If you’re from the UK, or have lived and worked there for any length of time, it’s very possible that you have been a member of a defined benefit (DB) pension scheme.
The Financial Conduct Authority (FCA) who are responsible for regulating financial services in the UK, have published a lot of guidance regarding such schemes, in particular around the issue of transferring out.
Read details of what the guidance says, and how you could be impacted. Also read about four key issues the FCA have highlighted.
How DB pension schemes work
A DB scheme is type of pension plan in which an employer promises a specified pension payment, on retirement, which they guarantee to pay you for the rest of your life.
The amount of pension payable is based on several factors, usually including your final salary and how long you worked for the company concerned.
As well as paying you a pension for life – which will normally increase in line with inflation – a DB scheme will also pay a pension to your spouse or civil partner when you die, dependent on the rules of the scheme.
Clearly, the benefits provided by a DB scheme are valuable. Such schemes are often referred to in the media as being “gold-plated” because of the intrinsic value of a guaranteed pension for life.
The decline of DB schemes and rise of “transferring out”
Over the last 30 years, outside of public-sector arrangements, such as the NHS and Civil Service schemes, DB schemes have declined.
Few, if any, are now open to new joiners. And, in most cases, staff have been switched to defined contribution (DC) arrangements that are based on the fund you accrue rather than your earnings and length of service.
There are a variety of reasons for this decline. Many of these are complex, but the most straightforward is that schemes can be expensive for employers to run, especially as longevity has increased markedly since many schemes were originally set up.
Because of the increasing cost of providing a pension for life, schemes have offered substantial transfer values to individuals who want to transfer their retained benefits out of the scheme into a private arrangement.
Transferring out looked an increasingly attractive option in 2015 when the UK government introduced “Pension Freedoms”, giving people far more control over what they could do with their pension fund.
The British Steel Pension Scheme as a catalyst for change
The perceived attractiveness of a substantial lump sum meant that many people were persuaded to transfer out of DB schemes.
In some cases, the reason for transferring out were valid. These included the benefits for individuals with health issues, the potentially enhanced death benefits, and the flexibility a large sum can provide, especially when set alongside other pension arrangements.
However, because many financial advisers were basing their advice on “contingent charging” – effectively, the adviser only earned money if the transfer went ahead – mis-selling has been common, and many people have transferred out of a DB scheme when it was not in their best interests to do so.
The big catalyst that has prompted the FCA to take regulatory action was what happened to the British Steel Pension Scheme (BSPS).
Driven by the decline of steel manufacturing in the UK, most plants have closed, and many workers have lost their jobs.
The result has been 7,700 British Steel Pension Scheme members transferring out of their DB pension after taking financial advice. Suitability reviews undertaken by the FCA in the years since have confirmed that nearly 50%of transfers were mis-sold.
This has resulted in the Financial Ombudsman Service receiving hundreds of complaints from former BSPS members who have lost out on a guaranteed retirement income.
4 key issues raised by the FCA
In their analysis of the cases of mis-selling raised by the BSPS issue, the FCA have pointed out four issues that both advisers and clients involved in potential DB transfer enquiries should be aware of.
- Administrative failings
Rather than actual deliberate mis-selling, many BSPS-related complaints have been around a lack of proper administration of many client files.
Many cases had key information missing. While this is not a clear indication of deliberate wrongdoing, it does raise concerns about the quality of advice given.
- The importance of a cost-benefit analysis
On the face of it, a transfer value can often look like a substantial sum of money when presented in isolation without context. But, when it’s compared to a guaranteed pension that increases annually in line with inflation, it becomes less attractive.
It’s essential that your adviser runs a comparative analysis to illustrate what you’d lose by transferring out of the scheme.
- Alternatives to transferring
The flexibility provided by access to a lump sum has often been cited as justification for a DB transfer, but it’s crucial to consider other alternatives that would provide this and did not result in losing out on a guaranteed income.
These could include other pension funds, or savings and investments.
- The importance of client vulnerability
A key issue the FCA have flagged up is the ability of clients to make crucial financial decisions at certain times.
For example, as we’ve already stated, many British Steel employees were facing redundancy, which could have clearly impacted on their decision-making. They may have anticipated pressure on their future finances, which could easily have made a lump-sum transfer look attractive.
They may have rushed into a decision that was based on short-term thinking, without due consideration of the long-term consequences.
Returning to the present, the unprecedented economic impact of the Covid pandemic may mean many people may be in a financially insecure position and not able to make a valid decision.
Important things to consider if you’re a DB scheme member
If you’re either currently a member of a DB scheme or have retained benefits in a scheme that’s now closed, the starting point is that the FCA’s starting point is that a transfer out of a scheme like this, is not in your best interest. However, this position does not take into account individual circumstances and some of the tax benefits that are available to Australian residents that transfer their pension to Australia.
Given the importance of making the right decision, it’s essential that you get financial advice that you’re comfortable with, and that considers the key issues that the FCA have raised and that you’ve read about in this article.
Get in touch
We have wealth of experience when it comes to advising clients about their defined benefit pension scheme. We’ve also produced a detailed guide on the subject of DB transfers.
If you’d like to talk through your own situation, get in touch to find out how we can help you.