In the past few years, house price inflation has run at such a rate that people’s homes have earned more money than they have. The same has started to be true for some people with defined benefit pension rights.
The recent fall in interest rates means the transfer values being offered by many DB pension schemes are now far higher than a year ago. Cases where transfer values have risen by tens of thousands, or even hundreds of thousands, of pounds are not uncommon.
But can we be confident that the current regulatory regime ensures the option to transfer is taken up by the right people? And that others who should not be giving up valuable DB rights are not tempted to do so by the huge cash sums on offer? There are three key changes to policy and regulation that need to be made if we are to ensure the transfer process works effectively.
1: Updated regulation
The first is that the regulatory regime needs to be updated to reflect the advent of pension freedoms. The current rules were written in an era when it was reasonable to assume most people who transferred would use all or most of their transferred cash to buy an annuity. That assumption no longer holds.
If someone specifically intends to take the cash and invest it for the long term in a drawdown product, it seems odd to undertake a transfer value analysis benchmarked against using the funds for an annuity.
2: FCA and FOS consistency
The second change is that the relationship between the approach taken by the FCA and the Financial Ombudsman Service needs to be reviewed for consistency. A vital part of a functioning transfer market is advisers having confidence that, when they do their job properly, they will not find themselves unfairly challenged at a later stage.
However, I have come across cases where advisers who have followed FCA guidance in providing transfer advice have faced a complaint to the FOS, which appears to apply its own rules as to how the process should work. It is vital there is consistency between the two bodies.
3: Partial transfers
The third key change is that members of DB pension schemes need to be given the right to a partial transfer of their DB rights. At present, the decision as to whether or not to transfer your DB rights is often a binary choice: transfer all or transfer nothing. For some people, though, the option of a partial transfer might represent a better outcome.
A combination of guaranteed income from the state pension and part of your DB pension, plus a cash lump sum to be invested, might be the right mix for some and should certainly be an option. Although some DB schemes will offer partial transfers, they are under no obligation to do so. This means too many savers end up with a stark choice between staying put and surrendering all of their DB rights.
We recently published a guide setting out five reasons to think about transferring and five reasons not to. On the plus side, a transfer can give you much greater flexibility, can improve access to tax-free cash and can improve the prospects of leaving some of your pension wealth to the next generation.
On the other hand, giving up your DB pension means taking on investment, inflation and longevity risk. Many people would be better served by leaving those risks in the hands of their company pension scheme. The balance between these factors will be different for each individual.
For understandable reasons, the FCA requires advisers to start from the premise that a transfer will not be in a member’s interests. One advantage of this approach is that it highlights the considerable value inherent in DB pension rights.
But I have spoken to a number of people for whom a transfer was clearly the right thing to do. For this reason, it is vital there is a good supply of well qualified advisers, willing and able to advise on transfers, and confident they are backed up by the regulatory system when they do a good job. That is why the current rules need to be looked at again.
Steve Webb is director of policy at Royal London