (5 years), even if he’d wanted some investment risk, I have advised against it. Investing is for the medium to long term, 5 years plus, any timeframe shorter than this doesn’t give the fund chance to recover any downturns.
After some further discussions we chose to use a Fixed Term Annuity – cash out plan.
£35,000 was paid as tax-free cash immediately and a fixed £22,000 income, paid annually as a lump sum, will be paid for 5 years. No investment risk, no volatility, no ongoing fund charges. A simple solution.
Billions of pounds worth of pension assets are changing hands today in the UK.
Several factors are behind the change including regulatory changes and new demands from investors. What do these changes mean for you and your financial future?
Pension Transfers In The News
What exactly is happening when it comes to pension fund transfers? To answer that question, let’s consider a few recent news reports:
- Partial Pension Transfers. According to industry experts, only 10% of defined benefit pension funds currently offer the option to transfer a part of your pension assets. That reality means people are being forced to move their whole cash equivalent transfer value causing a huge spike in pension money movements. If you have a defined benefit pension, it’s worth asking if a partial transfer is available. (Source: FT Advisor)
- Record Volume of Pension Transfers. In 2016, more than £25 billion in pension assets were transferred out of pension schemes. This activity suggests that investors are seeking additional flexibility and control over their assets and financial future following Pension Freedoms. (Source: FT Advisor)
- Improved Market Options. Recent FCA rules require that annuities offered by product providers internally now be made available on the open market. This means you now have a wealth of new choices for your pension money and the income it provides (Source: Money Marketing)
This trend also means that many more investment firms will be seeking to serve you. To make a smart decision about your pension funds, you need to start by understanding the options.
Questions To Ask Yourself
In some cases, your pension plan may provide for all of your financial needs for years to come. But how do you know that for sure? With all the changes in the pension marketplace, take the time to fully review your pension.
What Are My Pension Options?
In regards to occupational pension schemes, each employer has different priorities when it comes to compensation and pension benefits. For example, recently formed companies tend to emphasize flexibility in retirement funds through a defined contribution scheme. Some older organisations can provide higher payments but fewer options as in the case of defined benefit schemes.
Action Step: Contact your current and past employers to request documents explaining your pension plan options.
Is A Lump Sum Option Suitable For Me?
Most defined benefit scheme offer the option of tax-free cash or the options to exchange some of this for more guaranteed lifetime income. Do you need the tax-free cash or will a higher income be more beneficial?
The majority of non-defined benefit schemes offer access to 25% of the transfer value as a lump sum. If you don’t take it and you’re buying an annuity, you can purchase more income. If you are looking to move into drawdown and don’t take it immediately, you will be taxed on future withdrawal, whereas at the outset, 25% of it is tax free. If you need an income or small lump sum from your pension, but don’t need the maximum tax-free cash, consider phased drawdown.
Action Step: Review your pension plan’s options regarding lump sum payments and transfers.
Do I Have A Complete File On My Pensions?
Keeping track of your retirement benefits may not be at the top of your list. After all, you may be concerned with other matters like taking care of family, volunteering in the community and pursuing personal projects. Fortunately, you don’t have to spend weeks or even days on your pension and financial matters. A few hours per year is all you need to commit.
Action Step: Schedule one hour in the coming week to review my pension file and request any missing documentation (e.g. forms and statements).
Questions To Ask Your Financial Adviser
With so many options available when it comes to pension funds, you’re probably wondering if you are making the most of your money. A meeting with an investment professional can give you the answers you need. To make the most of the meeting, come prepared with these questions.
Identify any terms, options and language you don’t understand in your pension and request an explanation
Investment documents sometimes use unclear language. Make sure you understand the key terms and options that relate to your pension such as the difference between a defined contribution plan and a defined benefit plan.
Ask for several investment options with different objectives
No professional will recommend a “one size fits all” approach to investments. Seek out at least 2-3 investment plans. Expect that investment plans that promise higher returns will come with a higher risk of investment loss. The investment plan should feature a portfolio of investments such as bonds, stocks and other assets.
Ask to see any testimonials of clients previously helped by the adviser.
If you’re new client to an adviser practice, you may not have that trust built up which is so important. Many firms have online reviews where you can read about the experiences of previous clients.
Ask about the investment professional’s experience and process regarding pension plan assets
You need to be comfortable with the financial professional who is looking after your pension. If mistakes are made during the process, it can cost you a lot of money. In 2016, the FCA issued a fine over £200,000 to an investment professional who recommended unsuitable and unregulated investments to clients.
Look on the FCA Register for both your Financial Adviser and also the Firm they work for.
The FCA is considering the revision of the calculation of redress an entity has to pay in case of unsuitable advice given to a client regarding joining a private pension scheme. According to the officials at the Financial Conduct Authority (FCA), the current methodology that is used to calculate the redress does not provide the financial security that was guaranteed before. The present method to calculate the redress by the Financial Ombudsman Service was designed for the Pensions Review scheme that took place in the 1990s.
Pension transfer advice is given or sought by clients who want to leave the benefit of a defined pension scheme, that guarantees retirement income, in preference for seeking higher returns on their investments elsewhere. If the advice is not provided with a fiduciary duty or is not properly given there can be consequences for the clients. This can mean that the client doesn’t understand the risk in such schemes and/or doesn’t see the returns materializing. They may even face losing their original capital. A redress, in case such a mishap arises, is the amount that has to paid by the firm or the individual who gave such unsuitable advice to the client.
The aim of revamping this method will be to define a methodology that calculates the redress fees in a way so that the consumer is back in the financial situation that they would have been if they hadn’t followed the advice to pursue a private pension scheme. The review is scheduled to take place in autumn later this year.
The regulator said it that intends to consult on changes to the current methodology in autumn this year and will try to reach a conclusion by the spring of 2017.
The FCA dictates that the inherent principles to deal with such complaints will remain the same. These being the treatment of such complaints in a fair and prompt manner.
The Financial Conduct Authority stated that if an outcome of such a case will be desired under the current regulations, then it won’t consider it fair treatment for the firm to settle the matter with a client through any kind of financial payment before this review is complete. This regulation will remain in place until an outcome has been reached. The firm will write to the customer explaining why such a response is not suitable. The firm will be advised to consider other options for dealing with such a complaint on an interim basis until a consensus is reached. This may include offering a provisional redress and then providing a final payment at a later date when the result of the consultation is known.
However, some like the pensions director at Aegon, Steven Cameron, questioned if the consultation is the only solution to this problem.
He thinks that rather than reviewing the redress methodology, the authority should make efforts to improve the process of deciding what is considered good advice on moving out of defined benefit schemes. According to him, using a simple formula for return on capital invested in an annuity is no longer an appropriate comparison to the flexibility that private pension schemes provide to the transferees. A review to the redress calculation methodology can be made when these factors have been considered.
There have been mumblings of a total ban on private sector defined benefit pension transfers in the last few days.
The calls come amidst a marketed increase in requests from people to move their cash out of occupational defined benefit schemes since the pension reforms.
The government put a ban on unfunded public sector schemes shortly after the pension reforms were announced but private sector schemes have been allowed to take part in the revolutionary pension freedoms rules.
Notable objectors to the proposed idea is the Association of Consulting Actuaries (ACA), who state it’s ‘not appropriate’.
ACA Chairman, Bob Scott stated that there is a ‘very real danger’ that a proposed ban would cause a surge in the number of requests before a suggested deadline.
This action could destabilise an already struggling defined benefit sector, with constant reminders of schemes being underfunded and with deficits.
Bob Scott continued
“We don’t see a blanket ban on transfers as the answer. Many schemes may well be happy to see members take transfer values that reflect RPI indexation, always remembering that DB scheme members must take independent advice before making a transfer decision. And if a scheme is concerned that paying transfers at that level would jeopardise funding, and hence other members’ prospective benefits, there are mechanisms under current legislation to reduce transfer values where underfunding is judged to be a problem.
“A blanket ban could also lock some members into schemes where there is a real possibility that targeted benefit will not be forthcoming and it would seem very wrong that in such cases members, particularly those with long service, should be prevented from protecting their pension prospects by way of a transfer ban.”
The rush to unlock the cash held in defined benefit scheme has been constant since the reforms were announced. People with especially large schemes have the chance to retain control of their assets rather than being lost back to the pension scheme if they were to die early, and particularly if they have no spouse.
The recent fall in gilt rates has made the offered Cash Equivalent Transfer Value even more attractive to some.
Defined benefit schemes offer extremely valuable pension benefits and any decision to move requires consultation from a suitably qualified pension transfer specialist.
Those with final salary of defined benefit pension plans, who were looking to transfer their benefits may be in luck.
The vote to leave the EU has, as experts predicted, had some negative economical effects. One of which resulted in gilt yields falling to historic lows.
Why is this important?
Well, gilt yields are largly responsible for annuity rates (along with longevity), and as these fell, so did the underlying annuity rates of many providers.
Source AMS annuity.
The bad news for those with defined contribution schemes looking to buy an annuity was the opposite for those with defined contribution schemes looking to transfer out.
The calculations involved in the offer of a Cash Equivalent Transfer Value (CETV) for a member, involves, amongst other factors, the use of gilt rates to try an offer a fair value. A transfer value which, if invested correctly could try an offer similar benefits to those offered within the scheme by purchasing an annuity.
The CETV is designed to represent the value of the benefits being given up. It’s the Scheme Actuaries job to look at all current economical factors, and offer a fair value with certain assumptions built in.
The result of which currently leads to the highest transfer value calculations for a few years. Xafinity’s transfer value index was 4% higher than the highest level in 2015 on the 30th June.
So what are the reasons people might be looking to transfer?
Well, it’s a difficult pill to swallow knowing that a lifetimes pension savings could be lost back to the scheme if the member dies shortly after retirement. DB scheme were largely missed of any pension freedoms and so the rules regarding flexibility and ability to pass assets on are fixed.
For the most part this means, 50% spouses benefit with no ability to pass funds on to children or any other party the member wishes, unlike Defined Contribution schemes.
Transferring benefits away from Defined Benefits schemes gives up the rights to the safeguarded benefits but does offer more flexibility.
We’d always encourage defined benefit/Final Salary scheme member to ask for a Cash Equivalent Transfer Value to understand what their scheme is worth. Generally the scheme will allow one free valuation per years and it doesn’t affect any rights or benefits within the pension.