In June 2017, the FCA (Financial Conduct Authority) published its proposals for changing the advice that individuals get from financial advisers on transferring their pension. In most cases, these transfers involved moving a pension from a defined benefit pension to a pension contribution scheme. Both have advantages:
- Defined benefit pension – has ongoing protection for the individual’s annual pension income
- Pension contribution scheme – individual often get more than the value of their current pension plus they have more flexibility over what to do with the money in the pot
In summary, the FCA’s recommendations want financial advisers to be more cautious before recommending a pension transfer to a client. What exactly are the proposed changes, however, and why is the FCA doing this?
The Proposed Changes to Pension Transfer Advice
The FCA's proposals include changing the TVA (transfer value analysis) requirement. It wants to replace this with a comparison so individuals can see more clearly the benefits they will give up by going through with the transfer.
The proposed changes also require financial advisers to make personal recommendations to each individual. This is to ensure the financial adviser considers an individual’s personal circumstances in the advice they give. The proposals will require greater assessment of the suitability of a pension transfer for an individual, particularly in relation to safeguarded benefits.
So, the FCA's proposed changes mean financial advisers will have to ensure a pension transfer is in the client's best interest.
Why Is This Important?
Shouldn't financial advisers be acting in the best interests of their clients anyway? Of course, but the FCA's move comes amid a dramatic increase in activity over recent months in the pension transfer market. Since the 2015 pension reforms that gave individuals much more flexibility with their pension, it is estimated that about £50 billion has been transferred from defined benefit pensions and into pension contribution schemes.
In addition, individuals can get up to 50 times the projected value of their annual pension income as an incentive to switch. The suspicion from the FCA is that financial advisers are doing this for reasons of profit rather than because it is in the best interests of their clients.
In addition, companies also benefit when individuals transfer their pensions as the company's pension liability reduces – in some situations by significant amounts.
Losing the Safeguards
Transferring a pension from a defined benefit pension to a pension contribution scheme is an attractive option for many individuals. One of the reasons for this is it allows them to access some of the cash earlier.
The main difference between a defined benefit pension and a pension contribution scheme, however, is the former guarantees an income for life. A pension contribution scheme, on the other hand, has no such protections. Instead, it is based on the amount of money that is in the pot. As that money is being invested, it can go up or down. So, even though an individual gets up to 50 times the projected annual income, they could potentially receive less than the projected annual income at some stage in the future.
In other words, there is a risk involved in transferring a pension. As a result, it is not the best course of action in every situation. The FCA wants to ensure the interests of the pension holder get priority when financial advisers make pension transfer recommendations.