The regulator’s policy statement PS20/6 introduced a number of changes to the provision of defined benefit (DB) pension transfer advice, the vast majority of which came into force on 1 October 2020.
These changes, along with escalating difficulty in securing professional indemnity (PI) cover for this type of business, could see advisers exit this market resulting in the supply of advice being unable to meet the level of demand. Perhaps an increase in the availability of partial transfers could help.
In July 2019 we undertook research with 535 people working in financial advice firms to gather their views on partial transfers. Some 65% had advised on a transfer out of a DB scheme at some stage, but only 20% of these had ever advised their client to take a partial transfer.
When asked why around three quarters said it was because the option wasn’t available with that scheme.
Although there’s no explicit requirement for advisers to request information about the availability of partial transfers, this supports the results of 2019 research by LCP which found that only around 20% of schemes offered partial transfers within their rules.
However, when we asked advisers in the July 2019 survey, “if more schemes offered partial transfers, what proportion of people who took a full transfer do you think would have been likely to have taken a partial instead?”, there was an obvious demand for this option. Although we can’t ignore the fact that the largest answer was none at 34%, nearly a quarter of advisers think more than 50% of the clients they advised would have, and overall two-thirds of advisers say this option would have appealed to at least some of their clients.
These advisers were then asked a similar but crucially different question. “If schemes offered a partial transfer, what proportion of people who didn’t transfer, would have been likely to take a partial transfer instead? Around a third of advisers said more than 50% of their clients would have been likely to do this, and almost three-quarters said some would have been likely to do so.
This highlights the common “all or nothing” decision facing most clients considering a transfer out of their DB scheme, when perhaps the half-way house of a partial transfer would have better suited their needs.
At-retirement advice best practice often advocates segmenting clients’ retirement income needs, for example, essential expenditure (food, clothing, heating, shelter etc.); discretionary (nights out, gifts etc.); aspirational (German cars and international holidays a few times a year).
This best practice almost always indicates essential expenditure and possibly a small element of discretionary income are secured by some form of guaranteed income for life, such as an annuity or DB pension. The remainder, however, is often accessed flexibly, usually via an income drawdown plan.
People with only defined contribution (DC) benefits can quite easily use some of their pot to purchase an annuity, while leaving the remainder of the plan to be used flexibly. Those with only DB benefits, however, cannot generally exchange some of their guaranteed income for a flexible lump sum in excess of tax-free cash, unless a partial transfer is available.
There is no legal or regulatory requirement for schemes to offer partial transfers, and the administrative burden on the scheme is often cited as the reason for not doing so.
However, there are potential benefits for the scheme of making partial transfers available. Schemes get to exchange unknown future liabilities for known costs now and although liquidity needs to be managed, trustees may view this positively.
In guidance to trustees on DB transfers, TPR highlights that partials are an option trustees may wish to consider and also points out that access to this option could be on a specified basis. TPR also says that trustees should try and align the approach to transfers under scheme rules with that applicable to statutory transfers in order not to cause confusion.
We know the FCA has a heavy focus on demonstrating that a client’s essential expenditure can be met for the rest of their life. DB pensions do this very effectively but aren’t as effective at providing flexibility above the level where the required guaranteed income has been secured.
Partial transfers do appear to be an effective solution to this. Leaving clients with a portion of secure income to meet those essential needs reduces the risk of ruin, which could reduce the level of complaints about unsuitable advice, and this should have a positive impact on the price and availability of PI cover.
This is important as PI cover, along with regulatory scrutiny are the two biggest issues cited by advisers in our research, and PI, in particular, appears to be the main driver for advisers exiting this market in the last three years.
Justin Corliss is senior pensions intermediary development and technical manager at Royal London