Conflicted DB pension transfer advice – a cautionary tale

9 July 2019

Bovill - DB pension transfer advice

Only 50% of recommendations to transfer out of defined benefit pensions are suitable according to the FCA’s latest review. For most investment advice they would expect 90%. And to make matters worse, some firms seem to refuse to recognise and eliminate conflicts of interest from their DB pension transfer advice. In an environment of increasing scrutiny, turning a blind eye to contingent fees is likely to result in a costly remediation exercise, as we see in our cautionary tale.


Let’s use an imaginary firm called Pluto Financial Planning as an example

Chris is an adviser at Pluto Financial Planning, which prides itself on the ‘out of this world’ service it provides to its clients. Chris has been approached by Dave, a potential client who wants to transfer out of his employer’s DB pension scheme, which was closed to new accrual a few years back. Dave has been referred by a colleague at work who received advice from Chris to transfer out of the same DB scheme a few months ago.


Seeking DB pension transfer advice

During their initial conversation, Chris explains to Dave that the DB pension transfer process advice is complex, time-consuming and expensive – usually several thousand pounds – and that there’s no guarantee that he’ll recommend a transfer at the end of it. But the good news is that Dave won’t have to stump up any fees unless Chris recommends a transfer, and Dave accepts that advice. After the transfer completes, the advice fee (1.5% of the sum to be transferred) will be deducted from Dave’s pension fund, so he won’t need to raid his savings to pay for it. Assuming the transfer goes ahead, there will also be a fee of 1% per year for ongoing advice on the investments within Dave’s pension fund, and on his retirement strategy. But Dave will not need to pay the ongoing fees directly, they will be deducted from his pension fund.

On the other hand, if Chris recommends against a transfer, Dave won’t be charged a penny – the advice will be free. So, he’s got nothing to lose by receiving advice on whether to transfer. This sounds like a good deal to Dave, so he signs up on that basis.


Dave’s financial background

Dave is 55 and intends to work for another 10 years or so. He is in good health and hasn’t yet considered his income needs in retirement. Dave is keen to explore the possibility of transferring out of his DB scheme because he’s heard through the grapevine at work that the transfer values on offer are at a historic high, and that there are question marks about the sustainability of the scheme.

He would also like to take advantage of the flexible income and death benefit options now available if he transfers. For example, not needing to buy an inflexible and poor-value annuity and being able to leave the whole pension fund to his family if he dies before he retires. He would also like to leave any unused pension fund to his family, free of IHT, after his eventual death.

Dave has been told by colleagues who have already transferred that he can take a bigger tax-free lump sum if he transfers out, and that he can take it now rather than having to wait until he retires. Dave would like to access his tax-free lump sum now to pay off his £10,000 car loan (which has 3 years to run), to pay for a new conservatory, and to contribute towards his daughter’s tuition fees when she goes away to university later this year.

Dave is an engineer earning £50k per year. His wife, Sarah, who is also 55, works part-time and earns £12k. They have two teenage children. They have a £100k mortgage (with 10 years to run) on their home, which is valued at £250k. They currently spend all their net monthly household income, so they aren’t saving anything apart from their workplace pension contributions. Dave has obtained a CETV for his DB pension scheme. It is £400k, which represents 20 times the projected £20k income at the scheme’s NRA of 65. Since the DB scheme was closed to further accrual, Dave has been contributing 5% of his salary to a GPP through his employer, and the fund is currently valued at £45k. He has no other pension funds. Sarah has accumulated several, small pension pots over the years, valued at around £50k in total. Dave and Sarah keep £5k in a cash ISA for emergencies, but they have no other savings or investments, and no investment experience.


Fees contingent on advice to transfer out of DB pension

Chris recommends that Dave transfers out of his DB pension scheme into a SIPP, with the funds invested via the firm’s in-house discretionary portfolio service. This meets his objectives of accessing the maximum tax-free lump sum now to pay for the aforementioned items (but without generating taxable pension income he doesn’t currently need) and securing the flexibility of retirement income and death benefits he wants.

Chris writes a 30-page suitability report which includes the APTA outputs, the details of the ceding DB scheme, several pages of technical information about pensions, and warnings about the security of retirement income he is giving up by transferring. This includes a sentence to confirm that Dave feels that flexibility and control of his retirement and death benefits are a higher priority for him than the security of a guaranteed and index-linked retirement income for life. Before the suitability report is issued, the firm’s PTS, Sally, conducts a pre-sale check. Everything required by the tick-box checklist is present and correct on the client file, so Sally signs the advice off.

Dave accepts the recommendation and the transfer proceeds. Pluto Financial Planning receives an initial advice fee of £6,000 (1.5%), plus an ongoing advice fee starting at £4,000 per year (1%), and a £3,000 per year (0.75%) fee to Pluto Investment Management for the discretionary management service. All this revenue is being taken from Dave’s pension fund.

If Chris had recommended that Dave remained in his DB scheme, there would have been no initial advice fee, and no investible assets to generate the ongoing advice and investment management fees. The amount of work involved in the advice process up to the delivery of the suitability report was 4 hours of Chris’s time, 15 hours of a paraplanner’s time and 2 hours of an administrator’s time. Chris knew that his firm would not get paid for any of this work if he had recommended against a transfer, and that the time he spent would not have contributed towards his challenging monthly revenue targets. Of course, Chris sincerely believes that this knowledge did not influence his recommendation in any way.


When the FCA comes knocking

Meanwhile, Pluto Financial Planning has recently received a questionnaire from the FCA. This asks lots of questions about the firm’s DB pension transfer business including, for example, how many recommendations it has made against a transfer.

After submitting Pluto’s response to the FCA questionnaire, its Principal, Mike, reads in the trade press that the FCA has recently found that only 50% of DB pension transfer advice recommendations are suitable. So, it will be using the responses to its questionnaire, issued to all 3,000 firms with DB pension transfer permissions, to conduct a major programme of supervisory activity during 2019 and that all firms that have been active in the market will be affected.


Taking the right steps, if you can’t prove your advice is suitable

Concerned by the FCA’s unusually strong language about taking serious action against firms who can’t prove that their advice is suitable, Mike decides to ask an independent external suitability specialist to review a sample of client files. Unfortunately, the independent reviewer concludes that there’s a high risk that Chris’s recommendation to Dave is unsuitable. Given Dave’s circumstances, the reviewer says that the stated objectives justifying a transfer are flimsy and unconvincing, and that it appears Dave can ill afford to give up the guaranteed retirement income from his DB scheme.

Altogether, seven out of the ten DB transfer cases reviewed for Pluto by the independent specialist are judged to be either unclear or unsuitable. This is bad news for Mike who is now faced with the prospect of an expensive and time-consuming remediation exercise, as well as notifying the FCA.

Share this