‘Defined benefits’ – why you definitely need pension advice
First published 19 July 2017 • Updated 19 July 2019
Have you been offered the chance to transfer your defined benefit (final salary) pension? But do they insist that you take advice first? Then be glad about that – because it’s for your own protection. Article by Nick Green.
There’s a story of an engineer called out to a factory to fix the main sprocket-moulding machine. He reaches inside, tightens a single screw, and presents the owner with a bill for £950 plus VAT. The owner protests at the size of the fee for such a simple job, and demands an itemised bill. The engineer agrees and presents a new bill: ‘Tightening one screw: £5. Knowing which screw to tighten: £945.’
There’s another story about a chap nearing retirement who discovered a small final salary pension from a previous employer. He wanted to transfer it to his main pension pot, but was told he needed sign-off from an independent financial adviser first. He approached several IFAs asking them simply to sign off on his request – and all declined to do so. Each IFA insisted that they would have to give him full advice first, even though he had already decided what he wanted to do. Naturally, the chap was puzzled and frustrated, but the advisers wouldn’t budge.
How are these stories connected? They’re similar because the layperson doesn’t always see what the expert sees. What looks on the face of it to be a very simple task – tightening a screw, or signing a letter – may actually be a very complex and even dangerous undertaking. And although the first story may be apocryphal, the pension story happens to quite a lot of people. It may even have happened to you.
So if you have a final salary pension and want to transfer it, why is it so difficult? And why won’t your IFA just sign off on it?
The £30,000 ‘mandatory advice’ threshold
For those not already familiar with the issue, a final salary pension is a workplace pension that pays you a guaranteed annual income for life from a particular date. This makes it very different from an ordinary workplace pension, which is simply an accumulated pot of money. Historically, final salary pensions have been very desirable. However, it is now possible to transfer them into pension pots, converting them into a lump sum of money (the ‘transfer value’) that can be invested or withdrawn as desired. Transferring has become even more popular lately, as transfer values have risen significantly.
If a pension’s transfer value is over £30,000 then the law requires you to seek independent financial advice before the transfer can be made. However, some providers insist on advice even with smaller transfer values, to protect themselves against possible future litigation if the pensioner later decides they made the wrong decision.
Two advisers who are familiar with such requests are Alan and Ricky Chan of IFS Wealth and Pensions Ltd. Ricky sums up the core of the problem with a neat analogy. ‘Imagine going to the doctor and saying, “I’ve done my research online, and I’m convinced I'm suffering from this particular illness. Please sign a prescription for this drug, because it’s certainly going to be right for me.” Of course the doctor will still insist on seeing you first to diagnose the problem before prescribing the right medication, because ultimately it’s their responsibility. The same sort of thing applies with IFAs and pension advice.’
Alan too warns against rushing into such a big decision. ‘Some clients just expect advisers to sign a bit of paper, and the job is done. For those who believe they have made up their minds already, I can see why they feel that way – but I can guarantee there are many factors they will not have considered, such as death benefits, life expectancy, investment risks, changing needs, their own tolerance of risk and so forth.’
Ricky points out that the ‘signed letter’ providers want is just the end of the process, not the process itself. ‘Clients tell me their providers have asked for this letter from me. What the provider hasn’t made clear is that this letter is confirmation that they have received full, regulated and independent advice. Obviously, I can’t sign the letter unless I’ve given that advice.’
Why the DIY approach to pensions doesn’t work
But what if you have a final salary pension, have done all the research yourself, and concluded that you definitely want to transfer it? Why won’t an IFA simply sign off on your decision without charging you for their own advice?
‘Some believe that they can take an informed decision by doing their own research,’ says Alan. ‘But pension transfers are a very complicated area, and decisions are irreversible. One mistake today can negatively affect the next 30-40 years of a client’s life.’ Final salary pension schemes contain ’safeguarded benefits’. Any transfer of the benefit will result in these guarantees being lost, and you need to know if the transfer value would make up for this loss from your point of view – a very subjective issue. As Alan points out, ‘Transfers of safeguarded benefits are rarely just about the maths – that’s why the law requires you to seek advice.’
Another problem with doing one’s own research is also the risk of confirmation bias – you will tend to favour the information that supports what you want to do. For this reason, even IFAs who want to transfer their own pensions must by law obtain advice from another.
Ricky has had clients who’ve offered to sign a waiver or disclaimer in order to get that signed letter without the advice, but this is not a solution. ‘Documents such as waivers hold no weight with the Financial Ombudsman, who can still hold IFAs liable for the consequences of a pension transfer. In this area there is no such thing as an “execution-only” transaction – advice is always a legal requirement for pensions above a certain size.’
How independent pension advice can prevent mis-selling
This cautious approach to final salary pension transfers is a lesson learned the hard way. We’re all now familiar with the concept of the ‘mis-selling scandal’, whether this relates to endowment mortgages, PPI or something else. Transfer values have soared recently, and this has led to pension transfers surging in popularity. Such a ‘gold rush’ has some hallmarks of a future mis-selling scandal in the making, and IFAs know this. Therefore you’re unlikely to find an adviser (at any rate, not a good one) who is willing to sign a piece of paper without doing all the necessary groundwork. And this, ultimately, is a very positive thing.
So if you’re thinking about transferring your final salary pension and your provider or the law insists you take advice first, don’t think of it as mere red tape. Taking advice is a prudent way to safeguard your own long-term interests. It can help you understand things about your pension that you may not have realised before, and it can encourage you to think about the future in more detail than you may have previously considered. After exploring all the facts and figures with your adviser, you may well reverse your original decision. But even you don’t change your mind, you’ll be able to go ahead knowing that it has signoff from a regulated adviser, which may entitle you to future compensation if it turns out to be the wrong choice.
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Thanks to Alan and Ricky Chan of IFS Wealth and Pensions Ltd.