Pension transfer schemes
3rd October, 2019
The Financial Conduct Authority (FCA) has found that financial service providers' poor pension advice has left thousands set to lose out on a larger pension fund than they were originally entitled to.
After the Government introduced pension freedoms in 2015, many financial advisers have recommended that employees with Defined Benefit pensions (DB) transfer to a Defined Contribution pension (DC).
Employees with a DB pension are promised a defined level of benefit on retirement or death, based on the employee’s average or final earnings. This is most beneficial and attractive to an employee as the employer promises to pay the balance of the fixed amount. Compared to a DC pension, whereby both the employee and employer arrange to pay contributions that are credited to the employee’s individual account and then typically on retirement an annuity is purchased to provide an income. As such, the investment risk falls on the employee and the value of the benefit is not certain.
It is widely viewed by financial service providers that having a DB pension over a DC pension is nearly always in the best interests of the employee.
Poor financial advice: contingent charging
For DB pensions valued over £30,000, an individual must seek financial advice from a regulated firm before they can transfer to a DC pension.
The FCA’s position is that most people with a DB pension would be best advised to keep it; therefore it is concerning that 69% of savers who sought advice from a financial adviser have been recommended to transfer.
Whilst many financial advisers work diligently to provide the best advice for their clients, unfortunately, the conduct of some is potentially tarnishing the integrity of the profession by giving advice below what the FCA regard as an acceptable standard.
The issue lies in a conflict of interest, where financial advisers charge contingently for their services, thus are only paid if a transfer ensues. Therefore, the advice given in these circumstances may not be completely impartial or necessarily in the best interests of the client.
The FCA’s analysis found that financial advisers have been charging around 2 to 3% of the value of the transfer, therefore on a pension transfer value of £300,000, contingent charges can be around £6,000 to £9,000. Non-contingent charging, i.e. on an hourly basis, can be up to two thirds less.
Between April 2015 and September 2018, the FCA surveyed 3,015 firms, 2,426 of which had provided advice on DB pension transfers, and a total of 162,047 out of 234,951 advisees were recommended to transfer to a DC pension.
A Parliamentary select committee for work and pensions has advocated for the FCA to ban contingent charging.
The issues with transferring
In 2015, the government introduced “Pension Freedoms” where from age 55, anyone with a DC pension no longer needs to purchase an annuity and can withdraw any amount they wish, 25% of which is tax free. The remaining 75% can be withdrawn all at once or in lump sums, and income tax is paid at the individual’s usual marginal rate. Thus giving savers the freedom to spend their pension how and when they please.
People with a DB pension would not receive this pension freedom. However, DB pensions provide better monetary security given that because the level of income is guaranteed, the pension normally rises with inflation and also usually pays spousal benefits on death.
The other major issue with transferring to a DC pension is that because the risk is passed to the employee, the value of the pension fund is reliant upon the performance of the stock market.
As of May 2019, the Financial Services Compensation Scheme (FSCS) has paid out £1.8 million in compensation to 61 employees of British Steel who were wrongly advised to transfer their DB pensions into self-invested personal pensions.
For individuals who have lost money due to unsuitable financial advice, compensation can either be sought from the company itself, or from the FSCS if the company is insolvent.
The FSCS’s remit is to “put people back in the position they would have been had they not been mis-advised rather than compensate for the costs of future investments”.
Martin Woodford, a Partner at Ward Hadaway who specialises in pension and investment disputes, commented:
“Whilst the overwhelming majority of IFAs who we encounter provide excellent advice to their clients, there does appear to be a specific problem with contingent charging in some pension transfers, which is a cause for concern.”
Joe Kelley, an Associate who works with Martin, added:
“We are seeing an increasing number of individuals seeking advice in these circumstances. Given the value of some DB schemes, the losses which have potentially been suffered as a result of any sub-standard advice are often significant.”
If you would like to discuss any of these issues which are covered by this article, or have been affected by a pension transfer, please get in touch.
Please note that this briefing is designed to be informative, not advisory and represents our understanding of English law and practice as at the date indicated. We would always recommend that you should seek specific guidance on any particular legal issue.
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