The FCA paper on structural problems with the pension freedoms that I wrote about yesterday, is the first evidence of Government admitting all in this garden is not rosy.
What has happened since 2015 is an increase in people hammering poor pots for cash usually unadvisedly and sometimes foolishly. This is not where there’s a market failure. Most small pots can be drawn down in a few stages to give the over 55s a well earned bonus as they come to the end of their working lives. This may not be prudent, but nobody says you have to be prudent. It may not be sensible to take your money from a tax-free investment account and put it in a (potentially) taxed deposit account, but nor is that disastrous. What happens to the victims of pension scams – that’s disastrous.
If all that had happened since 2015 was the reallocation of minor savings from pensions into bank accounts then I could be as sanguine as Steve Webb – on this morning’s Wake Up to Money.
What about the £50bn flow from DB Schemes?
The vast majority of the £50bn Mercer estimated has been unlocked from “frozen” DB plans has come as CETVs well in excess of £30,000 and has been advised upon.
This is not money that individuals have saved, it is money that has been accrued by trustees and appears as a windfall to most ordinary people. The cost of unlocking this money is typically the cost of advice. Advisers have found ways of mitigating the cost by deferring the bill so that it can be paid out of the proceeds of the transfer. This is known as conditional charging and has three advantages.
- It takes away the need to charge VAT (@20%)
- It bundles the cost into an annual management charge rendering it painless
- It ensures that the proceeds of the transfer provide annuity income to the adviser
Unsurprisingly, conditional pricing is hugely popular with advisers and clients. It has fuelled the transfer boom. Advice- for those with the money in their pension pots, need not be an obstacle and can be a great help in future planning.
But here’s the problem
Those who have built up these huge DB CETVs have seldom read the scheme accounts. If they had they would see that the costs of investment management , actuarial ,investment and legal advice, custodianship and administration are met by the scheme.
When you take your CETV, these costs do not go away, they are transferred to you. What is more, where the scheme can get economies of scale by pooling these costs – you can’t. You have to pay the majority of these fees as an individual.
This shift of management costs from group to individual is part of the price of freedom. If you are paying 1% pa of your CETV of £1m to an advisor, you are paying £10,000 pa. If you pay a platform fee of 0.6% for fund administration, you are paying another £6,000pa. If you are paying 1% in annual management charges for the investment of your money, that’s another £10,000pa. If you are paying another 1% in transaction costs within the fund(s) in which you are invested, that’s another £10,000pa.
It is not unusual for the total cost of ownership of an advised Discretionary Fund Management contract to exceed 3%pa of funds under management. On a £1m transfer, that’s £30,000 + that you are paying in fees. You can scale up or down depending on the size of your transfer, my point is that these are fees that you would not have paid if you had stayed put in your DB plan and these fees, whether directly charged or wrapped up in the product, eat into the value of your plan.
This is what the FCA are most worried about. They are most worried that in a low-growth investment environment, a 3%pa cost of ownership could reduce a gross return on investment by as much as 50%, that’s either an immediate pension income cut or it’s storing up problems for future years.
The problem that the FCA are most worried about is that much of the £50bn that’s come out of DB plans since the granting of the freedoms, is under management that is so expensive it is almost bound to cause problems in five, ten or fifteen years time.
Should advisers be accountable for the outcomes of their advice?
The simplest answer to the question “should I transfer” is “no”, not unless you have confidence that you can invest the money to provide a better income than that promised by your pension scheme.
But it’s no longer as simple as that. Firstly, the inflated transfer values caused by low interest rates and by schemes de-risking into bond-based strategies, makes it a “no-brainer” for most people to say
“yes we can do better than the critical yield you are showing me”.
But can they do better than the critical yield + 3% ?
Do they have, what pension schemes have, which is a way of pooling risks so they can manage payments without disinvestment – when times are tough?
Can individuals pool mortality risk to protect themselves against out-living their and their adviser’s cash flow projections?
These and many other similar questions are what any adviser should be worrying about. Because the FCA are becoming increasingly explicit that unless advisers are taking into account these risks in their recommendations – and unless it can be made clear that those taking CETVs are aware of and comfortable with these risks, then there is residual risk on the adviser if things don’t work out.
Advisers are increasingly accountable for the decision people take, which is why so many outsourced agencies that provide the basis for that advice are being asked to cease trading.
The problem is not with the advice but with the product
There is of course an element of scale in the transfer itself. The £1m CETV may merit a discount on some fees bringing that 3% down to 2% or less. I can see a point where an advised DFM approach makes a lot of sense.
But like the FCA, I worry that these expensive drawdown solutions are being marketed to people who do not fully understand the cost, nor are willing to pay it – over time.
I mean those people who have £50,000 + in their pension pots – either through saving or through CETV .
These people do not have the means to be considered wealthy, but they are being sold wealth management.
The use of wealth management is as inappropriate as the use of an annuity. Most people unlocking money from DB schemes or investing their lifetime pension savings need something different.
They need something like the DB scheme they left, but with property rights (the right to take money out in emergency), they need higher income than offered by an annuity and they need to take some risk to get all this.
We are failing to provide people with this product.
Ironically, the only financial product on the market which comes close to doing what the ordinary person wants it to do , is the Prudential with-profits fund. This is fast becoming the stand-out option for advisers keen to offload the risks associated with wealth management gone wrong.
The Prudential With Profits fund is not the ideal product but it is closer to the ideal product than much else.
Infact it is a kind of proto-type for a product that should have been rolled out later this year, had the DWP’s then minister not canned the Defined Ambition project initiated by her predecessor.
The FCA lament the failure of the financial services industry to develop an affordable drawdown solution for the mass market, but how could it?
I drew the attention of anyone who’d listen to the folly of canning DA and in particular the rules that would have allowed us to provide the equivalent of scheme pensions from collective drawdown schemes (CDC).
Now, exactly as predicted, we have the need for mass market drawdown arrangements which do as CDC schemes do, providing certain income streams, mortality protection at a low-low cost. But we do not have the product.
Those of us who continue to campaign for the revival of the DC legislation being drafted till the summer of 2015 by the DWP, need to shout again for that project to be restarted.
We cannot wait till the current problem becomes a crisis. We have to have a mass market answer that recognises that CETVs will continue to be taken, that DC savings will be much greater and that neither wealth management or annuitisation properly takes the strain. We need a third way product that builds on with-profits but betters it.