In recent months, transfer rates for individuals looking to transfer their defined benefit pension to a flexible draw-down have increased significantly. But by transferring albeit at higher rates, are consumers giving up a valuable benefit? Before entering into any agreements, consumers may find our piece on transfer rates helpful before consulting an IFA.
Transfer rates: Too good to be true?
Ever since the government’s introduction of so-called Pensions Freedoms in 2015, there's been a steady flow of people looking to transfer their pensions from the guaranteed income (but perceived constraints) of their defined benefit schemes to the anticipated freedoms of a flexible drawdown pension. Recently, this transfer activity has increased partly as a reaction to economic uncertainty brought by the COVID economic crisis.
At the time of writing, an individual looking to transfer their defined benefit pension to a flexible draw-down will also potentially benefit from highly-inflated Cash Equivalent Transfer Values (CETVs). This transfer value inflation, alongside real concerns about the economic climate post COVID, could be seen as driving a flurry of transfer activity before the transfer rates potentially go down again, due to anticipated changes in the calculation basis, driven by the likely reality of future economic conditions.
The regulator steps in
However, in some instances, this increase in transfer activity could arguably be a case of certain less-than-fully-reliable Independent Financial Advisers (IFAs) driving their customers to transfer before the FCA's new ban on contingent charging for Defined Benefit pension transfers came into force on 1 October. Contingent charging is where a financial adviser only gets paid provided a transfer goes ahead.
The ban on contingent charging is intended to remove this potential or perceived conflict of interest. From now on, clients will pay to receive advice, whether it is ultimately to remain in their schemes or to transfer.
Another FCA ruling comes into effect this month, which will require IFAs recommending a transfer out of a Defined Benefit scheme to compare the proposed destination for the funds against a low-cost workplace pension. On the face of it, this may seem odd, as many people are looking to transfer out of a workplace scheme in the first place. But it appears that some of the products that are currently commonly used for transfers have multiple tiers of charges and the FCA is concerned that they may represent poor value.
The overriding question
Before transferring out of a Defined Benefit pension, people need to ask themselves why are current transfer rates so high? Customers might be enticed by the potential of taking higher cash values and believing that to be a positive outcome of the current COVID situation, but would they be better off in the long run by staying in their Defined Benefit scheme?
Today's transfer values are high. However, part of the reason for this could be that pension fund managers are said to be incentivising transfers out of final salary schemes due to issues of future affordability.
When deciding on transfer values, pension scheme administrators will usually consider factors such as the age of the member applying to transfer, the scheme’s set retirement age, the cost of living, the life expectancy of the average member and the scheme’s current status as regards investment costs and returns.
In an era where pension scheme managers have to navigate low-interest rates, plunging bond yields and rising longevity, final salary pensions are proving to be expensive schemes to run. After all, a final salary pension scheme is a guaranteed income for life and many schemes are index-linked so that they’re set to rise each year with inflation.
It’s an experienced and appropriately qualified financial adviser’s job to determine whether a final salary pension transfer is the right option for a particular client. They will take into account amongst other things, the risk of losing guaranteed income from the defined benefit scheme compared to the net returns and income that can be generated by transferring into a flexible pension plan. The former choice is 100% certain whilst the latter option is based on a lot of assumptions, including the level of investment risk the client is prepared to accept.
Less regulation, more innovation?
It’s the role of the government and the regulator to take action to protect outcomes for savers; as conflicts of interest and inefficient schemes need to be settled. Nonetheless, there remains a fundamental unresolved issue for a key segment of the financial services market; an historic lack of innovation and a failure to deliver genuine freedom and choice for older consumers. People are living longer, starting families later, having second careers and embarking on second marriages later in life, but then finding that their financial options in early retirement are increasingly diminished. Earlier generations tended to work until retirement and then come to a full stop, but retirement is now more of a process than an event; many people are still be working well beyond the traditional pension age, and they are seeking new options to raise funds in later life.
When the industry has looked at innovation, it has sometimes overlooked the potential for new services in the retirement and semi-retired sectors. The FCA’s regulatory sandbox programme seeks to test innovative products, services, business models and delivery mechanisms and its latest programme made a welcome call for propositions that ‘make finance work for everyone’. But a review of the six cohorts that have taken part in the programme over the years found that only 2 out of the 140 companies were focused on new approaches to retirement planning or later life finances. So while this call for innovation is refreshing and welcome, in our view, we need more of it.
Re-thinking finance to make make a freedom of choice a reality
Savers, advisers, policy-makers and financial services companies all have a role to play in addressing the status quo. No two individuals are the same and, as such, we need a diverse range of tools to support people through retirement to make freedom and choice a reality.
Ultimately, we need to address the situation where savers who are seeking to raise capital to fund their early-stage retirement have so few options once they hit a certain stage, and are sometimes obliged to act against their own best interests by choosing inappropriate products or where they are unable to fulfil their plans.
Recognising that change doesn’t happen in a vacuum, the financial services and fintech industries need to work together to explore new solutions, provide different options and forge new approaches to improve the financial landscape for the over 55s. In other words, rethinking finance.
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Please note: This article was believed to be accurate at the time of writing and is intended to provide general information only to the reader – it does not constitute advice of any kind. Before making any decision about your savings, investments and your pension, you should consult an Independent Financial Adviser.