In a world full of uncertainties and low interest rates, final salary pension schemes are widely considered a treasure but they can be inflexible and are often not specifically targeted at individual members’ needs. Members of such schemes often transfer out for a variety of reasons. These include: to access greater flexibility under the new pensions freedoms brought in last year; to draw their cash lump sum to reduce debt and to ensure that their families better benefit from the fund, in the event of their death.
In the recent months we have seen transfer values (the capital value of the benefits promised by a scheme, sometimes called the CETV or Cash Equivalent Transfer Value) at unusually high levels – sometimes as much as 40x the annual pension income. This has been driven by recent reductions in government bond returns brought about by the Brexit vote and also the measures taken by The Bank of England to prop up the economy. It is fair to say that this combination of factors is unusual and likely to be short lasting. When Bond returns revert to their traditional range, it would be reasonable to expect transfer values to reduce. So there is a bit of a window of opportunity to extract quite a bit of value for your pension, which can not be expected to last. This is definitely a good time to review whether your final salary pension is in the right place.
Differences Between Pension Schemes
One important thing to point out is that different pension schemes use a variety of factors when calculating transfer values. These include your current age and when you are entitled to draw the benefit, as well as the scheme specification in terms of escalation of benefits before and after retirement and any spouses and dependents benefits. In general, the closer you are to retirement, the higher the CETV multiple. Conversely, the more time left for the assets to grow, the lower the present value. The only way to know the exact figure is to request a CETV quotation from your pension provider. The state of funding and therefore the security of your benefits can have a bearing on the transfer value as well. If the scheme is very underfunded, transfers values can be subject to a discount.
When to Transfer (and When Not)
Guaranteed income is the main advantage of defined benefit schemes. When you transfer to a defined contribution scheme, you lose these guarantees and your future pension income will depend on returns earned on the invested assets. When you get a CETV quotation, you can actually calculate the exact rate of return needed to beat the income which you would have received from the old final salary scheme. The current high CETV multiples make these required rates of return lower than usual – sometimes as low as one percentage point above inflation.
When transferring out of a final salary scheme, investment risk shifts from the pension provider to you. One of the key things to consider when deciding about a transfer is your ability and willingness to take this risk. The former is mostly about your financial situation and whether you have other assets and income sources to possibly rely on in case your investment returns turn out lower than expected. The latter is mainly about your risk attitude and psychological factors.
Risk and return are major parts of the decision, but not the only ones. Your existing pension plan may come with other (often non-financial) benefits which you would be giving up. At the same time, final salary schemes are typically quite restrictive and inflexible – transferring out opens up new ways to access your pension pot and thereby new options for retirement and inheritance tax planning.
To sum up, those with more wealth and other assets besides their pension, those who intend to pass a substantial portion of wealth to children, or those looking for greater flexibility and control over their retirement savings are more likely to find a transfer suitable. Conversely, those with limited assets and those who prefer security and guaranteed income will probably want to keep their existing final salary scheme. These are, of course, generalisations – the actual decision will depend on the particular numbers, as well as many unique, personal factors.
The Window of Opportunity
While a decision to transfer a pension must never be taken lightly or made hastily, keep in mind that the current high transfer values are caused by recent short term market developments and these are unlikely to last. When bond rates go up, the CETV multiples can be expected to decline.
Contact us now for a free initial consultation to check out your options. You can find more details about our pension transfer advisory process by visiting our sections on UK Pension Transfers and Expat pension Transfers