Thinking of cashing in your pension early? Read this first
Thousands of people over the age of 55 have cashed-in their salary-based pensions so they can reinvest the money – and often to also take a lump sum out to spend now.
But there is new evidence that they are getting poor advice from financial advisors – who many are forced to consult, and to pay for that advice.
Anyone whose pension is worth over £30,000 has to take advice from an Independent Financial Advisor (IFA).
The Financial Times estimates that since pension freedoms were introduced in April 2015, some £50 billion has been taken out of final salary pensions.
The Financial Conduct Authority, which polices the UK’s 35,0000 financial advisors, looked into 88 cases of final salary pension transfers carried out by financial advisors. It found that in more than 50% of cases IFAs should not have advised that customers give up their final salary pensions
In only 47% of cases examined was it decided the opt-out recommendation was suitable. The FCA added that it was also unclear whether the recommendation was correct in 36% of cases.
Nearly one-in-five of the transfers looked into were found to have been unsuitable.
When the FCA looked at products recommended to those who were advised to transfer, it found 24% were unsuitable, and it was unclear in 40% of cases whether the product was right for the client.
In only 35% of cases did the probe find suitable recommendations had been made.
What all this means is that thousands of people could have made hugely expensive financial mistakes because of duff advice – advice that they pay to receive.
Keith Richards, chief executive of the Personal Finance Society, told the FT, “On the basis of these findings, the regulator should now be looking to conduct a full thematic review of the transfer market.
“Whenever there is a spike in any activity, such as pension transfers, it warrants deeper scrutiny.
"We need to make sure there is no repeat of past pension mis-selling scandals.”
What is a final salary pension?
These are also called defined benefit or DB schemes, and are generally thought to be the best kind of pensions around.
In fact, they tend to be so generous that almost all companies now say they can no longer afford to pay them.
They promise a fixed income for the rest of a person’s life after retirement, which is fixed as a percentage based on your final salary, or, more commonly, based on your total earnings while you have been in the scheme.
Unlike other types of pensions, where the payout is determined by the performance of an underlying investment, DB schemes are fixed only based on salary. Most DB schemes are also linked to the rate of inflation.
And when you die, your partner or spouse usually gets 50% of what you were paid until their death.
Why does anyone want to transfer out of a scheme like this?
If that all sounds like a good deal, that’s because it is.
But changes in the rules surrounding pensions in 2015 created a buzz of excitement, largely because people aged 55 or over were suddenly able to take control of their own investments AND, even more importantly, cash in 25% of their pension pot early, tax free, and do what they wanted with it.
Here’s how it works:
Say you have a £100,000 pension pot, you can take up to £25,000 as a tax-free lump sum, if you want, and then you have several choices:
Take out the remaining £75,000 straight away, or in chunks, and pay tax at your marginal rate – so, 20%, 40% or 45%.
You can buy an annuity with the £75,000 – which will mean you hand over all the money and get a guaranteed income for life. With interest rates as low as they are, this option has been unattractive in recent years.
Leave the £75,000 invested in the stock market and take out (draw down) as much as you want in income – or none at all, of course.
Buy an annuity with some of the money and invest the rest, or take it out of your fund and spend it.
The choice is yours. However, if your fund is worth more than £30,000, you have to seek advice from an IFA.
The other big reason people transfer out is that, because companies can't afford to operate these DB schemes any more, they have offered people what is described as an ‘enhanced’ transfer value – basically bumping up the value of a person’s pot if they take the money and leave the scheme.
What are the rules on advisors?
Under the rules anyone who advises on the transfer of a final salary pension must consider what your funds will be invested in and whether this is suitably secure and appropriate.
The FCA expects an adviser to estimate the expected returns of any scheme you’re considering transferring your money to, based on what is known as a “critical yield” test.
This is the rate of return that you’d need to achieve to reach the same benefits you’d get in the defined contribution pension scheme.
The IFA should also look at and take into account your personal circumstances before making any recommendation. The should consider non-financial factors like your age, your health, and your outgoings and other assets.
If you think the advice you are given is unsatisfactory, you can complain to the adviser, and they have eight weeks to respond. If you are still not satisfied, you can take your complaint to the Financial Ombudsman Service. This is an independent arbitrator that rule on whether there has been any fault.
How do you know you are getting good advice?
One thing you can do is take advantage of the government’s free advisory service, Pensionwise.
It is a free, independent service that is available to anyone over 50 who has a personal or workplace pension. It offers specialist guidance to help you make sense of your options and the service can be conducted either over the phone or in your local area.
* Think about what advice you’re looking for– is it just advice on your retirement savings, or do you want help with all of your financial planning? Be clear about what you want covered and make sure you dictate the agenda.
* Consider the level and experience that the adviser has- particularly in the areas where you think you need help. Ask them, check them out: look at their website, their qualifications, where they’ve worked.
* Look at the typical clients the adviser takes care of in their business - do they have needs similar to your requirements?
* Think about whether you will be dealing with one adviser or different advisers, or, perhaps a team of people - What are you most comfortable with?
* Look at what products they recommend for you- Do they recommend products from the whole market, or are they products tied to one, or a small number of providers?
*Understand what the adviser will charge for their services and that you can afford to pay these charges.
*If you don’t understand something ask for it to be explained again– and again if necessary. Never agree to something you have not fully understood. If you need more time to get it straight in your mind, ask for it.
*You should always check that the adviser is an authorised to provide financial advice- You can check the Financial Conduct Authority’s (FCA) Register, by clicking here.
* You can also visit the FCA’s website to get help in understanding what a financial adviser should do.
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