Apathy, complexity and a shortage of advisers mean the jury is still out on whether DB-to-DC transfers will transform from a trickle to a deluge. John Lappin finds plenty of reasons both for and against
When it comes to transfers from defined benefit schemes being used to facilitate freedom and choice, most corporate advisers and individual IFAs have seen a steady increase but not a surge.
Capita Employee Benefits head of marketing Robin Hames says: “There was an increase in transfer value request activity prior to April but this has not translated into actual requests for the transfer of funds as yet.
“We are currently reviewing the responses to our latest Employee Insight survey, a 3,000-employee survey conducted in Q1 2015, and this seems to suggest that although an increased level of transfers is likely, it may not be the surge predicted by some. It found 4 per cent of DB scheme members aged 55 and above said they would look to transfer their entire DB pension to take advantage of the new freedoms in place.
“As administrators of over four million pension scheme members, we have expended considerable energy planning our transfer processes to ensure they are robust. With the increased use of technology, we don’t feel that the numbers will be unmanageable with regard to this aspect of the reforms.”
Independent pension consultant Rachel Vahey notes that the criteria for transferring have shifted dramatically.
She says: “The freedoms mean that a conversation that rests solely on the sturdiness of a critical yield is now redundant. How can you base your whole argument of whether a transfer is good advice or not on replacing a DB annuity with a DC income now that you can take the whole as cash? This entire area needs reviewing and the FCA must enter this discussion as early as it can.”
LV= Retirement Services head of distribution Steve Lewis says: “We are seeing a significant increase in requests for final salary analysis. Advisers are looking at final salary schemes, although there was also a surge pre-April from public sector DB.
“Trustees are troubled by the new regulations. There is a challenge for trustees and scheme administrators in communicating to members what they can do. Should a scheme facilitate access to a pension fund from a DC-based scheme? We think we will see more people transferring their benefits in full from final salary schemes because of a desire to have it in their personal ownership.”
He adds: “There could be an interesting space where trustees will consider partial transfer of benefits out of the scheme, perhaps retaining a guaranteed income of £5,000 a year from your final salary scheme, with a cash equivalent value of the balance being transferred to the member in a DC flexible arrangement.”
Yet will members get that far? John Broome Saunders, a consultant at Broadstone, believes that many transferring members will struggle to find an IFA to give that advice.
He says: “From 6 April, there’s been a legal requirement to take advice before transferring. Quite rightly, taking advice should be a key step in the process, but actually finding an adviser who is happy to provide advice on such a transfer is likely to be difficult. This is understandable as industry memories are still fresh from the last pensions misselling scandal and the industry is mindful of the potential future financial cost in the event a member complains many years down the line.
“The reality is these transfers cannot usually be carried out without the assistance of an adviser, and many advisers may simply refuse to assist in processing a transfer, especially if they have advised against it. What is more, many large pension providers are refusing to accept DB transfers unless a member has actually been advised that transferring is the best option. Frankly, it will be a miracle if anybody from a DB scheme manages to transfer, given the impediments that appear to be looming.”
Ringrose Grimley IFA Victor Sachs is similarly sceptical. He says: “Someone would really have to convince me why I would consider even taking someone out of a final salary scheme. My worry is that there are chartered advisers out there who are saying ‘Give me £2,000. I’ll do the due diligence and if it works I will take you out.’
“If you are single, you may well ask why you are paying for a spouse’s annuity. But there is a calculation I have just done where the client has got an £84,000 pot but his pension was worth £3,500 a year. In order to get that income elsewhere, he would need to have £120,000. Even in ill health, there is another £50,000-odd, which the company is not going to fund in the transfer. Why lose that and CPI increases?”
Vahey notes that the reduction in the lifetime allowance has muddied the waters. She says: “Because of the very low conversion factor of 20:1, people transferring from DB to DC must be aware of the bear pit that is the £1m LTA. They also have to account for the odds that this will stay at £1m; the chances surely have to be it will reduce yet again. This is a big factor.
“But for some, they may prefer the flexibility of £1m and accept that they will pay tax. With today’s zeitgeist, can we criticise someone for making that decision? The whole ethos of freedom and choice is predicated on the basis that you choose what you want to do with your money and pay tax if you want to. So how can anyone say that’s the wrong decision? There is no more black and white – only shades of grey.”
LCP partner and DC consultant Andrew Cheseldine welcomes the regulator’s recent publication of guidance but notes that it is arguably easier to facilitate a transfer than a conversion. He says: “It is almost easier to transfer to another employer’s DC scheme than transfer from the same employer’s DB scheme to the DC section.
“That is technically a conversion and you have to be really careful in your communications that you are not inducing or persuading someone.
“TPR says it isn’t trustees’ role to second-guess the members’ individual circumstances. You have no right to see the advice but you do have to check that it has been given and that the person who has given it is authorised to give pension transfer advice. It also requires them to be careful about fraud. Trustees will want to make sure that their members haven’t been misinformed or misled, but they will want to be careful they don’t expose themselves.”
But in terms of numbers, Cheseldine says half of people in DB could at least “have an argument” for moving.
He says: “There is not one solid group and the only way you know for definite is when they die and what investment returns they have got. It is a balance of risks: how long you are going to live, how long your spouse is going to live, whether your DB scheme will be solvent. Do you have debt you can clear on which you are paying 30 per cent interest, or will you put it into an Isa where you may be paying twice the charges and getting half the return? Death benefits come into it and are by no means a simple choice.”
He adds: “The biggest driver of whether it makes sense is what you think could happen to long-term interest rates. They are really low at the moment so transfer values are quite high, but in five years’ time if inflation is running at 4 or 5 per cent, and long-term interest rates are running at 6 to 7 per cent, your transfer value is going to be half what it is today and you may be kicking yourself.”
Pan Trustees managing director Roger Mattingly says: “The main issue from a trustee point of view is to abide by the law and make sure we are doing what we should be doing: making sure the member has an IFA and ensuring we preserve the financial integrity of the remaining fund. If a scheme is hugely in deficit, trustees need to make sure the transfer value is contemporary and reflects the current unusual economic circumstances.
“If there is a big migration, they have to be protective, although it may work from a de-risking point of view. If the scheme is in deficit and you give a 100 per cent transfer value, you reduce the funding. All schemes have to make sure the transfer value basis is up to date. They should consider reducing values – maybe not doing so but making an active decision about it.
“Of course, the power of cash and instant gratification cannot be under-estimated. Yet once the individual applies to get their money out, once they realise the hurdles, including getting IFA advice, it may end up in the ‘Too difficult’ pile.”
Mattingly is worried about scammers. “The TPR code is an important read. Trustees need to be very vigilant. I have access to two or three lists of scam operators. They are very blatant and pervasive – determined to use modern technology to prey on the easiest victims. It is not easy to monitor. It is do-able, but it is not a hobby but rather a very real responsibility.”
He also says there is a greater burden on schemes given the new approach.
“It is labour-intensive. You need to make sure you are not disinvesting at the wrong time, etcetera. It requires greater cashflow modelling. It requires an active decision about transfer values, although administrators are on the case on fraud warnings.”
Premier senior consultant John Reeve believes the industry may have underestimated demand. “I expect a lot of retirees to consider the option and thus we can expect a large number of enquiries for CETV calculations, even if they do not go ahead. Once they see the numbers and despite the tax consequences, I think a significant number will go ahead.
“In many cases, CETV calculations are long-winded and expensive to carry out. Indeed, for many small and medium-sized schemes, the CETV can only be calculated by the scheme actuary. If the number of cases quoted increases significantly, trustee costs will increase at a time when they can least afford it.”
He continues: “There will be merit in relatively small transfers. For members with a small benefit – not just those under the trivial limits – a transfer and full encashment may well be appropriate. Even a benefit of, say, £1,500 a year would translate to a CETV of about £50,000. While this will need advice, it is possible that a retiree could get
better utility from a lump sum of this size, even after tax, than from a small pension of £125 per month. Those who don’t want future increases, dependants’ pensions or those in poor health could do even better.”
Reeve worries that trustees who believe “they should not tell members about the option to transfer for fear of being seen to encourage a transfer will be deemed guilty of not allowing members to properly consider the options”.
He says: “If a member is in poor health and could benefit from a transfer and an enhanced annuity, or indeed the better inheritance terms available on death, he may consider that he has not been well served by trustees who did not make these options clear. The financial services industry is littered with historic examples of where providers have been held accountable for not making options clear, and trustees could fall into this trap.”
Reeve says that, by quoting CETVs within retirement packs provided to members close to retirement, there are two key effects. “First, it encourages members to consider a transfer. Some employers feel that the costs will be offset by the gain from a significant number of transfers.
“More importantly, it helps members see the real value of the benefits being given up. Asking a member to pay up to £1,000 to help decide what to do with a £5,000-a-year pension seems like a lot of money, but a £5,000-a-year pension is likely to mean a CETV of about £150,000. So £1,000 to help decide what to do with a benefit worth this amount seems more reasonable.”
LEBC divisional director Nick Flynn says: “It is not that everyone should transfer, but everyone should consider doing it. It could be a third of retirees who are single and many have health issues. You may ask: why leave that money when it could be inherited? I have done a couple of £1m cases recently, where they can’t believe the family will pick up what’s left.
“If you have £1m in a pot and take £30,000 each year, you don’t pay much tax and you can leave a fortune to your family. You don’t have to be massively wealthy to have a big DB fund.”