New rules from the Financial Conduct Authority (FCA) on pension transfer advice will bring about a significant change in the conversations between schemes members and their advisers, according to a joint policy paper from consultants Lane Clark & Peacock and mutual insurer Royal London published today.
From 1st October 2018, financial advisers are obliged to show their clients how the transfer value they have been offered by their company pension scheme compares with a ‘transfer value comparator’ (TVC). This is an estimate of the lump sum needed today to buy an equivalent pension at retirement to the one being given up. (The TVC is based on the assumption that the money transferred is invested in ‘risk-free’ assets up to retirement and is then used to buy a guaranteed income in the form of an annuity).
The two figures will be shown in the form of a bar chart, with the TVC figure almost always being the higher of the two. The key findings from the LCP research are:
- For members ten years away from retirement, the transfer value on offer will on average only be around 55% of the ‘full value’ of the pension given up, according to the FCA methodology;
- The range of transfer values offered by different schemes is very large – with some schemes offering transfer values as little as 40% of the ‘full value’, and others offering transfer values of more than 80% of the “full value” – there are good reasons for this, but it may come as a surprise to some members of schemes;
- For members within a year of retirement, the transfer value on offer will typically be higher, with an average transfer value being around 75% of the ‘full value’ of the pension given up;
- As well as typically increasing as members become older, the generosity of transfer values is likely to drift up over time, other things being equal. This is because most occupational pension schemes are gradually changing their investment mix towards lower risk and lower return assets. This makes it more expensive to provide pension benefits and therefore increases the amount schemes are willing to pay someone who is prepared to transfer out.
Financial advisers surveyed by Royal London were in general in favour of this new method of talking to clients about whether transfers are a good idea, with most agreeing that a comparison between two lump sum figures was easier to understand than the old concept of a ‘critical yield’ which was often used in advice conversations. Although telling a client that he or she is being offered only 55% of the ‘true’ value of their pension could put some people off transferring, most advisers felt that this would not have a major impact on the volume of transfers. It would however prompt advisers to have to explain more about the level of risk that those transferring would be taking on.
The paper suggests that this greater clarity about the relative ‘generosity’ of transfer values offered by different company pension schemes could cause trustees of those schemes to review their policy on transfer values. Schemes offering the most generous transfer values (relative to the new FCA benchmark) might ask themselves whether they needed to be as generous to those leaving the scheme, whilst those with the least generous transfer values might face pressure from members to increase the amount on offer. In addition, where a client has rights under more than one DB scheme, the relative generosity of the transfer value on offer from each scheme could be a factor used by advisers in deciding which transfer to prioritise.
Commenting on the results, Jonathan Camfield, Partner at LCP said:
“Our research shows that people ten years ahead of retirement who are considering transferring out of a company pension will typically be told that they are giving up around half of the ‘full value’ of their pension. This does not necessarily mean that transferring is a bad idea, but it does show very clearly that those who transfer out are forgoing a great deal of certainty about their future retirement income and that this certainty is of considerable value”.
Steve Webb, Director of Policy at Royal London said:
“With around 200,000 people having transferred out of a company pension in the last couple of years, and thousands more doing so every week, it is vital that they have a clear understanding both of the advantages of transferring and of the valuable benefits they are giving up. If this new way of assessing transfer values results in better informed conversations with impartial financial advisers before decisions are made, this would be a good thing”.