The freedom to transfer pension benefits has since the 5th April been denied to millions of those with deferred pensions. If you are a member of an unfunded Government pension scheme (any scheme other than the Local Government schemes), they you are no longer entitled to a transfer value. Evidence of why was announced by the CEO of Legal and General- Nigel Wilson – who publicised that £1,400,000,000,000 of public debt was hidden by these unfunded pension liabilities not being on the public balance sheet. To put this in perspective, the current funding deficit for the NHS is estimated to be £8,000,000,000, around 1/175th of this pension debt.
The reason why we cannot have transfers from unfunded public sector schemes, is that were this to prove popular, any chance of balancing the country’s books by 2020 would be out of the window. So it’s a case of “Lord give me freedom, but not yet!”.
We of course have no idea how many people really want to give up the security of an inflation linked guaranteed income for life, for loadsamoney and potentially a big fat tax-bill. Knowing public servants a little- they do not appear to be the kind of people who would do that kind of thing- but you (eg George Osborne) never know!
So the first great paradox of pension freedoms is that it has denied freedom of movement for those in unfunded Government Defined Benefit Schemes.
When freedom means captivity
The second paradox is that it has made it almost impossible to transfer defined benefits from a funded (or partially funded) defined benefit to a DC pension and hence to freedom.
The reason for this is very complicated but can be simplified as follows;
Anyone with a meaningful funded defined benefit, valued at more than £30,000 has to take advice on its transfer.
Almost inevitably the transfer value will fail something called a Transfer Value Analysis (TVAS), because the transfer will reflect the funding of the scheme and will only be a partial transfer of the fully funded value.
The adviser will have no choice to say that the transfer value is not worth taking (according to the TVAS) you will be deemed an insistent customer if you persist and the adviser will walk away- for fear of being sued, of losing his Professional Indemnity Insurance and on the advice of his or her compliance officer.
In practice, rather than doing work for you on which he or she won’t be paid, or if paid- paid under sufferance, most advisers are simply not engaging with transfer work at all.
So the second great paradox of pension freedoms, is that even where a voluntary transfer is allowed, the chances are you will not be able to get the advice needed for you to transfer. Most advisers do not want to brand you an insistent customer (blind to your own folly).
When freedom can be purchased by your boss
But there is a third situation which is even more curious and paradoxical. While many people are banned from transferring and many find it practically impossible, the employers of companies with legacy DB schemes are being told by consultants that now is the time to make transfer offers to members of their schemes, making them an offer they can’t refuse.
How does that work?
It works on a simple behavioural principle. If an adviser is being paid to take a legal course of action with no risk to himself and following that course of action will pay his fees, he will pursue that course of action.
Which is why the approach advocated by Aon Consulting in this article makes common sense. Aon argue that now is a good time for employers to enhance the transfer values offered to members to somewhere close to the full buy-out cost. While these transfer values might still fail a TVAS, it will show as being a closer run thing.
But here is the behavioural bit. Recent statistics I have seen show that more than 50% of the transfer values taken in these “exercises”were taken by “insistent customers” against the advice given.
We might reasonably ask what is behind this and why this might not apply to ordinary non-enhanced transfers. To some extent it is because of the enhancement (it is a more close run thing) but that is only a part of the story.
When people are able to engage with the decision and weigh up the potential benefit of the freedoms against the loss of the guarantees from the scheme, a high number vote with their heart not their head.
And when advisers are being paid by the employer , they feel empowered to say “no” knowing that people will do what they want regardless. There is here no risk of not getting paid and no personal embarrassment involved with the decision.
So the third great paradox of pension freedoms is that given the choice people will do what they think best for themselves. The current voluntary transfer rules mean they have to pay a high price to have that choice.
How the reduction in the LTA makes the PPF lifeboat more attractive
Whichever way you look at it, the rules surrounding DB to DC transfers are an absolute mess. We are urgently needing consistency. People (especially journalists) will continue to talk and so long as we have an advisory system that takes no account of people’s objectives and focusses simply on a financial calculation then these anomalies will continue. We need a new code of conduct for advisers agreed with the FCA as a matter of urgency, a code that allows advisers to advise holistically on the totality of the decision and not just the financial assumptions.
As a final point, we need to be much clearer about risk and the nature of guarantees within the DB environment. The recent planned reduction of the LifeTime Allowance, (LTA) means that (if valued on a DC basis) the full PPF pension (around £32,000) would probably exceed the LTA! In other words , the Government is moving towards guaranteeing 100% of our normally taxed pension allowance.
That the DB valuation factors mean that theoretically, only “£640,000” of the £1m is notionally within the safety net is irrelevant, compared with DC equivalence, the LTA limit means that for most people the Pension Protection Fund is a pretty complete guarantee and the risk-adjusted value of the DB promise is improved.
This needs to be made clear by advisers. In terms of protection, the employer covenant is now of less importance as the PPF takes more of the strain.
For most people, the transfer values arising from DB schemes are staggeringly high. Aon estimate that 25% of pre-retirement quotes are now including these transfers as standard.
Dangling transfer values in front of people’s noses, only to present them with an almost impossible process to get to the money (under pension freedoms) is a crazy way to go about things.
We need to go in one of two directions. Either we lump all DB transfers in together and say “no” on a blanket basis or we create an advisory framework that makes it possible for people to make an informed choice on the decision in a free way.
We cannot go on having supposed freedoms which are anything but.
A very good article which gets to the nub of the problem. We have a regulator and an ombudsman that make contradictory rules and judgements, and advisers have PI insurers who will only cover non-insistent advised transfers. Whilst advisers can be successfully taken to the ombudsman for taking a holistic view rather than looking at the numbers only then advisers cannot do anything other than make their recommendation based mainly on the numbers. There are exceptions of course, but generally we are where we are because of regulation and because of the freedom for the Ombudsman to take whatever they want to into account when assessing a subsequent claim against an adviser. The regulator makes rules based on the now somewhat outdated assumption that advisers are as ill-informed and unaware as they were in the 1980s, and seems to more often than not assume that all customers are recently escaped village idiots who need protecting from ravenous salespeople. And we have a regulator who does not have to answer to Parliament so regardless of the sense of their rules and policies they can pretend to listen and then still do what they want anyway. It’s not good, it’s worse than that Captain Kirk. So in over-protecting consumers, we deny them the freedom to make their own informed choices about their own money and assets. Great system eh?
Couldn’t agree more Brian- i rather prefer your comment to my post!