What’s going on in the final salary market?

Financial advisers are accustomed to dealing with unintended consequences of decisions made by those who set policies. One such area that has garnered more column inches than most is the Final Salary / Defined Benefit (DB) pension scheme market.

One thing everyone agrees on is that these types of pensions, which were commonplace for years, have proved to be unaffordable for the companies or public bodies that offer them, in the long run.

A population that lives for longer needs more money to pay for retirement. A scheme that promises to pay a level of income for the rest of retirement may have a level at which it becomes impossible to meet its commitments. We’ve seen with the collapse of some schemes (BHS and British Steel for example) that this happens, while other schemes have discovered a ‘black hole’ in their finances – essentially, there’s not enough cash to cover liabilities.

This is where the Pension Protection Fund has stepped in to take over the administration of those schemes.

The rush to transfer

All of this might never have materialised, but for the single biggest change to pension policy for generations. Demand for advice to transfer DB pensions was driven initially by the introduction in April 2015 of ‘pension freedoms’ which provided for much greater flexibility in the use of defined contribution (DC) pension pots. This growth was reinforced by surging transfer values (primarily reflecting ultra-low interest rates) and a relatively permissive / benign regulatory regime. (From “Mind the transfer advice gap?”- A joint paper from LCP and Aviva on the current state of the DB transfer market, September 2021)

Cue a rush for companies with these schemes to de-risk themselves by offering members the opportunity to transfer out for a lump sum.

As is often the case, cracks emerged in the market several years ago, with malpractice coming to light. Clients were given the green light to transfer without proper processes being followed. The highest profile example of this being British Steel, where some scheme members were provided with improper advice.

The regulator acted and banned ‘contingent charging’ – a practice whereby advice firms offered advice regarding a pension transfer and the client only paid if the recommendation was to proceed. With the transfer, clearly this would wrongly incentivise the firm to recommend a transfer and we have always operated an objective process to determine the advice we give, not influenced by whether there’s a fee to charge.

The ban on this activity has led to a reduction in advisers willing to provide advice on transfers from DB pensions because it became unaffordable for some clients to pay for the advice, alongside rises in the professional indemnity insurance premiums required to operate in this market.

Advising on these pensions is a specialism. Wren Sterling invests significantly into technical qualifications and ongoing training for our advisers, as well as the infrastructure to support our advisers, which includes highly qualified business quality monitors and financial modelling software to generate the financial information required to provide advice.

It has also left those with relatively small DB pension pots without a place to turn. It is a legal requirement for the holder of a pot valued at over £30,000 to get financial advice before the scheme will facilitate a transfer. In some cases, the fees for such work eat into the potential value to such an extent that it is pointless.

Why we’re committed to the market

Wren Sterling believes that it is our responsibility to help clients evaluate whether a transfer is the best outcome for them. It must be said that in the overwhelming majority of cases, it is not. Very often the benefits of the scheme and the likely impact on a client’s quality of life in retirement cannot be bettered by transferring and we recommend that clients remain in the scheme. We provide this advice to individuals and scheme members for some of our corporate clients, sometimes advising hundreds of members in the same exercise.

We’ve been awarded the Pension Transfer Gold Standard quality mark from the Personal Finance Society. The Gold Standard is a voluntary code of good practice for safeguarded and defined benefit pension transfer advice, based around a set of principles.

We have adopted this standard and principles, so people can be confident they are dealing with a firm that is going beyond minimum requirements when giving financial advice in this area.

MM: What will the recent changes to charges mean for DB pension holders in the future?

Paul Chafer: Irrespective of pensions freedoms and other legislative changes, or the number of IFAs providing advice – people need this advice. Your DB pension could be worth as much as your home and may be the largest asset to consider when planning your retirement income.

This is why the Pension Transfer Gold Standard is so helpful, as it signposts which advisers are able to provide this advice and have committed to excellence in this area. Clients can also look at how many clients an adviser has supported, and what they have to say. At Wren Sterling, we have supported a number of large corporates with Defined Benefit Transfer advice for their employees.

We’re going to see increasing demand as there’s still a lot of people in final salary schemes, against reducing supply of advice. Recently the regulator said that firms must demonstrate value for money and make it frictionless for customers to enter and exit products.

MM: What does that mean for Wren Sterling?

PC: I think we always challenge ourselves to think ‘are we providing value for money to clients?’ After all, if we didn’t give value for money, our clients will quickly go elsewhere! A number of large corporates look to us to support their employees with regular advice programmes. To do so, we employ top class advisers, and a supporting team of Paraplanners and Administrators. We acknowledge that advice isn’t cheap, but I do believe we provide value for money – and always have the customers’ interests at heart.

MM: What about those with smaller pots?

PC: Anyone under £30k can transfer away without needing advice. Self-administering can have its own challenges as few people will be used to filling in pensions paperwork. The process is the same whether your pension is worth £30,000, £300,000 or £30,000,000!

MM: Do you anticipate it being harder for a client to transfer their DB pension?

PC: Where transferring is right for the client, and they find a qualified adviser, I don’t think it will be any more difficult. Where it’s not right for the client, they’ll find difficulties in transferring – but you could argue that’s not a bad outcome. There will always be clients who want to transfer because they’ve seen a friend or family member transfer recently – but it won’t be the right decision for them and could leave them worse off.

If I say to you “you shouldn’t transfer your pension – because you can get what you need in the happy environment of a safeguarded pension” but I then help you fill out the forms for this, I would be found wanting from an ethical standpoint.

There may be the option to do a ‘partial transfer’. This hasn’t always been possible, and is quite rare, but I think it will increase over time.

MM: What is a partial transfer? Could this help people who need a bit more flexibility in a DB pension?
PC: If you have a DB pension, you are usually facing a binary decision; to transfer or not to transfer. Let’s say you need to downsize or make changes to your home, but a full transfer isn’t recommended. With a partial transfer, you could supplement your income by taking a portion of your DB pension. This could leave you a comfortable level of income in retirement, and the flexibility to do what you need to do with the remaining pot.

I think partial transfers will help with immediate needs, and will help manage emotions around your retirement because you’ll need to rely on these funds. For some, even if a transfer is the right decision, clients are hesitant to transfer away. Particularly for people who are quite risk averse, or only have their DB pension as their source of retirement income, a partial transfer would allow you to mitigate that risk.

However, only around 1 in 5 schemes currently offers partial transfers. The difficulty is the demand on the Scheme Administrators so at the moment, there are two choices, stay or transfer. I can see this changing as more people begin to see the benefits of a partial transfer and administrators find a way to offer it to members. As technology improves for example, I do think we will see more schemes offering partial transfers.

IMPORTANT: Accessing pension benefits early is not suitable for everyone and may affect your entitlement to certain means tested benefits. When investing your capital as at risk.