Defined BenefitSep 28 2016

Spotlight: DB transfers

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Spotlight: DB transfers

Those with defined contribution pensions now have increased choice as to how they access their funds and get the best from them in retirement. Consequently, a growing number of people with defined benefit (or final salary) pensions – to whom the new rules do not apply – are considering whether to give up their secure pension income in favour of more flexibility. 

This growth has been further fuelled by record high transfer values, due to the latest round of quantitative easing and base rate cuts, and by the shock of front-page negative pension stories such as those concerning BHS and Tata Steel. 

There can be compelling reasons to consider a pension transfer. Some will simply want to take advantage of flexibility while others will transfer to improve death benefits or to buy an enhanced annuity paying higher income. Conversely, there can also be many compelling reasons not to transfer.

Increased demand is predicted to result in transfers of £10bn per annum and there is likely to be considerable interest from those approaching retirement and those with deferred pensions. However, the increase is putting pressure on schemes and administrators, which can result in delays and scheme administrators becoming less flexible.

Differing approaches

Anyone in a funded DB scheme has the right to request a cash equivalent transfer value (CETV) once every 12 months, unless they are within a year of the scheme’s normal retirement date, although many schemes will also permit transfers within this year.

My company, Intelligent Pensions, advises many clients on transferring and recently came across a scheme that decided to enforce the ‘one CETV every 12 months’ rule. The scheme was managed by one of the UK’s largest administration providers, but it is considered likely that other schemes will follow suit.

Guarantee period

If schemes are to take a less flexible approach they will need to ensure their members are aware of the implications. Members start a three-month guarantee period when they receive their CETV, but often do not seek the required specialist advice until just weeks or days before the guarantee expires.

If a scheme is unwilling to provide a recalculation after the guarantee period, it is likely some members will simply miss the window and be forced to wait another year before being able to effect a transfer. 

At the time of sending out the CETV and scheme information, administrators need to realise that decent advisers will want more than basic information if they are to provide full advice to scheme members.

Enforcing the ‘one quote a year’ rule may be about saving costs, as most big schemes outsource their administration and are charged for each piece of work carried out. Another reason for enforcing the rule may be an active trustee choice to protect the interests of remaining members.

Members might let CETV guarantees expire in the hope that a recalculated value will be higher. 

My company has seen evidence of some clients receiving substantially higher transfer values by taking this approach. As a trustee, however, protecting the interests of other members means not allowing a member to get regular requotes to pick the best timing for themselves. 

If a transfer value increases, the extra money can only come from the pooled fund and, however miniscule the effect, this must weaken the security of other members. That said, one of my company’s clients paid £350 to get a new transfer value that was £10,000 higher, so you can see why people do it.

While the possibility of a transfer value increasing is positive, advisers should never advise a client to take the gamble because other factors, beyond gilt and bond yields, could result in transfer values going in the opposite direction. 

Questioning assumptions

If the future inflation assumption used by the actuary in calculating the benefits at retirement – and in costing inflation-proofed pensions – is reduced, then it is likely that the transfer value will also be reduced. The lower inflation is, the lower the estimated revalued pension at retirement and the lower the cost of securing it. 

If the scheme reduces its assumptions about the percentage of members who will leave a qualifying widow it will reduce the value of the widow’s pension. 

A quarter of a century ago, actuaries typically assumed that 90 per cent of members would leave a qualifying widow; today the assumption could be as low as 70 per cent. 

There are many assumptions used by the scheme actuary and the transfer basis will be reviewed regularly.

Following a triennial valuation, the actuary could advise the trustees to scale down transfer values because the scheme is underfunded. If a scheme is, say, 70 per cent funded it can be argued that members taking transfers should not be entitled to 100 per cent of the value. 

Impact of falling yields

Higher transfer values are a reflection of current economic conditions. At the start of this year, long-term gilts and corporate bonds were yielding 2.6 per cent pa and 3.7 per cent pa respectively. Now these yields are down to 1.4 per cent pa and 2.5 per cent pa. 

Depending on the term to retirement, using a yield that is 1.2 per cent pa lower could add 25 per cent to the transfer value. 

However, some schemes use a rolling average over two or three years to smooth values, so not every transfer value will increase in this way.

While there are real dangers of letting guaranteed CETVs expire – not least the fact that schemes could make you wait 12 months for a recalculation – there could be strong grounds for advisers to revisit previous cases where their recommendation had been against transferring. 

A transfer value of £200,000 rejected last year on the grounds of poor value may yield a different outcome with a £250,000 value.

There is no doubt the world of DB is complex and fluid. With the deficit of all defined benefit schemes now estimated to total £1tn and the increasing costs of future accrual, there will be pressures and these could lead to changes that will further complicate the advice process.

Specialist advice

There will always be a host of factors at play when advising on defined benefit pension transfers, which is why specialist advice is mandatory for anyone with a transfer value of more than £30,000. 

Unless you are doing transfers on a frequent basis, the time, effort and cost of doing them can be high and this is a dangerous market to just dabble in. 

However, with more than 5m deferred members, it is likely that most advisers will come across pension transfer enquiries and it is essential to have a process to tackle such enquiries, whether in-house or outsourced.

Telling your clients that a defined benefit transfer is never a good idea will just leave you prey to the first person who tells them otherwise – and it could also lose you significant amounts of business.

 

David Trenner is technical director at Intelligent Pensions