9. Scheme health
The health of pension schemes has been the subject of much comment. Pension scheme deficits are often trumpeted (perhaps only in the months they grow) and there were the BHS and British Steel events and, of course, the recent DWP green paper.
This could lead to a client who may want to transfer because they believe their scheme is ‘in danger’. Is this a good reason to transfer?
It may well be, but what due diligence do you perform? What makes the client think the scheme is in trouble? Do we have funding statements for the scheme – is it getting better or worse?
Have enquiries been made about the employer covenant – is it strong or weak and is there a recovery plan in place?
If this is a key driver I’d want something on file beyond a client expressing concern. But there’s another aspect - getting the Pension Protection Fund (PPF) into context.
If you transfer out you lose this protection. As we’re dealing with deferred members, broadly you’d get 90 per cent of your accrued benefit protected, subject to a cap. For 2017-18 it’s £38,505.61 (£34,655.05 when the 90 per cent is applied).
So someone with £20,000pa of pension is accepting all the risks on themselves to avoid a £2,000pa or 10 per cent downside. That might be a risk trade-off that’s not worth it. Conversely, where the pension is £70,000pa there’s a 50 per cent downside, a totally different consideration.
10. Critical yield
TVAS reports calculate the estimated net investment growth, known as the critical yield, that an individual pension would need to achieve to match the benefits provided from a defined benefit scheme at normal retirement age using annuity purchase.
This helps a member compare the implications of leaving deferred DB benefits with the scheme, or transferring to an individual pension arrangement.
A TVAS illustration is required for almost all DB transfers, except at the scheme’s NRD. The FCA specifies the process and the various assumptions that must be used with TVAS systems.
Basically, if the transfer value, less the charges, achieves the calculated yield, the receiving plan will grow enough to broadly match the benefits being given up.
The FCA says an over-reliance on meeting a critical yield is unlikely to deliver suitable outcomes as meeting the yield is only a small part of the jigsaw.
What identifiable needs and objectives are being met by the transfer? Do they understand the risk transference and trade-offs they are making to achieve their objectives and the desirability or otherwise of alternative solutions?
The key is for clients to understand the ability of their funds to sustain their income, death benefit objectives and longevity risk – that’s been the FCA mantra since freedoms began.
