Partial DB transfers could be the perfect solution for those caught between needing income security and income flexibility.
Not only could partial DB transfers offer the best of both worlds to clients, it could also be advantageous to employers and trustees too. Most people with a DB pension will be best advised to stick with it. A DB pension offers the peace of mind of a fixed income for life. It will be too much for most people to contemplate giving up, no matter what level of transfer value is on offer.
But what if the guaranteed income level needed to allow clients to sleep easily knowing that they’re financially secure can be met with only part of their accrued DB promise? Transferring the excess to provide income flexibility when required, or to be passed on efficiently to future generations, could generate a situation where everyone is a winner.
- Member – win: For members who want some guaranteed income, but not as much as their full DB entitlement, partial DB transfers may be the best fit for their needs. It can provide the guaranteed income they need, plus flexibility with the balance of their accumulated DB wealth.
- Employer – win: Growing numbers of employers have realised that allowing partial transfers helps get DB liabilities off their balance sheet efficiently. If they stick with an ‘all or nothing’ stance, more liabilities will stay on their books.
- Trustees – win: Every transfer paid normally improves their scheme’s actuarial funding position – leaving remaining members more secure. It’s rare for a transfer value to be higher than the actuarial ‘technical provisions’ they have to reserve for to back the DB promise.
Who might it be right for?
It may be clear cut whether or not partial DB transfers are appropriate for most clients. But there will be some who sit in the ‘grey area’, needing some guarantee but equally attracted to DC and the benefits that freedom and choice can offer. And it’s these clients who will benefit most from seeking a partial transfer.
A guaranteed retirement income may provide peace of mind that the bills will be paid in old age. Giving up this guaranteed, inflation-proofed income for life could be a risk too far. Most simply can’t take on the downside risk of moving to DC and should stick with DB.
But for wealthier clients, worries about paying their bills or running out of money won’t be an issue. A DB income for life may simply mean surplus income and unnecessary tax. A transfer to a modern, flexible DC pension may be a better fit for their needs. The ability to take income and tax free cash from a SIPP at the levels they need, when they need it, may give a more tax efficient income and a larger legacy for loved ones.
The advice framework – and how partial transfers fit in
The FCA rules are clear. An adviser’s starting assumption should be that a DB transfer isn’t suitable. A transfer to DC should only be recommended if it’s clearly in the client’s best interests.
This doesn’t mean it’s safe to leave clients in DB where DC would suit them better. But it gives advisers a useful ‘no transfer’ default for cases in the grey area – and some leeway over where they draw the line.
However, where a partial DB transfer is an option, this changes the advice equation – and can remove any grey area. Although a full transfer may not be appropriate, a partial transfer might meet the client’s needs and aims better than sticking with the full DB pension.
Example – A client with a £40k yearly DB pension may only need a guaranteed income of £24k. A transfer value of £1M is on offer in lieu of the pension. But the client couldn’t sleep at night without their guaranteed £2k a month.
- No transfer: Sticking with the full DB pension provides the guaranteed income the client needs. But it also gives an extra £16k a year unneeded income, an unnecessary income tax bill and, potentially, an IHT problem further down the line.
- Full transfer: Transferring it all into flexible DC won’t guarantee the required £24k a year – risking a bad client outcome, regulatory sanction and lost sleep all round. And in current conditions, partial annuitisation under DC post-transfer to secure the £24k a year may not make economic sense.
What if a partial transfer was available?
- Partial transfer: Leaving £24k a year guaranteed income in DB, and transferring the other 40% of the value (£400k) into a flexible DC plan, could give the best of both worlds. It covers the client’s guaranteed income needs efficiently and gives flexibility to draw extra funds when needed, manage tax or create a legacy with the balance. The ideal advice solution?
Will schemes offer partial transfers?
Many schemes don’t currently offer the option of a partial DB transfer. It simply wasn’t historically a feature of the DB landscape. But the numbers now offering partial transfers is on the rise.
The barriers holding some DB schemes back from introducing a partial transfer option are the perceived complexity and cost. Legal fees to amend the scheme documents, actuarial fees to develop a transfer basis and the costs of implementing the necessary administrative processes can all be off-putting.
But these are all achievable. If scheme trustees thought about it, they already provide partial transfers every time they receive a pension sharing order. It’s just about industrialising the process. And the payback for all concerned could be worth it.
Clients with DB and DC rights under the same scheme now have a statutory right to transfer their DC rights and leave the DB pension behind (or vice versa). An ‘all or nothing’ transfer ultimatum doesn’t always support the best member outcomes. It’s why the law was changed to allow DB and DC rights to be transferred independently. But there’s currently no statutory right to make a partial transfer of DB rights.
There are some potential legislative obstacles which may prevent a partial DB transfer. For example, the law doesn’t allow for a partial transfer of GMP rights. And scheme specific protection to both tax free cash entitlement and early retirement ages may be affected following a partial transfer. But there are normally ways to plan around these.
If this ‘best of both’ option is the best fit for your client’s needs, ask the question of the DB trustees – does their scheme offer partial transfers? And if not, ‘why not?’ By articulating the win/win result this option can produce, it might just trigger a light bulb moment for the employer/ trustees that opens up the most appropriate option for your client and creates the best advice solution for you.
Source: Standard Life technical consulting 10th May 2017