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Advising on DB transfers: the income sustainability hurdle

DB pension transfer advice has much in common with drawdown advice but with a fundamental difference, says Alastair Black, head of Financial Planning Propositions, Adviser & Wealth Management Propositions, Standard Life

There’s no doubt that pension freedoms has changed the retirement landscape, reigniting public interest in pensions and fuelling a wholesale move away from annuities to drawdown. The appeal of flexible, easy access to pension savings has also been a key driver behind the surge in demand for advice on DB transfers.

At a fundamental level, the ‘DB or DC?’ and ‘annuity or drawdown?’ dilemmas have similarities. They’re both about comparing the peace of mind afforded by a guaranteed income for life with the lifestyle freedom a modern flexible drawdown plan can deliver. It comes down to what the client needs and their willingness, and ability, to take risk.

The key difference, that takes the advice requirements to a different level, is that a client with a DB pension is starting from a position of guaranteed income security and considering giving it up. And they may not be entering the conversation with an open mind. The latest FCA guidance tackles this head on.

What the Regulator expects

The Regulator recognises that pension freedoms has changed the advice equation, but still firmly believes that sticking with DB is likely to be the right outcome for the vast majority. So, they’re really challenging advisers to ensure clients properly understand the real value of their DB pension – and what it could mean to their lifestyle if they give it up and plans go off track.

This involves focussing on 3 key areas, within the context of the client’s needs and wider circumstances:

1. Income sustainability: would a transfer away from the security of DB mean the client risks running out of money in retirement?

2. Value for money: is the transfer value offered by the DB scheme good value for the client?

3. Death benefits: how do the potential death benefits under DB and DC compare?

Of these it’s clear that robustly stress-testing, and properly articulating, the likely sustainability of the client’s retirement income relative to their needs is the Regulator’s primary expectation.

AKG’s research calls out that advisers’ biggest concern around DB transfers is the risk that clients retrospectively challenge their advice, and seek compensation, if plans don’t work out. This is most likely to arise if they start to run out of money so, again, hinges on income sustainability. So how best to manage this risk?

Where investment advice is concerned, assessing a client’s risk appetite and capacity for loss are second nature. For potential DB transfers, the Regulator also expects advisers to assess a client’s attitude to income (un)certainty in retirement and (not) being dependant on markets. This will help establish the client’s ability to take investment risk.  Any income sustainability assessment needs to reflect this investment framework, and the pension vehicle and charges likely to be put in place, if the transfer proceeds.

Is cashflow modelling the answer? Multi-scenario cashflow modelling can be a powerful tool to deliver against the Regulator’s expectations. It helps translate a client’s risk appetite into reality, demonstrating sustainability risk in a transparent way clients will struggle to challenge in the future.

Running a series of cashflow projections, reflecting the client’s:

• intended income pattern(and a Plan B with lower income which the client must be comfortable with),

• the likely charges and tax payable, and

• a range of potential investment outcomes (from best estimate, through prudent to resilience testing)

helps paint a clear picture for the client of what they’re getting into.

Ensuring the client properly understands their income isn’t guaranteed if they transfer, and the potential downsides, helps keep you safer too. Negotiating this sustainability hurdle means your transfer advice is built on solid foundations.

Previously published in the AKG Pensions Freedoms 2018 paper

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