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Sweet and low

O&M Systems director Jason Wykes asks just who is the customer that needs to be treated fairly – the employer who pays a benefit consultancy to encourage members to leave a DB scheme or the member who is about to give up valuable retirement benefits for a flat-screen TV and an unexpected tax bill?

The growing practice of employers offering a cash inducement to deferred members of final-salary pension schemes to transfer out is finally getting attention from The Pensions Regulator and the FSA.

Are all these sweeteners a bad thing and should advisers steer clear?

It is fair to say that the majority of such offers are simply not good value.

The employer is hoping the dangled carrot of cash in the pocket will entice members to lose all reason and accept any offer on the table.

The covering letters to scheme members are often provocatively written and this is an area where the scheme trustees and The Pensions Regulator should look very closely.

For example, the letter issued in December 2005 by PWC to members of the Harland and Wolff scheme made shocking reading, with comments including “Transferring to a personal pension arrangement can provide opportunities… including taking a tax-free cash sum” (they did not mention that the scheme can also pay a tax-free cash sum) and “The employer has limited resources so the top-up…will only be available on a first come, first served basis…”

It is unfortunate that some commentators are suggesting that IFAs must resist the option of providing advice on these bribes. Surely, this is not the answer.

Scheme members need to understand the true value of the benefits they are giving up and this is precisely why IFAs must provide advice to their clients or at least point the client to where they can get advice.

The trend among big IFA firms I have spoken to is a big increase in the number of clients seeking advice in this area, with the percentage of positive transfer recommendations being considerably less than 20 per cent of cases.

This is good as it means that the members are being given clear, independent advice about the value of their benefits, including, in most cases, the likely benefits offered by the Pension Protection Fund).

The advice, however, is not always cut and dried. One employer my IFA firm dealt with recently paid us a fee to advise the 20 or so deferred members of the scheme on an enhanced transfer value offer. The critical yields on these cases were in the range of 3 per cent to 5 per cent, so even the cautiously minded individuals were interested in pursuing a transfer.

On the other hand, we are advising 40 members of another scheme where we have only recommended a transfer to two of them.

As with all advice issues, we need to look at each client individually rather than tar the entire issue with the same brush. Some of the offers merely top-up the already low MFR-based transfer value while other offers go some way towards the true buyout cost of the benefits.

Another contentious issue is on taxation of the cash inducement. Currently, it appears that HMRC is leaving this down to each inspector of taxes as the central pensions office in Nott-ingham has declined to provide any clarity.

Referring to the PWC letter to Harland and Wolff members, it said the cash payment “would not be subject to income tax but would be treated as a capital gain.”

The Federation of News-agents’ scheme said it would need to deduct basic-rate tax before making any such payment while many others are suggesting it will be completely tax-free.

This raises three issues: First, shouldn’t the tax basis be the same for all schemes? (that is, HMRC centrally makes a policy decision). Second, as a taxpayer, I would have to ask why this should be considered tax-free? Third, the tax-free status is based upon the employer’s discussion with their local inspector of taxes.

Most deferred members, who, by definition, are generally no longer employed by the company, will probably be looked after by a different tax office – that of their new employer. Under self-assessment rules, surely it is down to the individual to tell their local tax office and hope they agree on the tax- free status – a high-risk strategy.

If the authorities want to dampen down these incentives, the easiest way is to apply income tax on any cash sums paid. No one likes to pay tax. But it is also becoming clear from the DWP that it may be looked at as a wilful deprivation of benefits when assessing benefits on retirement.

The positive effect of this would be for more sweeteners to be offered as enhanced transfer values rather than cash that will not be around at retirement.

Another interesting angle in this area is where the employer hires a big benefit consultancy to offer generic advice to members. This is better than no advice at all but the definition of advice is blurred. Members feel they have been given advice while the benefit consultancies point to the small print and say they merely provided information.

The fact that a stakeholder plan application form is often enclosed with the “advice” only serves to muddy the waters. The water gets no clearer when you introduce TCF into the equation.

Just who is the customer that needs to be treated fairly – the employer who pays a fee for the benefit consultancy to encourage as many members as possible to leave the scheme, or the member who is about to give up valuable retirement benefits in exchange for a flat-screen TV and an unexpected tax bill after the event?

It should become increasingly clear that advice is needed for scheme members but the issues involved are complex. Most advisers should refer the client to a specialist every time.

It will be interesting to see whether the guidance being drafted by the regulators will help to clarify any of these issues. From my discussions, I fear that the guidance will be so vague as to be of little value. As usual, everyone, including the regulators, wants to cover their backs. This does not bode well for the future of the industry, nor help to regain public confidence.

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