The pension freedoms, which came into force in April 2015, have driven a surge in the amount of pension transfer advice being provided, creating opportunities and dilemmas for advisers.
Transfer advice is high risk for firms and clients. The regulatory requirements can be found in COBS 19, but the Financial Conduct Authority (FCA) has issued a couple of alerts around specific unacceptable practices and TR14/12 contains examples of good and poor ones. The Personal Finance Society has also published a transfer advice Good Practice Guide.
Here are some ways to avoid the three most common issues advisers encounter as part of the file review service that often causes advisers to fall at the first hurdle.
Transfer strategy
Unless the client is transferring at the normal pension age for the ceding scheme, advisers must prepare a transfer value analysis system (TVAS) and give a copy to the client. We often find the TVAS is based on inaccurate assumptions or on a basis that does not reflect the intended position following transfer.
The TVAS must use accurate plan, fund and adviser charges. If the target plan or funds are unknown, you cannot advise, as the suitability of the assets in which the client’s funds will be invested must form part of the advice given to the client.
The TVAS must reflect the intended situation following transfer. For example, if the client intends to draw benefits prior to the scheme’s normal retirement date (NRD), TVAS should be done to the desired age and to the scheme NRD.
If the client intends to draw a pension commencement lump sum, TVAS should include a critical yield calculated on that basis. If the target plan, funds or basis change, a new TVAS is required.
Finally, do you obtain scheme commutation or early retirement factors, or just let the TVAS use defaults?
Balancing act
Advisers must interpret and explain key elements from the TVAS, primarily the calculated yields. Despite some advisers questioning whether critical yield is still relevant since the pension freedoms, it remains the only permissible means of demonstrating the value of guarantees the client would forego.
A suitability report should highlight the advantages and disadvantages of transfers in a balanced manner so the client can make an informed decision. We often see the critical yield quoted and immediately dismissed, because advisers believe they will not buy annuities, and flexible income and legacy is more important.
Advisers often quote past performance before fund and adviser charges, but published performance figures of 6% could easily reduce to 4% or less after charges, which could significantly change the client’s understanding of the comparison between yield and potential returns.
Justifying choices
Alternatives, including non-product solutions such as debt counselling, should be considered. Issues around alternatives are often linked with poorly identified objectives, especially product-led objectives such as releasing cash at 55, flexible income and legacy.
The need for cash should be challenged to ensure it is quantified and genuine. The desire to pay for a dream holiday might be genuine, but is it in the client’s best interest to lose scheme guarantees? Are there other ways of raising the cash?
Life cover should be considered in relation to the legacy aspect. Unless the client intends to draw little or no income from the fund, the higher the critical yield, the less likely it is there will be anything left anyway.
Finally, if the client is not yet 55, is it necessary to transfer now?
Steve Bailey is director of ATEB Consulting.