City watchdog attacks final salary pension advice
People who have been advised to switch from a final salary pension scheme to a defined contribution alternative may have been poorly advised, according to the City watchdog.
The Financial Conduct Authority (FCA) said people who were offered 'enhanced transfer value' incentives (ETVs) to leave their employers' defined benefit pension scheme risk losing out on retirement income due to poor advice.
It studied around 300 pension transfer cases between 2008 and 2012 and found that a third of cases involved unsuitable advice. But the watchdog did not go as far as banning the practice outright.
Clive Adamson, director of supervision at the FCA, said: "Transferring from a defined benefit scheme to a defined contribution scheme is an important decision for consumers. It is disappointing that our review saw failings in the advice given, particularly when incentives have been provided to consumers to transfer.
"All firms active in this complex area of pension transfer activity should think very carefully about the quality of the advice process and assurance framework required to deliver fair customer outcomes."
Those affected were offered enhanced pension transfer values, some in the form of a direct cash payment. But people who switch out of a DB scheme lose the underlying guarantee of a final salary at retirement and must also take on responsibility for investment decisions that affect their underlying fund.
With that in mind, the FCA said many firms failed to tailor advice to reflect the specific circumstances of individuals, nor did it establish people's attitude to risk. Many also made unsuitable fund recommendations, and did not take into consideration the tax implications of individuals.
The FCA said it will contact the firms involved and ask them to offer redress to affected clients, where appropriate. But it urged anyone who has "immediate concerns" about the financial advice they were given to contact the firm that advised them in the first instance.
A spokesperson for Standard Life welcomed the fact that the FCA did not ban the practice completely: "For very many pension savers, a DB to DC transfer is not appropriate. But many DB pensions won't offer savers greater flexibility in taking their retirement income. DC pensions allowing more choice may be attractive for some people from the age of 55 when the new flexibility begins."
The watchdog also warned that many self-invested personal pension (Sipp) providers are failing to fulfill their regulatory obligations, despite previous warnings. It said many firms did not have the expertise to advise on higher-risk or non-standard investments but were doing so anyway.
The FCA has written to chief executives of all Sipp firms to warn them of the failings uncovered by its recent review, warning them to take action to address the failings.
The cash equivalent transfer values (CETV) is an assessment of the total accumulated cash value of a pension you will be able to take out of your existing pension and move into a new one should you change employers or decide you want to move to a more flexible scheme with greater benefits and lower administration costs. The transfer value will depend on the trustees of the pension fund assessing your contributions and investment growth to determine the transfer value, which may have to be certified by the scheme’s actuary.
Like a self-select ISA but for pensions, self-invested personal pension is a registered pension plan that gives you a flexible and tax-efficient method of preparing for your retirement. It gives you all sorts of options on how you put money in, how you invest it and how it’s paid out and offers a greater number of investment opportunities than if the fund was managed by a pension company. SIPPs are very flexible and allow investments such as quoted and unquoted shares, investment funds, cash deposits, commercial property and intangible property (i.e. copyrights, royalties, patents or carbon offsets). Not permitted are loans to members or people or companies connected to the SIPP holder, tangible moveable property (with the exception of tradable gold) and residential property.
Defined benefit pension
Often referred to as a “final salary” pension, benefits paid in retirement are known in advance and are “defined” when the employee joins the scheme. Benefits are based on the employee’s salary history and length of service rather than on investment returns. The risk is with the employer because, as long as the employee contributes a fixed percentage of salary every month, all costs of meeting the defined benefits are the responsibility of the employer. (See also Final Salary).
Generally thought of as being interchangeable with insurance but isn’t. Assurance is cover for events that WILL happen but at an unspecified point in the future (such as retirement and death) and insurance covers events that MAY happen (such as fire, theft and accidents). Therefore you buy life assurance (you will die, but don’t know when) and car insurance (you may have an accident). Assurance policies are for a fixed term, with a fixed payout, and unlike life insurance have an investment aspect: as a life assurance policy increases in value, the bonuses attached to it build up. If you die during the fixed term, the policy pays out the sum assured. However, if you survive to the end of the policy, you then get the annual bonuses plus a terminal bonus.
Final salary pension
A defined benefit pension scheme is one where the payout is based on contributions made and the length of service of the employee. A typical scheme would offer to pay one-60th (0.0168%) of final salary (the one you’re earning when you finally retire) for each year of contributions to the scheme (even though these years were probably paid at a lower salary). Someone retiring on a final salary of £30,000 who had been a member of the scheme for 25 years would receive a pension of 42% of their final salary (£12,300 a year before tax). Sadly, many companies are winding up their final salary schemes or closing them altogether, meaning pension benefits accrued after a certain date (or those available to new employees) may be on a less generous money purchase basis.