Defined benefit scheme transfers

Steven Cameron, Public Affairs Director

For intermediaries only

This article is designed to give intermediaries information that they can use to help control and develop their business and shouldn't be relied upon by customers.

The FCA rules on transfers of safeguarded rights from a defined benefit (DB) scheme continue to require advisers to start from the assumption that transferring will be unsuitable. However, the FCA also states this doesn’t prevent an adviser from recommending a transfer where this can be demonstrated on current evidence to be suitable and in a client’s best interests.

The requirement for DB scheme trustees to see evidence that a member has received appropriate independent advice applies where the safeguarded benefits have a cash equivalent transfer value (CETV) of more than £30,000. Adviser firms must have the FCA permission to advise on pension transfers. For a firm with the permission, FCA rules permit an individual adviser who is not a pension transfer specialist to advise on pension transfers. However, the firm must ensure that the advice is checked by a pension transfer specialist.

The FCA’s new rules on DB to defined contribution (DC) transfers, set out in Policy Statement PS18/6(Opens new window), give a much clearer indication of the many factors advisers should take into account when making a personal recommendation in this area. The FCA has set out a list of considerations to cover within the Appropriate Pensions Transfer Analysis, providing welcome clarity on FCA expectations. You can also have a look at our DB to DC transfers - points to consider(Opens new window) guide which aims to outline the main issues and considerations you must include in any assessment.

Provided all of this is fully taken into account, the risk of future DB transfer advice being found unsuitable should be far less. We hope this will give more advisers confidence to offer advice in an area where the demand for advice is far outstripping supply. We also hope that Professional Indemnity insurers recognise this reduced risk and begin to reflect this by offering more affordable and comprehensive cover.

Against this backdrop, it was disappointing that the results of the FCA’s latest suitability review(Opens new window) published December 2018 found ongoing issues. This review was carried out shortly after the Policy Statement had been published and the new regime coming into effect. The figures were far from encouraging and clearly, any remaining issues need addressed.

However, on closer examination, the numbers may not be as adverse as the headlines suggested. The sample was small, and by the FCA’s own admission, not representative of the whole market. The proportion of unsuitable advice was heavily skewed by four firms who’d varied or surrendered their permissions after FCA intervention. Importantly, the concerns raised weren't new but were in areas where the new rules already offer clarification.

Rightly, the FCA will have no patience with firms which don’t take into account its Policy Statement and updated rules, or which fail to review their approach in light of the findings of the suitability review. We recommend reading the findings of the suitability review alongside the Policy Statement to gain further insights into FCA thinking.  

In the sections below, we bring together extracts from the updated COBS rules and suitability review(Opens new window), grouped under some key headings. Please note that these do not cover all of the FCA's expectations - we have selected topics covered in both the COBS rules and the suitability review. The Policy Statement tends to state what's expected, and the suitability review highlights what not to do by explaining weaknesses found by the FCA. We’ve also added some of our thoughts on each section.

Fact finding and income needs in retirement.
What the updated COBS rules say

"obtain information from the retail client …sufficient to inform both the advice on pension transfers, pension conversions and pension opt-outs and the advice on investments"

"have regard to the likely pattern of benefits that might be taken from both the ceding arrangement and the proposed arrangement"

Weaknesses highlighted from the suitability review

(Note the extracts we highlight may be in different parts of the document)

"Using generic objectives to justify a transfer, without obtaining the necessary information about those objectives. For example, basing a recommendation on the client’s objective to take control of their pension without exploring the reasons for this. This prevents the firm adequately assessing whether the client is able or willing to take the risk required to achieve their objectives.

Using generic objectives in fact finds, such as 'flexibility' or 'increase pension' without exploring what these mean to the client, whether the client is able or willing to take the risk required to achieve those objectives, or why they were prioritised ahead of the other needs and objectives of the client.

Failing to obtain the necessary information about the client’s income and expenditure before making a personal recommendation. For example:

  • Recommending that clients use a Pension Commencement Lump Sum (PCLS) to repay debt or buy a property without obtaining details about the amount needed or exploring alternative finance options.
  • Assuming that the client wants or needs a similar income to what they are currently earning, instead of obtaining details on what retirement plans the client actually has or what their income needs are likely to be in retirement.

We continued to observe failings in these areas. Several firms failed to collect sufficient information on the client’s personal circumstances (for example, their other pension arrangements or plans in retirement). Even where this information was collected firms did not always fully consider this information when making their recommendation.

We observed firms:

  • Failing to consider relevant information about their client’s needs and circumstances when making a recommendation. For example:
    • Failing to adequately take into account the client’s proposed retirement date or the costs of the receiving scheme. In some cases this led to firms recommending clients invest in schemes where the aggregated charges had the potential to negate future investment returns so the client was unlikely to financially gain by transferring and had a high risk of being worse off."
Aegon commentary

These comments point to the need for a very comprehensive fact find and for advice to be highly personalised. A fact find which may be appropriate for advising on investments is unlikely to be sufficient for the separate regulated activity of advising on conversion or transfer of pension benefits.

The FCA expects you to identify realistic retirement income needs and the impact transferring has on achieving these. This includes understanding your client’s intentions regarding the age at which they expect to access their pension benefits. It’s also important to understand the form your client intends to take benefits in - annuity or flexi-access drawdown.

A general desire for flexibility is not enough to justify switching – you should explore in more detail how important this actually is and whether your client can afford to take the risks associated in delivering this.

You should also assess any other sources of retirement income. The absence of any other secure income to meet essentials may reduce the likelihood of a transfer being suitable.

Transfer risk versus investment risk
What the updated COBS rules say

"the retail client’s attitude to, and understanding of the risk of giving up safeguarded benefits (or potential safeguarded benefits) for flexible benefits, taking into account the following factors:

  1. the risks and benefits of staying in the ceding arrangement;
  2. the risks and benefits of transferring into an arrangement with flexible benefits
  3. the retail client’s attitude to certainty of income in retirement;
  4. whether the retail client would be likely to access funds in an arrangement with flexible benefits in an unplanned way;
  5. the likely impact of (iv) on the sustainability of the funds over time;
  6. the retail client’s attitude to and experience of managing investments or paying for advice on investments so long as the funds last; and
  7. the retail client’s attitude to any restrictions on their ability to access funds in the ceding arrangement"
Weaknesses highlighted from the suitability review

"Failing to assess, or using flawed methods to assess, the risk the client is willing to take in relation to their benefits. In particular, we saw firms relying on investment risk assessment tools which were not designed to assess the specific risks associated with transferring from a defined benefit scheme. Where transfer risk was assessed, we saw some firms using unbalanced language which was likely to steer clients to respond in a certain way."

Aegon commentary

The FCA’s latest rules highlight the distinction between investment risk and transfer risk, which relates to giving up safeguarded benefits. You must assess both explicitly.

If your client isn’t able or prepared to accept transfer risk, then it’s unlikely that a transfer will be suitable, irrespective of their attitude towards investment risk. But even if they’re willing and able to accept transfer risk, their attitude towards investment risk might prevent you recommending transferring.

While the two types of risk need to be considered separately, they’re not entirely unconnected. Transferring / giving up guaranteed benefits can affect future investment risk appetite.

Death benefits
What the updated COBS rules say

"consider how each of the arrangements would play a role in… the provision of death benefits, where relevant (including by providing comparisons on a fair and consistent basis between the ceding and proposed arrangements both at present and at various future points in time)"

Weaknesses highlighted from the suitability review

"Prioritising the provision of ‘death benefits’ for spouses and dependants in the event of the client’s untimely death without exploring alternative options (eg existing DB scheme benefits or an insurance policy). Firms also failed to take into account the risk that the flexi-access funds could be depleted by the time of the client’s death."

Aegon commentary

Clearly, the FCA won’t accept a general assumption that death benefits will be better on transferring into flexi-access drawdown. They expect a far more thorough assessment, looking at how they compare at future points in time.

The FCA may also challenge advice to transfer which appears to be heavily influenced by death benefits where other means of providing desired death benefits without transferring haven’t been explored.

Life expectancy
What the updated COBS rules say

"plan for a reasonable period beyond average life expectancy particularly where a longer period would better demonstrate the risk of funds not lasting throughout retirement"

Weaknesses highlighted from the suitability review

"Failing to take into account longevity prospects beyond average life expectancy to inform an assessment of the sustainability of income.

Failing to consider the client’s actual health, as opposed to the client’s perception of their risk of early death, which may often solely be based on the early death of family members."

Aegon commentary

While in a DB scheme, clients don’t need to consider the risk of living longer than their pension fund. Under flexi-access drawdown, longevity risk is significant. Clients often underestimate their life expectancy.

Income tax considerations
What the updated COBS rules say

"take into account the impact of the proposed transfer on the tax position of the retail client, particularly where there would be a financial impact from crossing a tax threshold or entering a new tax band"

Weaknesses highlighted from the suitability review

No additional commentary.

Aegon commentary

Clients planning to opt for flexible drawdown need to consider the implications on marginal income tax, either leading to an increase or possibly being able to remain below a threshold.

Transferring from a DB to DC scheme could take individuals above the lifetime allowance.

Access to means tested state benefits
What the updated COBS rules say

"take into account the impact (if any) on the retail client’s access to state benefits"

Weaknesses highlighted from the suitability review

No additional commentary.

Aegon commentary

This relates to means tested benefits. This may rarely be an issue as most clients transferring are likely to have private pension benefits that will take them out of means testing.

Partial transfer availability
What the updated COBS rules say

Not specifically covered.

Weaknesses highlighted from the suitability review

"Weakness: Recommending clients transfer multiple DB schemes without considering whether the client only needed to transfer one scheme to meet their objectives."

Aegon commentary

There’s increased interest in the availability of partial transfers and we may see a growing number of DB schemes offering these in future.

Even if they’re not available, an individual can often have benefits in more than one DB scheme. In this instance, the most suitable advice might be to keep one or more and transfer others. In this case, the adviser will need to consider which schemes offer more generous transfer terms or which look safer for remaining in.

Alternative ways of meeting client needs
What the updated COBS rules say

"consider how each of the arrangements would play a role in…meeting the retail client’s income needs throughout retirement (relative to other means available to meet those needs)"

Weaknesses highlighted from the suitability review

"Failing to consider the client’s other assets or pension schemes and how these could be used to meet the client’s objectives."

Aegon commentary

This indicates advice on transferring and meeting retirement objectives must look beyond pensions.

Manage competing objectives and trade-offs
What the updated COBS rules say

"consider the trade-offs that may occur by prioritising differing client objectives (e.g. prioritising income needs throughout retirement over the provision of death benefits and vice-versa)"

Weaknesses highlighted from the suitability review

"Failing to adequately manage situations where the client had multiple competing objectives. For example:

  • Recommending a transfer because the client wanted immediate cash and income in retirement and to leave death benefits to their heirs without considering or demonstrating to the client the impact that achieving one objective may have on the client’s other objectives.
  • Recommending that the client accesses PCLS from their pension, when doing so would jeopardise the client achieving their desired or required income in retirement."
Aegon commentary

This will be a highly personalised consideration and could also be highly complex, requiring you to agree on priorities with your client and be able to explain how competing priorities have been managed as part of your personal recommendation.

For further information on DB to DC transfers take a look at our DB transfer hub.