It is over two years since the game-changing pensions freedom legislation was introduced by the UK government. While the new rules have largely bedded down, pension transfers still remain as contentious as ever and continue to divide opinion. So with the question of 'DB or DC' still reverberating, how has the debate moved on?
Why the sudden interest?
Whether to stay with a defined benefit (DB) pension scheme or move to a more flexible defined contribution (DC) pension remains a burning issue for advisers and clients alike. Since the introduction of the pensions freedom legislation in 2015, there has been a phenomenal surge in demand for advice around this often contentious issue. This shows no sign of abating, as more and more DB pension members look to explore their options and take advantage of the same freedoms offered to their DC peers.
The flexibility to switch income on or off, increase or decrease it as personal circumstances dictate, combined with enhanced death benefits, tax efficiency and greater control have proved appealing to many DB pension members. On top of this, the massively elevated transfer values currently assigned to DB pensions have only served to stoke this voracious appetite for pension advice.
Tantalising transfer values
There are three key factors that have seen DB pension transfer values rise spectacularly over the past few years. Firstly, people are living longer so pensions need to be paid out for longer. Secondly, DB pension schemes have derisked, moving from a greater allocation to equities in favour of government bonds. Therefore, we are seeing lower returns on pension scheme assets. And on this increased allocation to government bonds, historically low gilt yields mean DB pensions now cost much more to provide. These trends have combined to create a 'perfect storm' that has led to record high values. The transfer values assigned differ between providers but have typically been in the range of 30–40 times the projected annual income of the DB scheme. For some high earners, this could equate to significant and extremely tempting transfer values.
Black, white or somewhere in between?
From day one of the pension reforms, the default position of the Financial Conduct Authority (FCA) on pension transfers has remained very much on the side of DB. It believes that clients are almost always best served by remaining with their 'gold-plated' DB pensions and the guaranteed income and inflation protection that they provide.
For many clients, this is likely to be appropriate. But what about the needs of clients who are of higher net worth, who may have other sources of income at their disposal and can afford to be more risk tolerant in their pension planning? Transferring from DB to DC could well be the right decision. The DC pension flexibility could allow them to manage their tax affairs more efficiently, for instance, or leave a legacy to cascade down the generations.
Then there are those clients who sit somewhere in the middle – they value the comfort that the guaranteed income of their DB scheme provides, but could perhaps benefit from investing a proportion of their accrued DB pension into a DC scheme. In this case, a partial transfer could be an acceptable satisfactory compromise. Not all DB schemes offer this option but if it is in the best interest of the client, it is a question worth asking. And if a partial transfer is not an option, why not?
This is an area where the DB to DC debate has definitely moved on. Partial pension transfers could be a 'best of both worlds' option, for which we may see growing demand. We would argue that the DB to DC question does not necessarily need to be so binary. The evolution of the partial pension transfer may be a real area of opportunity for the advice industry as we move forward. It could help clients achieve their desired financial outcomes, while also helping pension trustees and employers manage their liabilities – so potentially a win-win situation.
Navigating the new retirement terrain
The pensions landscape certainly looks very different from only a few years ago and a confluence of social trends, industry developments, legislative reform and a changing financial market backdrop has brought us to where we stand today.
But while the terrain may be more challenging to navigate, clients' retirement needs haven't really changed – they likely want sustainable income, access to rainy-day money, the ability to leave a legacy, and flexibility and control over their retirement savings.
Democratisation of financial risk, pension-member empowerment; however you define it, is a trend that will continue and the crux of it is that clients' retirement planning is very much in their own hands. They face difficult long-term choices, which require more robust and rigorous advice than ever before, and high-quality investment solutions to match.
Keeping clients' interests front and centre of mind, and applying efficient processes around pension transfers, means that it doesn't need to a minefield. Advisers who can demonstrate that they understand the benefits of both DB and DC schemes, and are cognisant of the long-term implications of transferring, could have a fertile field to plough.
To find out more about Aberdeen Standard Capital's discretionary fund management service, email asc@aberdeenstandard.com