Pension Transfers and Regulated Financial Advice Flashcards
There are key stages in the production of suitable advice and the production of your report. There are essentials that MUST be in your report. These are:
- Establishing ATR: appetite for risk
- Tolerance of risk; their psychological make-up, such as risk aversion and the willingness to take risk – as well as a description of ALL the risks associated with the advice recommendation
- Capacity for risk/ loss
- The financial loss they could stand; in other words, affordability to take risks
- Suitability and reasons why it is suitable for the client’s objectives
- Explains why the firm has concluded that a recommended transaction is suitable to meet the clients objectives. It details the reasons why the advice is suitable. It must contain both the client objectives and the reasons why the advice is suitable.
A client’s risk profile is made up of:
- Objective factors, such as timescale, income and assets
- Subjective factors, such as their attitudes and aims
Generally, when a firm is making a personal recommendation to a client about their pension or investment, it should consider all the relevant circumstances including:
- the client’s investment objectives; need for tax-free cash from their pension and state of health;
- current and future income requirements, existing pension assets and the relative importance of the plan, given the client’s financial circumstances holistically;
- the client’s attitude to risk (ATR) and tolerance of risk
There is also an area where behavioural finance is playing an increasing part and the FCA has produced papers in this area.
The factors that can affect a persons tolerance to risk (7):
- Timescale
- Familiarity effect i.e. more likely to accept risk where they are familiar
- People dislike losses more than they like profits
- Attitudes can change with circumstances e.g. childbirth/ redundancy
- Education and age: better educated young people are generally less risk averse
- Tolerance can increase when people are used to dealing with risk
- Events from the past - past investment experience can influence future decisions/ past job losses can influence attitude goig forward
The suitability report: advice outcome
The suitability report as outlined by COBS 9.4 must at least outline and explain to the client why a firm has concluded that a recommended transaction is suitable for the client. This must detail three key areas:
- specify the client’s demands and needs – or, in other words detail the clients aims and objectives, upon which the adviser is providing advice.
- explain why the firm has concluded that the recommended action is suitable for the client having regard to the information provided by the client;
- explain any possible disadvantages of the transaction for the client.
This is a report (for the client) which a firm must provide to its client under COBS 9.4 (Suitability reports) which, among other things, explains why the firm has concluded that a recommended transaction is suitable for the client. It details the reasons why the advice is suitable. For further reading: FG12/16 pages 11, 12 and 13
When deciding on the assumptions that are used to calculate a CETV, trustees must seek advice from the actuary and other professional advisers, for example: (5)
- Scheme specific, industry specific, and/or member specific factors. For example, mortality assumptions may be influenced by, for example, the industry in which the employer operates and/or by geographical location;
- Relevant scheme or external data from which average values can be deduced and trends observed;
- Expert opinions on the likelihood of past data remaining valid for the future. For example, economists’ opinions;
- Investment strategy when choosing assumptions;
- Scheme’s funding plan as set out in the statement of funding principles.
List topic areas that could (or maybe should?) be discussed when assessing a Pension Transfer:
- Early retirement
- ATR/ willingness to forgo guarantees
- C4L
- Other income/ assets that can be relied upon in retirement
- Investment experience
- Term to retirement
- Health and life expectancy
- Term to retirement
- Flexibility of death benefits pre and post 75
- Inflation expectations
- Income requirements in retirement/ flexibility
- Amount of PCLS available from the scheme vs personal pension
- Need for lump sums in the future, amount?
- Possible legislation changes?
- Complexity/ ongoing reviews/ adviser charges
- Funding status of schemes/ statutory protection
- Tax rates now and in retirement
- LTA position
- Availability of a partial transfer
- Objectives/ alternative options for meeting the need
When considering the transfer of moving safeguarded benefits into an arrangement where the benefits are not safeguarded, it is important that all risks associated with the transfer and the client’s feelings on them are ascertained and recorded.
In the case of a transfer, investment risk refers to:
- Investment risk
- Requires an assessment of the level of risk that the client is comfortable taking with their investment fund where they to proceed with a transfer. This requires structured questionning in which any anomalies should be addressed.
- Level of risk taken should reflect level of client’s experience and C4L, timescale to retirement should be taken into account.
- The level of risk taken should also reflect the form in which the client intends to take their benefits in retirement.
When considering the transfer of moving safeguarded benefits into an arrangement where the benefits are not safeguarded, it is important that all risks associated with the transfer and the client’s feelings on them are ascertained and recorded.
APTA requires an adviser to assess the client’s attitude to transfer risk as a separate matter to their attitude to investment risk.
In the case of a transfer, transfer risk refers to:
Attitude to transfer risk basically reflects the client’s views on giving up the guarantees associated with their DB scheme. Specifically the lifelong income and the inflation proofing.
As a result of the transfer, there will be no such guarantees and the client will be taking on those risks on an individual basis.
When considering the transfer of moving safeguarded benefits into an arrangement where the benefits are not safeguarded, it is important that all risks associated with the transfer and the client’s feelings on them are ascertained and recorded.
In the case of a transfer, mortality/ longevity risk refers to:
Basically this is the risk of the client outliving their money.
Where a DB scheme provides guaranteed, inflation proofed income for life which is sufficient to cover client outgoings there is little risk attached.
Transferring to a flexible benefit arrangement introduces risk - that of the client outliving their money.
Eg. where a client wishes to utilise FAD, can the client sustain a safe withdrawal rate while meeting their income needs?
When considering the transfer of moving safeguarded benefits into an arrangement where the benefits are not safeguarded, it is important that all risks associated with the transfer and the client’s feelings on them are ascertained and recorded.
In the case of a transfer, inflation risk refers to:
Where a client has DB benefits, inflation risk is very limited. This is because DB schemes are required to revalue and escalate in payment at a minimum rate of CPI up to 2.5%. This may be more depending on scheme rules.
On transfer to a DC arrangement, the individual relies on investment performance to outperform inflation over the longer term, though there is a risk that in some years this may not be the case.
Is the client comfortable with the possibility of inflation eroding their pension pot?
When considering the transfer of moving safeguarded benefits into an arrangement where the benefits are not safeguarded, it is important that all risks associated with the transfer and the client’s feelings on them are ascertained and recorded.
In the case of a transfer, charges must be taken into account when assessing the merits of transferring out:
With a DB scheme, all of the associated costs (admin, actuarial, trustees, overheads etc) are footed by the sponsoring employer.
DC providers on the other hand are commercial organisations seeking to make a profit. Therefore ongoing costs will be taken from investments they hold.
Typically on transfer, a client may incur an intial fee for 1-3% may be ballpark, as well as similar for the ongoing costs. This must be offset against any expected investment returns combined with the inflation erosion.
When considering the transfer of moving safeguarded benefits into an arrangement where the benefits are not safeguarded, it is important that all risks associated with the transfer and the client’s feelings on them are ascertained and recorded.
In the case of a transfer, sequencing risk must also be taken into account:
Sequencing, or sequencing of returns risk relates to the effect which the timing of withdrawals from a fund can have on overall returns.
Effectively this is a variant of pound cost ravaging in which poor investment returns in the early years can magnify a reduction or loss in returns throughout the timescale of investment.
Sequencing refers to the taking of withdrawals when the markets are down, magnifying the impact.
When considering the transfer of moving safeguarded benefits into an arrangement where the benefits are not safeguarded, it is important that all risks associated with the transfer and the client’s feelings on them are ascertained and recorded.
In the case of a transfer, interest rate risk refers to:
Traditionally, DC pension funds have followed an investment path of increased equity exposure in the early years and increase in fixed interest exposure in the later years.
A drop in interest rates before retirement could have significant implications, especially if annuity rates remain low. Effectively leading to buying a lower income, with a lower than expected pension fund.
When considering the transfer of moving safeguarded benefits into an arrangement where the benefits are not safeguarded, it is important that all risks associated with the transfer and the client’s feelings on them are ascertained and recorded.
In the case of a transfer, product risk refers to:
As noted udner interest rate risk, annuities are reducing and the market is reducing in value since pension freedoms.
This means that firstly, less purchases of annuities occur. Secondly, there is less incentive for providers to compete and innovate - some may drop out of the market altogether.
With some clients deciding to hold off till the later years of retirement to annuitise their pension, by the time they come to do this a product may not exist which offers the features they desire.
