Transfers, exit fees and financial advice - what next for the pension freedoms?
What do exit charges, the pension transfer process and financial advice all have in common?
The Treasury's consultation paper "Pension transfer and early exit charges" suggests that these are all barriers to the Government's pension freedoms inhibiting consumers' ability to access their pension pots under the new freedoms from the age of 55.
Broadly, if a member is seeking to transfer from a final salary scheme to a defined contribution scheme with a cash equivalent value of £30,000 or more, then the member must obtain advice from a pension transfer specialist and the ceding scheme must check that such advice has been taken. In the event a member seeks to transfer so-called safeguarded benefits other than final salary benefits, the member must again obtain advice but this does not have to be provided by a pension transfer specialist. This is a simplification of a regime which the paper acknowledges has been criticised for its lack of clarity. In fact, the paper notes that in some cases members with a final salary pot of less than £30,000 have been required to obtain advice before transferring when there is no requirement to do so.
Although the paper makes no suggestion that the Government is looking at removing the advice requirement in the specific circumstances set out above, it does acknowledge the tension between requiring consumers to obtain advice and the reluctance of advisers to provide that advice where it is then ignored by the consumer –i.e. insistent clients.
The paper includes a section on insistent clients, referencing the FCA's recent factsheet on how to deal with these clients and states "In some cases it is clear that consumers are frustrated by existing legislative and regulatory requirements to seek financial advice in certain circumstances – although it is worth noting that there is no requirement in legislation to follow the advice taken". In light of this tension the paper invites responses on "what has been the impact of the legal requirement to receive independent advice on the process for transferring safeguarded benefits?"
The paper also looks at the pension transfer process. Currently the process is supposed to take 6 months from the date of the request to the date of transfer. A number of reforms to this process have already been introduced alongside the pension freedoms and which provide (1) an extended right to transfer for those with so-called flexible and safeguarded benefits, (2) for members to transfer up to and beyond their normal retirement date provided that they have not entered decumulation (i.e. started to receive their pension or purchased an annuity), and (3) for a statutory override permitting schemes to provide flexible benefits where the scheme rules would not otherwise allow for such benefits.
The paper includes little suggestion for reform in this area other than raising the question as to whether or not to adopt for pension transfers the Government's universal principles which apply to switching from one product to another (these universal principles currently apply to switching energy providers). The universal principles include (1) the process should be as short as possible, (2) the gaining provider leads the process (which is not currently the case for pensions), (3) the process should be efficient with effective redress mechanisms if things go wrong and (4) unless contractually bound, the process should be free to the consumer.
The core of the paper relates to exit charges which have received much recent press attention. The paper notes that there is no statutory definition of exit charges but they broadly meet three criteria: (1) a member wishes to transfer out or otherwise access their pension, (2) a member wishes to do so before their agreed retirement date, and (3) the scheme applies a penalty for that early exit.
The paper notes that there is limited consistent research in this area as to the applicability and level of exit charges, albeit that a recent Department of Work & Pensions report found that one in ten savers could be affected on transfer by exit charges and this is a particular issue with respect to products sold in the 80s and 90s. Further, in relation to legacy workplace pensions, around 7% (£4.8bn) of assets under management face early exit fees, and of this amount 60% (£3.4bn) face an early exit charge of 10% or more.
The paper sets out some of the options the Government is considering adopting including: (1) capping all early exit charges by reference to either a fixed percentage of the funds transferred or a capped monetary amount; (2) a flexible cap in certain circumstances, for example putting in place a de minimis threshold or applying a set exit charge to particular components of a fund; or (3) a voluntary approach from the industry to restrict exit charges and, for example, allowing trustees and managers to waive or otherwise have the ability to reduce an early exit charge.
Although the Government is keen to ensure that early exit charges do not scupper the pension freedoms, it does appear that the Government appreciates that pension providers have to provide for some exit charge in certain circumstances in order to cover their overhead costs. In particular, the Government is not looking at market value adjustments and terminal bonuses in the context of exit charges which it says are "exit charges conflated with deductions to project investment value". Although the Government is keen to increase the understanding and simplicity of both market value adjustments and terminal bonuses, it appreciates that these are not guaranteed and in the case of market value adjustments are often genuine provisions to recoup underlying costs.
We are now 4 months in from the introduction of the new pension freedoms and there are a number of consultations and calls for evidence looking at how the freedoms and accompanying new rules are both developing and working in practice.
The Government appears keen to ensure that consumers are able to enjoy these freedoms with minimal barriers and cost, whilst the financial advisory industry battles with how to provide the advice to match the Government's ambitions. How to address this tension is to form part of the major new review just announced by the Treasury into the financial advisory market and we will have to see what solutions are suggested this coming Autumn.