A hot topic in my recent discussions with advisers has been the growing number of people interested in transferring their defined benefit pension rights into a defined contribution scheme. With many schemes offering eye-watering transfer values, this is likely to be an area of increasing interest. However, many advisers, for understandable reasons, are reluctant to get too involved. How can we get to a situation where access to high quality, well-informed advice means the “right” people transfer and the “wrong” people do not?
At first glance, encouraging DB to DC transfers feels like it could be a win-win-win for DB schemes, scheme members and the Government. For the scheme it offers a chance to derisk and thereby reduce the volatility of the DB deficit figure on the balance sheet of the sponsoring employer.
For the scheme member transfer values have never been higher. Take, for example, a client of an adviser I met recently, whose transfer value had increased by more than the value of the average house in the UK over the last year.
For workers in certain situations – such as those who fear their sponsoring employer will go bust, those in poorer health who might prefer cash now or those who want to pass on part of the value of their pension rights to the next generation – a transfer out could be very attractive.
And for the Government, if people exchange an income for life for a lump sum and then draw down more rapidly than they would otherwise have done, there is a potential boost to upfront tax revenues, just as with the original freedom and choice reforms.
So with all these potential upsides, what is there to worry about? Well, the first concern is that individuals may be seduced by the huge cash sums being offered into giving up something very valuable: a guaranteed income for life, with a measure of protection against inflation and a pension for a surviving spouse. If savers are blinded by the lump sum on offer, they may be tempted to transfer out only to live to regret it.
The obvious antidote to this would be a ready supply of high quality impartial advice. But here the situation is problematic. Some advisers simply refuse to take on this work for fear of subsequent litigation or the problems of having to deal with insistent clients. Those advisers who are willing to do work in this area find their professional indemnity insurance costs can rise and live in fear of retrospective challenge – both from savers that transfer and later conclude they should not have done so and from those who do not transfer (having taken advice) and later decide they would have done better if they had. Advisers could be forgiven for thinking they will be damned either way.
“If savers are blinded by the lump sum on offer, they may be tempted to transfer out only to live to regret it.”
One halfway house that would reduce the risks all round but provide for greater flexibility than the current situation would be if partial DB transfers were more readily available. DB schemes might well object to the increased administrative cost of allowing partial transfers or perhaps providing a “menu” where scheme members can choose how much of their DB rights they want to transfer out. However, if such transfers were much less of an all-or-nothing choice then take-up might be much greater, to the benefit of the scheme. In this case, members could retain a guaranteed index-linked income as a floor for their retirement saving but could also enjoy the greater freedom and choice to turn income into capital, which DC savers already enjoy.
Ideally, there would be a regulatory regime that provides a safe environment in which advisers can service this market. But the current process, with its focus on “critical yields”, was designed very much with the world of the annuity in mind. Given many people who have built up large cash-equivalent transfer values have no intention of buying an annuity and are more likely to go for a mixture of drawdown and withdrawing cash, this seems to be the wrong benchmark for comparison. Although there is a lot in the FCA’s in-tray, the regulatory framework for advising on DB to DC transfers needs to be refreshed as a matter of urgency.
Steve Webb is director of policy at Royal London