Nevertheless, pension drawdown is usually a relatively high-risk strategy and advisers should always assess the client’s capacity for loss. If their financial needs in retirement are less than the income that would emanate from their private and state pensions they will have a higher capacity for loss. Equally, if they have surplus personal capital reserves that could be called upon if required to make up any shortfall as a result of a fall in the value of the fund, that would also indicate a higher capacity for loss.
Retirement modelling systems that can simulate a stock market crash are helpful in assessing capacity for loss. Typically I will look at a scenario where the equity element of the recommended strategy falls by 30 per cent, with no market recovery. That is a harsh test indeed, as stock market crashes are invariably followed by some recovery.
By benchmarking the client’s long-term needs against market annuity rates for a joint life index linked annuity, assuming the drawdown fund were switched to an annuity at 75, it is possible to assess whether the client can withstand such a financial shock.
This brings me onto the financial assumptions for assessing the suitability of a defined benefit transfer. In its recent guidance document, the FCA highlighted the need for advisers to consider the likely expected returns of the assets in which the client’s funds will be invested, relative to the critical yield.
The underlying assumption about the future growth rate will be based primarily on the proposed asset allocation, which would vary significantly depending on whether the proposed investment strategy is on an assumption of the pension being secured under an annuity at retirement or, alternatively, pension drawdown. A short-term strategy for the period to retirement would be totally different to a long-term drawdown investment strategy and in most cases two sets of assumptions will be needed.
The implied risk and return should also take into account the client’s risk appetite, as well as the client’s dependency level on the pension, taking into consideration their other assets and income resources including those of their spouse or partner where appropriate. The assumptions used in the transfer analysis should always reflect the proposed asset allocation. Any material variation could invalidate the advice.
Lastly, the tricky matter of insistent customers. While it is clear that advisers are permitted to facilitate insistent customer transfers, and the FCA has laid down three key steps that must be taken, my own view is that this is potentially dangerous. In such cases I take the view that either the client has misunderstood my advice, or I have misunderstood the client. This approach leads to an extended dialogue where the client is asked to explain in writing their reasons for still wanting to transfer in spite of my advice to the contrary.
