DB-DC transfer process needs radical overhaul and allow partial transfers
Mike Morrison, pension specialist at AJ Bell, says policymakers should radically overhaul the entire process of Defined Benefit to Defined Contribution transfers and the advice framework that exists around it.
In the report from the Work and Pension Select Committee published in December 2016, the Government was called upon to consult on relaxing rules for taking small DB pension entitlements as lump sums in a forthcoming Green Paper. We think it should go much further.
Pension freedoms and fears over the ability of defined benefit sponsors to pay pensions have fundamentally changed the DB to DC transfer equation. We now need a fundamental review of what constitutes good practice in the market today. The Transfer Value Analysis (TVAS) assumptions used to assess the appropriateness of DB transfers were introduced in 1994 and have not been changed since then.
These predated pension freedoms and are based on comparing DB benefits with what annuity could be secured from the transfer value, projected forward to scheme retirement age. If the comparison is poor or a high critical yield would be required to match projected pension benefits, the recommendation would, in most cases, be not to transfer.
However, those figures are no longer the only factor. Individuals particularly keen to take benefits from an earlier age or in a more flexible way may place a high value on accessing the pension freedoms.
FCA rules still stipulate that an assessment of DB – DC transfers must start with the assumption that it will not be in the client’s best interests. This now feels outdated in the post-pension freedoms market and at a time when many DB schemes are in deficit.
This presumption also introduces a regulatory bias in that many advisers will not advise on such transfers because to advise properly might mean having to go against the presumption. We would recommend a review of this presumption so that each case can be considered on its merits and the specific rights of the DB scheme member can fully be considered.
It is vitally important to consider the DB guarantee but in the time of pension freedom should we be treating DB and DC any differently?
When we spoke to financial advisers about this, half of them said they did not think this assumption was valid in today’s market so there is definitely demand for the regulator to have another look at this area.
The Government’s green paper would be the ideal time for the regulator to review the process surrounding DB transfers, including the TVAS assumptions, and provide good practice guidance that is appropriate to today’s market.
The answer in the majority of cases is still likely to favour the guaranteed benefits of a DB scheme but there may be cases where more flexibility can deliver a better outcome for the client.
For example, wider availability of partial transfers from DB to DC schemes could deliver benefits to clients, advisers and pension schemes. For clients and advisers they avoid the current ‘cliff edge’ decision they face when deciding to make a transfer. Clients would get greater flexibility and choice. Advisers would be able to meet a wider range of client needs without it being an all or nothing decision.
From the employer perspective there is the benefit of de-risking and potentially cost saving resulting from reduced pension liabilities.
As scheme members already have a right to a full transfer there is no obvious reason why the right to a partial transfer should not be offered. It might mean a rule amendment as well as some extra admin and actuarial calculations but this is done already for full pension transfers, so shouldn’t be a show stopper.