For Financial Adviser use only Pension Transfers: A technical guide March 2013 This guide looks at pension transfers from the perspectives of both HMRC and the FSA. HMRC provides guidance on the rules surrounding what transfers are allowable and any effect they have on the tax regime for pensions, whilst the FSA s main focus is to ensure customers are appropriately advised and fairly treated when taking out or transferring to a personal pension. HMRC rules and regulations Firstly, what is a pension transfer? A pension transfer occurs when an individual s pension rights in one scheme are moved to another scheme. The responsibility for paying benefits moves to the receiving scheme. Does a scheme have to allow a transfer out? The Pension Schemes Act 1993 gives members of pension schemes the right to transfer their pension benefits. Members of personal pensions (including stakeholder schemes and group personal pensions) always have this right; members of occupational pension schemes, with at least three months service, also have the right to transfer. Members of occupational schemes lose the right to transfer within 12 months of the scheme s normal retirement date, but many schemes still allow them to do so. Watch out for defined benefit schemes that provide full RPI linking as they do not have to offer transfers. In addition, schemes that have entered an assessment period or have been accepted into the Pension Protection Fund cannot provide transfers. Does a scheme have to accept a transfer in? The only type of pension scheme that must accept a transfer in is a stakeholder scheme. All other schemes can decide whether they want to accept; increasingly occupational schemes, particularly defined benefit schemes are not accepting transfers. What form will the transfer take? In the vast majority of cases a transfer will be in the form of cash but it is possible where both schemes allow for the transfer to be made in the form of assets i.e. in specie. This is common for transfers involving SIPPs and SSASs. Any asset transferred in this way must first be valued by an appropriately qualified independent person. Which transfers are allowed by HMRC? The tax rules for pensions define certain payments which are authorised, i.e. allowed within the rules without resulting tax consequences. Other payments will be unauthorised and attract unauthorised payments charges, therefore schemes may not make them. When it comes to transfers, recognised transfers are regarded as authorised payments; these are defined as transfers from one registered pension scheme to another or to a qualifying recognised overseas pension scheme (QROPS). Which overseas schemes accept transfers? HMRC defines three categories of overseas pension schemes: an overseas pension scheme; a recognised overseas pension scheme; a qualifying recognised overseas pension scheme (QROPS). Only transfers to QROPS are recognised transfers, therefore most schemes will only permit these. Schemes that are categorised as a QROPS must meet HMRC requirements and detailed guidance on these requirements runs for several pages in the Registered Pension Schemes Manual. Schemes that provide details to HMRC will receive a letter of acceptance which will include a QROPS reference number. HMRC maintains a list of QROPS and publishes these (where the scheme has consented) on their website: www.hmrc.gov.uk/pensionschemes/qrops.pdf
It should be borne in mind that a transfer to a QROPS is a benefit crystallisation event, so the value of it will be tested against the member s lifetime allowance and if the transfer exceeds the member s lifetime allowance, the lifetime allowance charge will be levied on the excess at a rate of 25%. When will a UK scheme accept a transfer from an overseas pension scheme? UK registered schemes may accept transfers from recognised overseas pension schemes. Individuals that do transfer in to the UK can apply to HMRC for an increase to their lifetime allowance to cover the transfer (since it was built up outside the UK tax regime it shouldn t use up a member s lifetime allowance). The enhancement has to be claimed no later than five years after 31 January following the tax year in which the transfer was made. What happens to enhanced, primary or fixed protection when a transfer takes place? Generally, protection is retained after transfer, however some transfers should be avoided where enhanced or fixed protection applies: Enhanced/fixed protection - While an individual has enhanced or fixed protection they will have either an unlimited lifetime allowance or a lifetime allowance of 1.8 million respectively. As long as the transfer is regarded as a permitted transfer then enhanced protection will continue. This includes tax-free cash protection where applicable. Most transfers will be permitted transfers, the main exception being transfers from defined contribution schemes to defined benefit schemes. Primary protection - Individuals with primary protection will have an enhancement to the standard lifetime allowance meaning they will be able to take a greater value of benefits without attracting the lifetime allowance charge, though this may still have to be paid if benefits have increased at a higher rate than the standard lifetime allowance. Primary protection will be retained after transfer, including any tax-free cash protection. How will a transfer affect stand alone lump sum protection? Some individuals that were in occupational schemes or Section 32s as at 5 April 2006 had an entitlement to a tax-free lump sum of more than 25%. This entitlement can be protected in the scheme that it was held in as at 5 April 2006 or a scheme where those benefits have been transferred, but only where the transfer is a block transfer. This means that in many cases protection will be lost as Section 32s cannot have more than one member and it may not be easy in practice to arrange a block transfer. Individuals may need to determine whether the higher cash amount outweighs the advantages of a proposed new scheme. What is a block transfer? A block transfer is a single transaction that involves the transfer of all benefits under the transferring scheme in respect of at least two members to the same receiving scheme. Section 32s cannot usually make a block transfer since there is only one member in the scheme, though there is an exception for Section 32s in existence on 5 April 2006, where the scheme is being wound up and where the transfer is to a deferred annuity contract. Will a protected pension age be retained after transfer? Where an individual was in a prescribed occupation (generally professional sportspeople) before 6 April 2006 and was a member of a personal pension or retirement annuity contract they would have had a normal retirement age of less than 50. Some members of occupational schemes may also have an earlier than normal retirement age or the right to take benefits from age 50. It is possible to transfer this protection to a new scheme but only where the transfer is a block transfer and the receiving scheme can pay the benefits early. When benefits are taken before age 50 they must be taken in full and the individual will see their lifetime allowance reduced by 2.5% for each year that benefits are taken before the normal minimum pension age. When can benefits already in payment be transferred? It is possible within the tax rules on authorised payments to make a transfer in respect of a pension which is already in payment; the most common transfer of this nature will be the transfer of a drawdown pension from one provider to another. 2
Needless to say there are certain requirements for these transfers, namely that the transfer must be a full transfer and once transferred must be placed into a separate arrangement in the receiving scheme. Any income limits and pension years/reference years that applied in the original scheme will continue under the new scheme as though the transfer did not take place so a transfer cannot be used as a way to trigger a review of the GAD limits. When can a transfer be split between schemes? Where benefits haven t come into payment, schemes can allow a member to transfer out and split the transfers between more than one scheme. However this would not be a permitted transfer or a block transfer. Schemes can also allow partial transfers where part of the benefit stays within the original scheme and part is transferred to another scheme. Again this can only be where benefits have not yet come into payment. When can a scheme accept a transfer after the original scheme has paid out the pension commencement lump sum? A scheme can accept a transfer but only where the original scheme has created an entitlement to the pension (scheme pension, lifetime annuity or unsecured pension). If the scheme gives entitlement to an annuity then the client can take an Open Market Option and purchase an annuity from another provider but they cannot transfer to an uncrystallised scheme i.e. to take a drawdown pension. In this case the transferring scheme must create an entitlement to a drawdown pension and therefore the transfer would be a drawdown to drawdown transfer. FSA rules and guidance As the regulator of all types of personal pension schemes the FSA wants to ensure that retail consumers get a fair deal and are advised appropriately in line with the fourth of the TCF outcomes from the FSA; Where consumers receive advice, the advice is suitable and takes account of their circumstances. The FSA is particularly concerned around pension transfers and switches which they define in different ways. Who qualifies as a pension transfer specialist? A pension transfer specialist is required to hold an appropriate qualification as detailed by the Financial Services Skills Council. For pension transfer specialists the relevant qualifications are as follows, though some are not available for new candidates: AF3 paper of the Advanced Diploma in Financial Planning G60 paper of the Advanced Financial Planning Certificate Fellow or Associate of the Chartered Insurance Institute (with three pensions-related subjects) Fellow or Associate of the Pensions Management Institute Pensions paper of Professional Investment Certificate Fellow or Associate of the Faculty or Institute of Actuaries If an individual who is not a pension transfer specialist advises a client on a pension transfer on a firm s behalf, the firm must ensure that the recommendation is checked by a pension transfer specialist. What were the findings from the thematic review? Quality of advice on pension switching: a report on the findings of a thematic review was published in December 2008. The FSA had assessed the files relating to 500 transfers to a personal pension or a SIPP and the advice was found to be unsuitable in 16% of these. The most common reasons for unsuitable advice were: the new scheme was more expensive but no justifiable reason for this was given, the original scheme included certain benefits which were not replicated in the new scheme and no justification was given for the loss, the funds recommended were not in line with either the customer s attitude to risk or their personal circumstances, and in some cases the FSA found that the adviser had not explained that ongoing reviews were necessary and/or had failed to put any in place. How do the FSA define a pension transfer? A pension transfer is generally defined as a transfer of deferred benefits held in an occupational pension scheme to a personal pension, while a switch covers other types of transfer for example a personal pension to a SIPP. The reason for this distinction is that the FSA puts much greater prescription around individuals that advise on pension transfers, which by their nature tend to be more complex. The requirements include the adviser holding specific permission to advise these individuals are called pension transfer specialists. What is a Transfer Value Analysis and when is it required? Before a client is advised to transfer out of a defined benefits scheme the adviser must ensure that a transfer value analysis is carried out. The aim of the transfer analysis is to calculate the critical yield that would be required from a personal pension or Section 32 contract to 3
match the benefits that would be available from the defined benefits scheme at normal retirement age. From here the adviser can make a recommendation based on the financial merit of the transfer taking into account the client s attitude to risk. The comparison of benefits has to be provided to the client, before or at the same time that the key features is provided, along with advantages and disadvantages so that the client can make an informed decision. The adviser needs to ensure that the client understands the material provided. What rules and guidance is given for suitability reports? Where a personal recommendation is given a firm must provide a suitability report. When it comes to transfers from defined benefits scheme the FSA state that an adviser should initially assume that a transfer is not suitable and only recommend one when there is evidence that it is in the member s best interests. A suitability report must: detail the client s demands and needs; explain why the recommendation is suitable for the client (taking the client s details and circumstances into account); and explain any disadvantages of the transaction. If a client is advised to transfer to a personal pension the suitability report should indicate why the personal pension recommended is at least as suitable as a stakeholder scheme. The FSA s thematic review on pension switching Transfers have long been on the FSA s radar and after seeing an increase in transfers to personal pensions and SIPPs since 6 April 2006 a thematic review on transfers was undertaken. The main concern was that consumers had been switched into higher charging pensions with features or flexibility they did not need. What action have the FSA taken? As well as addressing any findings with the firms concerned, the FSA wrote to over 4,500 firms providing advice on pension transfers. This letter provided firms with the standards expected and asked them to review their transfer advice and to take remedial action where appropriate. The FSA also visited firms and carried out desk-based research in the third quater of 2009. The failings they saw in their initial follow up work were generally consistent with those identified in their original review, the main reasons for unsuitability being: the switch involved extra product costs without good reason; the fund(s) recommended were not suitable for the customer s attitude to risk; the adviser failed to explain the need for, or put in place, ongoing reviews when they are necessary; and the switch involved loss of benefits from the ceding scheme without good reason. Recently they announced they had identified two additional concerns: firms operating tied advice models that prevent their advisers considering a customer s existing pension arrangements when giving pension switching advice; they considered were in breach of their rules; and advisers were recommending portfolio advice services with insufficient justification that the additional costs genuinely added value for customers. The FSA have already taken disciplinary action against one firm and the director of another for poor conduct relating to pensions switching advice. Four further firms are currently under enforcement investigation and 25 further firms are undertaking past business reviews. The FSA have provided the industry with a tool, that can be found on their website www.fsa.gov.uk which replicates the way that the FSA would perform a file review to ascertain if advice provided was suitable; this will form the basis for the FSA s ongoing work in this area. The template can be used to rate the advice on switches to personal pensions and SIPPs from all types of schemes except defined benefit schemes. It is not designed for immediate income withdrawal cases. Using the template will result in a rating of the case as suitable, unsuitable or unclear. The template should form part of a firm s overall file review process. 4
How can an adviser ensure a recommendation to transfer is compliant? Most firms will have their own procedures for providing advice, though the FSA is requesting that firms consider the strength of these in light of their recent findings. Based on these findings we have compiled a list of issues to look out for: If the new scheme has higher charges than the existing scheme If a personal pension is recommended rather than a stakeholder If the switch is being recommended because it meets the client s needs If If the switch is being recommended for investment flexibility If the switch is being recommended due to poor fund performance in existing scheme If the switch is being recommended for a drawdown option If the existing scheme is thought to be inadequate in some way If the switch is being recommended to move out of a with-profits fund If consolidation is recommended and results in additional costs If the original scheme has guaranteed benefits If the switch involves the loss of specific benefits which are not replicated in the new scheme If an asset allocation approach has been recommended If independent tools are used to select the provider Then Provide valid grounds to justify the extra cost - consider comparing the costs of both schemes in tabular form so client can easily compare. It is important to compare like with like as far as possible. The FSA are not against higher charges - only higher charges without good reason. If the client is happy to pay for an additional feature, for example a guarantee, this could be justified. Ensure there is a valid reason for this, for example the fund range is limited but the client should be using a wider range. You should also explain why the personal pension scheme is at least as suitable as a stakeholder pension scheme. Include evidence that options under the existing scheme were investigated as an alternative. Ensure that this flexibility is being used or will be used in the near future. Demonstrate why performance in the new scheme is likely to be better. Indicate why this option is needed and why it is suitable. Ensure this inadequacy is demonstrated by some objective evidence. Provide an analysis of the fund go further than just market value reductions and bonus history. Justify the additional costs in relation to the value that the client places on having simplified administration. Explain the existing scheme benefits and indicate whether they are likely to be higher than market rates so the client can understand what they are giving-up. Explain the implications of proceeding and why the recommendation is still justified. Ensure that the client is advised of the need for regular reviews and rebalancing. Indicate how these will be carried out. Take customer needs into account and don t manipulate tools to reach a desired outcome. 5
About our technical bulletins We use our technical bulletins to bring you regular information on current issues and to explain some of our product features. The information is for use by Financial Advisers only, and should not be relied upon by anybody else. If you have any questions regarding the content of this bulletin, please contact your local MetLife Representative directly or the MetLife Sales Desk on 0845 370 6040. Want to find out more? To find out more about how MetLife can make a difference to your clients financial future, contact us today on 0845 370 6040, or email salesresource@metlife.com You can also find out more at www.metlife.co.uk For Financial Adviser use only Products and services are offered by MetLife Europe Limited which is an affiliate of MetLife, Inc. and operates under the MetLife brand. MetLife Europe Limited (trading as MetLife) is authorised by the Central Bank of Ireland and subject to limited regulation by the Financial Services Authority. Details about the extent of our regulation by the Financial Services Authority are available from us on request. Registered address: 20 on Hatch, Lower Hatch Street, Dublin 2, Ireland. Registration number 415123. UK branch address: One Canada Square, Canary Wharf, London E14 5AA. Branch registration number BR008866. www.metlife.co.uk M13 00 042 l MAR 2013 l 0560.4.MAR2013