Final Salary Pensions, Hurry Whilst Shocks Last!
Well here’s something that doesn’t happen that often. The turmoil in the financial markets is actually presenting an interesting opportunity – and even Brexit may have had a hand in generating this particular happy shock!
I’m talking about Final Salary Pension Schemes here. In a world of future uncertainties and undetermined risk, a final salary pension can be seen as something to hold onto at all cost. But just consider the following for a second. They are often inflexible and are not usually targeted to accurately meet individual members’ needs. Which can cause members to transfer out to access things like greater flexibility under the new freedoms to pensions introduced last year. Or they might want to access a cash lump sum, to reduce debt or to ensure their families benefit more greatly from the fund in the event of their death.
Recently we’ve seen more and more people transferring values, by which I mean the capital value of the benefits promised by a scheme (sometimes called the CETV or Cash Equivalent Transfer Value) at unusually high rates. By high rates, I’m mean as much as 40 times the annual pension income!
So why are values so high and will it last?
The conventional wisdom here is that values have been driven up significantly by recent reductions in the returns one can achieve with government bonds, brought about by the result of the Brexit vote, combined with The Bank of England’s attempt to prop up the economy. Which is great for anyone looking to take advantage of the CETV on their final salary pension. But like all good things, it is likely that it will be coming to an end soon, because when the bonds return to their normal range, we can expect to see transfer values to reduce too.
So if you’ve been thinking, it might be time to start doing!
Right now there is an unusual opportunity to extract some significant value from your pension. However the situation is predicted to return to normality soon, so now is the time to act.
Working out your transfer value
It’s important to understand that there are a variety of factors that different pension schemes use to calculate transfer values. These usually revolve around your age now and what your age will be when you are entitled to start drawing the benefit. They may also include the specifics of the escalation of benefits before and after retirement as well as any benefits your spouse or dependents are entitled to.
As a rule of thumb, the closer you are to your retirement, the higher the CETV multiple will be. Oddly, the further away you are, with more time for the assets to grow, the lower the present value is. The state of your schemes funding and security of your benefits will also have an impact on final figures, as will the scheme being underfunded in any way.
The best way to know exactly what your potential opportunity might be, is to request a CETV quotation from your pension provider.
You can look before you leap
The main advantage with a defined benefits scheme is the guaranteed income. As you lose these guarantees when you transfer, your future pension income will depend upon the returns you earn on the invested assets. That’s why, once you’ve received your CETV quotation, it’s vital to calculate the exact rate of return you need to ensure you would exceed the income you were set to receive on your final salary scheme. But right now, the high rate of the current CETV multiples mean that these required return rates can be as low as just one percentage point above inflation to make the move a sound choice.
You should also consider that when you transfer out of a final salary scheme, the investment risk moves from the pension provider over to you. So you must consider your attitude toward risk. This will be influenced by factors such as your financial situation, other assets and income sources you might have that you could fall back on if you need to, should returns be weaker than predicted.
Apart from the questions of risk and return, there maybe other things to consider. Your existing plan may have other non-financial benefits attached to it, which you may not wish to give up.
Having said all that, final salary schemes are well known for their restrictions and inflexibility. So transferring out may open up some new ways to access your pension pot and therefore open some new options for your retirement and inheritance tax planning too.
So what does everyone else do?
Generally we find that individuals with more wealth and other assets beside just their pensions, who are looking for greater flexibility and control over their retirement savings; or are planning to pass a substantial portion of their wealth to their children are more likely to opt to transfer out of a final salary scheme.
Whilst those with more limited assets, who prefer the security of the guaranteed income, tend keep to their final salary scheme.
Like everything in financial services, it’s your individual circumstances and aspirations along with where you are in terms of your timeline that will help determine what’s right for you.
One thing’s almost certain – this opportunity won’t last
If you are considering requesting a CETV quotation, I’d do it sooner rather than later. As the current high transfer values have been caused by the short-term market developments I covered earlier – and the situation is unlikely to last much longer. As when we see the increase in bond rates, we will most likely see the decrease in the multiples you can currently secure with your CETV.
If you would like some help deciding what’s best for you, then call us now for a free initial consultation. We would be delighted to go through your individual circumstances with you and help you decide on the best option for you.