AF7 Pension Transfers Part 4: Making it compliant

Transcription

1 AF7 Pension Transfers Part 4: Making it compliant This part will consider the compliance issues around all pension transfers. The milestones are to understand: The difference between safeguarded and flexible benefits. The FCA definition of a pension transfer. The statutory requirements in arranging a transfer of safeguarded benefits. The current FCA requirements for advising on pension transfers including the post October requirements. Prior to 1988, an employer could make it a condition of employment that the employee joined the pension scheme. After that date employees could not be forced to join and existing members had the right to opt out. Many active and deferred members were advised that they could get a higher pension by leaving the scheme and putting the CETV into a Personal Pension. This turned out to be one aspect of the pension misselling scandal of the late 80 s and early 90 s. The regulatory system in operation at the time failed to recognise the problem and since then regulators have imposed strict standards in advising on transfers from DB schemes. Most transfers can only be advised by a Pensions Transfer Specialist who must have passed an appropriate exam. The issue of pension transfers was revitalised by the introduction of pension freedom in Transferring the CETV close to or at the point of retirement meant that members could take benefits flexibly and have the possibility of passing capital on their death. Defining the terms The Pensions Act 2015 introduced two new terms, safeguarded benefits and flexible benefits Flexible benefits were defined as those where the value of any pension is dependent on the value of the underlying fund, in other words almost all money purchase arrangements. Safeguarded benefits were not defined as such but were considered as any benefits that are not considered flexible! HMRC and the DWP have now drawn up their own definition of safeguarded benefits. The key point is that the benefits must include some form of guarantee about the rate of secure income that is provided by the scheme. However, a promise or guarantee about the rate on investment growth or future value of the pot is not sufficient for the benefit to qualify as safeguarded benefits 1

2 All DB benefits will be safeguarded benefits and most MP benefits will be flexible benefits. However, there are some previously grey areas that have now been clarified. Guaranteed annuity rates. These are the most common type of safeguarded benefits which are not salary-related. The benefit will be safeguarded even if the GAR is below the rate being currently offered on the open market. If the GAR has an expiry date, the benefits are safeguarded up until that date and flexible after that. Should there be multiple GARs expiring at specific points in the future is a safeguarded benefit until the last one expires. AVC schemes It s a statutory right that an AVC scheme can be transferred separately from the main DB scheme. Should it contain a GAR it will become safeguarded benefits and in assessing the total value both the AVC and main benefits must be taken into account. Guaranteed Minimum Pension and section (2b) benefits These pensions are related to the member s salary and are therefore safeguarded. However, in a few cases where liability for these have been transferred to a buy-out policy and the fund is greater than needed to provide the guaranteed amount, the excess is not a safeguarded benefit. Pension review top up plans These were put in place to compensate pension scheme members as a result of the misselling of transfers in the 1980 s and 90 s. These offer a guaranteed level of income and are therefore safeguarded Income guarantees on drawdown plans Occasionally the plan may include a guarantee that the value the member s fund will always be sufficient to provide a specified secure rate of drawdown for the member s lifetime then the benefits will be safeguarded. Guaranteed Lump Sums If a plan has a guaranteed amount of lump sum but no guarantees as regards pension income the plan will be not safeguarded and therefore flexible. Scheme specific protected tax-free lump sum As the guarantee does not relate to income this is not a safeguarded benefit. 2

3 Types of transfer The FCA has defined three types of pension transfer transaction. Pension switching is transferring an uncrystallised personal or stakeholder pension to another personal or stakeholder pension. The FCA regards this as the same as transferring any other existing investments and does not require any other permissions. Pension conversion is the conversion of safeguarded benefits into flexible benefits in the same scheme or the payment of a UFPLS from safeguarded benefits and advice can only be given by a Pension Transfer Specialist A Pension transfer is where individuals transfer deferred benefits from an occupational scheme or from an individual pension contract with safeguarded benefits to a stakeholder or personal pension scheme or a defined contribution scheme. The firm must have the required permissions to carry out transfer business whether these are safeguarded or flexible. Statutory requirements The Pensions Act 2014 made it compulsory to obtain independent financial advice when transferring from a DB scheme if the CETV is more than 30,000. The FCA has clarified that independent advice in this context means advice given independently of the scheme s trustees or sponsoring employer. It can be given by an IFA or a restricted adviser if they hold the necessary permissions. The Act also issued minimum standards as to how trustees of the ceding scheme should deal with transfer requests and ensure that advice has been taken. These will be overseen by the Pensions Regulator. Transfer Timescale and minimum requirements The member starts the process by requesting a transfer value. Within one month of receiving the request, the scheme must tell the member that independent advice must be taken unless the transfer value is less than 30,000. The scheme then selects the guarantee date. This is significant because it is the date from which all other deadlines will be determined. It must be within 3 months of the original request. The trustees must then give the member a statement of entitlement which summarises all the benefits they would get by staying in the scheme no later than 10 working days after the guarantee date. They must also inform the member that 3

4 evidence that independent advice has been received must be produced before they can arrange the transfer. The CETV is guaranteed for three months from the guarantee and the member must confirm they wish to proceed by the end of this period. They must also nominate the receiving scheme. The deadline for the member to provide proof of independent advice is three months after receiving the statement of entitlement. Finally, the deadline for the trustees making the transfer is within 6 months of the guarantee date. Joe sends a transfer request to his scheme on 1 May 2018 By 1 June 2018 the trustees must inform Joe that he must take independent advice if the transfer is to proceed. (Assuming the TV is more than 30,000) The guarantee date could not be later than 1 August 2018 but in this case the scheme selects 3 July By 14 July 2018 the trustees must give Joe his statement of entitlement. (weekends and bank holidays are excluded from the 10 day limit. In fact he receives this on 7 July. The final date for Joe to confirm that he wishes to transfer is 3 October 2018 and he must provide evidence that he has received independent advice by 7 October 2018 The final date for the trustees to transfer the pension is 3 January 2019 Meeting the FCA s compliance requirements Following a consultation process the FCA revised its compliance procedures from April These are in COBS Further changes are to be introduced from October Whilst the post October 2018 rules will certainly be tested in April 2019, candidates in the October 18 exam will probably be expected to have an awareness of these changes. The April rules and guidance These rules apply where the firm gives advice on A pension transfer from a scheme with safeguarded benefits A pension conversion A pension opt-out from a scheme with safeguarded or potential safeguarded benefits (COBS A) 4

5 The firm must make a personal recommendation when it provides advice on conversion or transfer of pension benefits. Before making the recommendation, the firm must determine the flexible benefits arrangement which will receive the TV and carry out a comparison of the DB benefits and the flexible benefits arrangement. The requirement to carry out a comparison does not apply if the only safeguarded benefit is a guaranteed annuity rate. The client is at the scheme s normal retirement age of the scheme and wishes to crystallise the benefits immediately the transfer has taken place The comparison (COBS C) Prior to October , a Transfer Value Analysis (or TVA or TVAS for short) had to be carried out. This has been criticised and considered unsuitable because: It is an automated process that uses prescribed assumptions that may not be relevant to the client. It assumes that an annuity will be purchased at retirement whereas the client is more likely to want to access benefits flexibly. One of the main outputs was the critical yield and the FCA was concerned that this was being used as the main determinant as to whether or not to transfer. As a result, a TVA in its present form will no longer be required after October and will be replaced by a Transfer Value Comparator (TVC) and an Appropriate Transfer Value Analysis (APTA). These will be considered in more detail later. April 2019 candidates can probably ignore the TVAS but it may still be tested in October A summary of the TVAS is shown as a separate supplement at the end of this part. The FCA gives the following rules for making a comparison. The firm must: Compare the benefits likely to be paid under the ceding scheme with the benefits under the proposed arrangements. Ensure that the comparison includes enough information for the client to make an informed decision. 5

6 Give the client a copy of the comparison drawing their attention to the factors that do and don t support the recommendation. This must be done in good time and no later than when the KFD is issued. Take reasonable steps to ensure the client understands the comparison and how it contributes to the personal recommendation. (COBS ) The comparison should: Take account of the client s relevant circumstances. Have regard to the benefits and options available under the ceding scheme and the effect of replacing these with the benefits and options under the proposed arrangements. Explain the assumptions on which it is based and the rates of return that would have to be achieved to replicate the benefits being given up. Be illustrated on rates of return that take into account the likely expected returns into which the TV will be invested. If the client is below the scheme retirement age but wants to crystallise the benefits immediately, it will compare the benefits available from crystallisation at scheme retirement age. (COBS ) FCA guidance on suitability The FCA states that a firm should start by assuming that a transfer, conversion or opt-out will not be suitable. It can only be considered suitable if it can clearly demonstrate, on contemporary evidence, that the transfer, conversion or opt out is in the client s best interests. To demonstrate this a firm should take the following client factors into account: How the pension benefits will be accessed. Their attitude and understanding of the risk of giving up safeguarded benefits for flexible benefits. Their attitude to and understanding of investment risk. Their realistic income needs including: o How this can be achieved o The role played by safeguarded benefits in achieving this. o The impact on those needs of a transfer, conversion or opt-out. Whether there are alternative ways to achieve the client s objectives rather than transfer, conversion or opt out. (COBS ) 6

7 The suitability report This should include: A summary of the advantages and disadvantages of its personal recommendation An analysis of the financial implications if the recommendation is to opt out. A summary of all other material information. If the advice is to stay in the scheme this should also be put in writing. The Pension Transfer Specialist (COBS ) Advice on pension conversions, opt-outs must be given or checked by a Pension Transfer Specialist. This does not apply if the only safeguarded benefit is a guaranteed annuity rate. Whilst the advice can be given by someone who is not a PTS, the PTS must: Check the entirety and completeness of the advice Confirm that any personal recommendation is suitable for the client. In other words the PTS must not be just a box ticker but must check that the proposed recommendation is suitable. Comparisons post October 2018 It will be mandatory to produce two documents: The Transfer Value Comparator (TVC) The Appropriate Pension Transfer Analysis (APTA) Transfer Value Comparator This compares the transfer value with the estimated value needed to replace the client s DB income through the purchase of an annuity in a defined contribution scheme. It will not take into account any of the client s personal circumstances such as marital status, health or their preferred retirement age. The replacement value is likely to be higher than the TV and the difference will be greater if the transfer is taking place years before normal retirement date. A key reason is that the investment growth assumption uses gilt yield returns and 0.75% annual charge. It also assumes a 4% charge in calculating cost of buying an annuity. 7

8 The FCA requires that this must be prepared to a set format 8

9 Appropriate pension transfer analysis Unlike the TVC this will be personalised to each customer s needs and objectives. The FCA is not providing detailed rules on its content but there are some factors that must be considered and documented. Full personal details; marital status, health, client objectives and needs Consider the likely pattern of benefits that might be taken from both the ceding and proposed arrangement Consider how each of the arrangements would play a role in meeting the client s income needs throughout retirement. Provide comparisons on a fair and consistent basis for death benefits between the ceding and proposed arrangements both at present and at various future points in time. Undertake any comparisons of benefits and options consistently The impact on the proposed transfer on the tax position of the client and their access to state benefits Consider the charges for the product, investment and advice. It must document alternatives. It must consider a reasonable period beyond normal life expectancy Transfer Value Analysis System. (TVAS) Pre October The TVAS attempts to give an objective measure of the merits or otherwise of transferring a DB pension. It should never be the sole measure and the FCA has agreed it does have limitations. It can be produced by an outside provider but it must be explained to the client by the adviser. The key point about TVAS is that it is an automated process using prescribed assumptions. This is the key difference between the CETV calculation which allows the scheme actuary to select any appropriate rate. The main output of the TVAS is the critical yield. This is the percentage return after charges for the CETV to match the capital sum required at various points in the future The process is similar to the CETV calculation Take the member s deferred pension at date of leaving. Revalue to Scheme retirement age Assess the annuity cost of that pension at normal retirement age 9

10 Calculate the growth required on the transfer Value to arrive at that cost The key difference is the third point which uses an assumed Annuity Interest Rate (AIR). This is not the same as the assumed rate used in the CETV. It is the assumed rate of interest used within the annuity rate calculation. It is used to calculate the annuity rate but it is not the annuity rate itself. For example, an AIR of 2.1% does not mean the member will get a rate of 2.1% on their pension. Calculation of the AIR is complicated as it will depend on the escalation offered by the scheme. The CII study manual quotes the current rate as 1.3%. The other assumptions are: Revaluation rates 2.5% Escalation (if RPI) 2.5% Escalation (if CPI) 2% The following inputs are normally required to produce a TVAS Date client left scheme The CETV together with the expiry date. Preserved pension at date of leaving scheme. Whether scheme uses CPI or RPI in revaluation. Escalation of benefits in payment. Any GMP split into pre and post 88 benefits Scheme retirement age. Client s preferred retirement age (if different) Early or late retirement factor Commutation factor used by the scheme. Lump sum death benefits once the scheme has been left Survivor Benefits once the scheme has been left. The fund(s) that the CETV would be placed if the transfer takes place together with its charges. 10

11 The main outputs (or content) of the TVAS are: The estimated pension at normal retirement date with no PCLS being taken. The estimated maximum PCLS at normal retirement and reduced pension. The same two figures at the client s preferred retirement age. The fund required to purchase an annuity giving the same income as the estimated scheme pension together with the same inflation and survivor protection. This figure should be calculated based on no PCLS, maximum PCLS at both scheme and preferred retirement age. The Critical Yield to achieve these funds. In other words, the investment return after charges. This means there could be up to four different critical yields o Pension with no PCLS at preferred retirement age. o Pension with maximum PCLS at preferred retirement age. o Pension with no PCLS at scheme retirement age. o Pension with maximum PCLS at scheme retirement age. The Hurdle Rate. The critical yield is the rate of return required assuming that the annuity provides the same inflation and survivor benefits as the ceding scheme. The hurdle rate is the investment rate to provide the same level of income but on a single life, level basis and no guarantees. This must be calculated for the same four scenarios as the critical yield. A comparison of the capital value of death benefits payable before retirement. For the transferred fund would usually be a return of fund. This should be done from Day 1 to scheme retirement date and at two other regular intervals between these two. The growth of the fund must be shown at the usual low (2%), medium (5%) and high (7%) rates of return. The critical yield required to provide the level of benefits that would be provided by the Pension Protection Fund at scheme retirement age. Using the TVAS The TVAS should always be discussed with the client. This will enable them to understand the issues in transferring and identify the limitations of the TVAS. Projected scheme pension The starting point is the projected scheme pension, with or without PCLS at scheme and preferred retirement age. It should be pointed out that that this is an estimate based on set revaluation rates and the actual pension may be higher or lower than this. The longer the time there is to retirement the less accurate this figure is likely to be. 11

12 Capital sum to buy an annuity This is the sum required to buy an annuity that would produce the same income and benefits as the scheme pension. It should be treated with a certain amount of caution for the following reasons. It will have been calculated using a set annuity interest rate which may not be the same at the date of retirement. If annuity rates are higher a lower sum will be needed, if rates are lower a higher sum will be needed At retirement date, the client may qualify for an impaired or enhanced annuity rates. It The result is that the sum needed may be higher or lower than this. It assumes the individual will use the fund to buy an annuity whereas in practice many individuals will transfer with a view to using Flexible Access Drawdown. Critical Yield Its aim is to give an objective measure as to the risk in making a transfer. The higher the CY the greater the risk. However, it is not a perfect measure for the following reasons. It is a mathematical calculation taking into account the CETV, the capital sum required to buy an annuity, the term to retirement and the charges. The only fixed one of those is the CETV, change any of the others and the CY will change. For example, if annuity rates were to rise the capital sum would reduce as would the critical yield. It is a snapshot of the position at the date of its calculation. It assumes that an annuity will be purchased whereas Flexi Access Drawdown might be the preferred option. It does not take into account a possible Lifetime Allowance Charge which would reduce the fund at retirement. This means the CY would have been understated. It can give a false sense of security in believing that achieving the CY will guarantee the preserved benefits will be matched. This is not the case because: o Inflation may have been higher than assumed in the CETV. o Revaluation within the scheme may have been higher than anticipated. o Annuity rates may have been lower than assumed in the CETV. o Charges may have been higher than in the original calculation. o Life expectancy may be higher than anticipated Some firms have used CY as the main factor in determining whether a transfer is appropriate. Their policy might be if the CY is less than, say 6%, the transfer can proceed but if it is higher the recommendation should be to stay. The FCA has stated that advisers who rely solely on the critical yield figure in recommending a transfer will not meet their expectations. Moreover, advisers must take into account the likely returns from the funds into which the transferred funds are invested. In other words, if the CY is 7% but the recommendation is to 12

13 put the transfer into funds that have an expected return of 4% it is less likely that the capital sum target will be met. The hurdle rate. The hurdle rate is the rate of return required to purchase an annuity that could produce the same starting income as the scheme pension but with no escalation or guarantees. It can be used to enhance the advice in the following ways. Illustrating the value of the scheme s escalation and spouse s pension. If the CY was 7% and the Hurdle Rate was 3% then the cost of providing the extra benefits is 4%. This can illustrate the real cost of providing these. To help discuss the implications of reshaping the benefits. If the client is single with no dependants then they might consider that achieving the hurdle rate will meet their requirements. Therefore, any increase in the actual return will give the client more options to increase the starting pension. To help quantify capacity for loss. In theory, the CY would produce the same pension as the ceding scheme so it follows that if it is lower the pension will be also be lower. If the client were to transfer achieving at least the hurdle rate would secure the same level of income Death benefits This will compare the death benefits if the member stays in the scheme and if transferred to a PP/SIPP. The scheme benefits will be capitalised even if part of them is the payment of a dependent s pension. The death benefit of the transferred fund will usually give a beneficiary the option of a cash fund/dependent s annuity/dependent s FAD. Since the CETV will be invested, it should grow and the TVAS will show this at the standard projection rates of 2%, 5% & 7%. The death benefits of a PP/SIPP will almost certainly be higher than the deferred scheme benefits but to be compliant the adviser must identify that better death benefits is a specific client aim and that other methods of meeting this have been investigated. Critical yield to provide PPF equivalent benefits A client may be concerned that the sponsoring employer may go into liquidation and the scheme may enter the PPF thus reducing the pension of a deferred member. The TVAS will show the estimated PPF pension and the rate of return required to achieve this. Since the PPF represents probably the lowest pension a deferred member would receive the adviser can use this to establish what consequences of this would be and whether transferring would at least achieve this level of pension. 13

14 Recommendation and suitability report The end of the advice process will result in one of three outcomes: The client is advised to remain in the scheme, at least for the time being. The client is advised to transfer with the CETV being invested until at least selected retirement age. The client is advised to transfer with the CETV being immediately vested. The report on the first outcome should still give the reasons why staying in the scheme is the best option. If drawdown is being recommended for immediate vesting the report must show why that is appropriate for the client. The reports for the other two options will be more detailed and should cover the following points: Income required in retirement The different critical yields. The likelihood of the recommended funds reaching the CY RU64 In transferring will the member be subject to the Lifetime Allowance. Health of the member and spouse. The loss of guarantees in transferring Marital status of the member The effects of inflation. The sustainability of income if drawdown is being used. Tax implications on taking income. The charges Impact on means tested benefits Debt Investment scams As mentioned earlier if the member decides to transfer a further application must be made in writing within the guarantee period. The member must provide evidence that independent advice has been received including details of the adviser s and/or firm s FCA authorisation details. The trustees must then check this. Finally, the trustees will check that the receiving scheme is willing to accept the transfer and transfer the money within six months of the guarantee date. 14

15 Insistent transfers Occasionally a client may wish to go against the adviser s recommendation, usually when the adviser recommends the client to stay and the client still wishes to transfer. The FCA has laid down three steps in dealing with insistent clients. The adviser must provide advice that is suitable and clear to the client. The adviser must make it clear with the client what the risks of the alternative course of action. The adviser should make it clear that the client s actions are against the advice being given by the adviser. Conflicts of interest The FCA has highlighted a potential conflict of interest in dealing with transfers. The recommendation to stay will probably bring in lower fees than a recommendation to transfer. They see this a potential conflict of interest that must be managed. This is particularly relevant if the firm uses contingent charging, that is a fee is only payable if the recommendation is to stay Advice on transfers to overseas schemes. The FCA has stated that non-uk residents considering a pension transfer are likely to need advice from both an overseas adviser for the investment advice and a UK adviser for advice on the transfer. The UK adviser should take into account the specific receiving scheme including: The likely expected returns on the assets in which the client s funds will be invested. The associated risks. All costs and charges that would be borne by the client. This means liaising with the overseas adviser. You should now understand: The difference between safeguarded and flexible benefits. The FCA definition of a pension transfer. The statutory requirements in arranging a transfer of safeguarded benefits. The current FCA requirements for advising on pension transfers including the post October requirements. 15