When does it make sense to give up a guaranteed, inflation-proof income for life and swap it for a lump sum today? On the face of it, recent history suggests the answer for a lot of people is quite often. Over the past four years, around 400,000 people have taken advantage of the “pension freedoms” that came into force in 2015 to cash in “final salary” schemes provided by present or former employers. Tens of billions of pounds have been transferred to so-called “defined contribution” pensions, from which it can be withdrawn as cash.
In some cases, this can make sense. The owner might have a life-shortening illness: a transfer gives them access to the full value of their pension savings immediately. Or the pension might be small—the result of a short period of employment—so cashing in will not have a big impact.
But these are exceptions. The Financial Conduct Authority recently noted: “For most people a transfer out of a [final salary] scheme is unlikely to be suitable.” That, however, has not prevented financial advisers recommending it in a remarkably high proportion of cases. The FCA now says that about 40 per cent of those advised to transfer out received advice that was not suitable for their personal circumstances, although that proportion has latterly reduced. In the notorious case of the British Steel Pension Scheme, only about 20 per cent of the 7,700 former steel workers who transferred out were found to have received suitable advice.
This was an accident waiting to happen. Behavioural economists have understood for many years that if you offer a choice between a lot of money today and regular, smaller sums in future, you shouldn’t be surprised when most people pick the lump sum. And if you allow advisers to offer contingent charging, whereby the client pays for the advice only if they decide to go ahead, it is even less surprising that advisers tend to recommend a transfer. The charging structure helps to reinforce the client’s natural bias. Perfect.
Contingent charging will be banned from October (why not immediately?) and almost a quarter of firms advising on pension transfers have left the market after conversations with the FCA.
But are we destined always to shut these doors after the horse has bolted? If financial professionals had a legal duty of care to their clients, things might have been different. This is exactly the proposal in a private member’s Bill that had its first reading in the Lords in January. Since then it has been stuck in limbo, waiting for parliamentary business to resume in full.
When it does, I hope the government backs it. It is simply bizarre that people charging for financial advice are under no legal obligation to protect their clients’ best interests.
