Pension freedoms have led many to consider transferring pension rights out of defined benefit schemes and into defined contribution ones. However, both advisers and clients should be very cautious about such transfers. The industry has been there before some 30 years ago – and it ended in tears.
There are clearly circumstances in which there is a strong case for transferring DB rights into a DC pension but advisers should bear in mind the risks for their clients and, indeed, themselves.
Remember that, in principle, a DB pension will provide a secure and essentially inflation-proof retirement income for the member’s life and probably also for that of their spouse/civil partner. And that income will be based on the member’s pay, not the investment performance of the fund. The employer takes on the risk.
To someone like me, who has never had access to such a pension, it sounds pretty good. If I had worked for a bank, local authority, school, university, the government or even an insurance company, I would really value that benefit. There would have to be a really good reason to abandon a DB pension. If I wanted flexibility, top-up income and estate planning, I would mostly look to assets outside it.
So leaving aside the complicated situations of financially ropy employers and poor schemes, what would drive a client to consider leaving the warm embrace of a good DB pension for the less certain destination of a DC scheme?
Well, there are many attractions of a DC scheme post-pension freedoms, including better death benefits, flexibility, control and access to more income when needed. The benefits of transferring will almost always come down to these features compared to DB schemes. It might make sense, for example, if the pension scheme member has a very sick spouse. In very few cases will the transfer analysis alone justify a switch from DB to DC, despite recent improvements in transfer values.
There has been a huge increase in demand for DB to DC transfer advice, with any client wishing to transfer a value of at least £30,000 having to take competent independent financial advice.
Advisers have had to take a long hard look at their business processes to make sure they can cope with the demand on a viable basis. This has meant challenging their own advice standards, fact finding and implementation processes and capacity. It as also meant looking at client review processes to make sure advice and portfolios are still appropriate. Transfer and forget is not an option. The hazards are many but the key ones involve investment losses from sequencing risk and reverse pound cost averaging, and simple overspending in relation to income.
Advisers need to remember the potential liability for advice could last 30 or more years. The flexibility and death benefits that prompted a confident 50 or 60-year-old to transfer out of their secure DB scheme might look less appealing to an 80-year-old who has run out of income.
A feature of the freedom and choice regime that appeals to many clients is the possibility of pension funds cascading down the generations free of inheritance tax and, depending on the circumstances, income tax as well.
To recap, if you die before reaching age 75, your pension fund will pass to your beneficiary or beneficiaries free of IHT and income tax. Die at 75 or later and the benefits are free of IHT and subject to income tax as the recipient’s income in the years they choose to draw it. This tax position passes on to subsequent generations on pretty much the same basis.
The trouble is that there must be a pretty strong likelihood this benevolent regime will not survive long enough for all of the current generation of pensioners to use it, let alone the generation to come. Creating IHT-free funds is not what pensions are for. Some future Chancellor might spot that.
So it is essential to warn clients of the possibility the rules could change. The chances of a major alteration need to be spelt out clearly so they do not take irreparable steps on the basis of a tax privilege that might not last – like transferring from a DB pension.
Danby Bloch is chairman at Helm Godfrey