If you are 50 years of age or over and hold a Defined Benefit (DB) Pension, chances are you are paying more and more attention to your annual Pension statement. You may be wondering, are pension transfer values going up?
The Transfer Values (TV) of many DB Pension schemes have increased materially in recent years, due mainly to this prolonged period of low interest rates.
Many market practitioners and actuaries might argue that we are currently at a ‘sweet spot’ for transfer values and with the threat of inflation creeping in daily to economic commentary, this period of historic low interest rates may be about to change.
Even a small incremental interest rate move upwards will negatively affect the value of DB Transfer Value.
Why, you may ask?
The reason being that the discount factor used to calculate this settlement is linked to long dated bonds, which have been negative yielding for some time (which is good for a DB TV holder), but this may be about to change.
It must be remembered that with a Defined Benefit Pension scheme, the holder is made a promise by the employer (not a guarantee!), that a payment will be made to him/her at the scheme retirement date. The strength or not of this guarantee is based on an actuarial assessment of;
- The future growth of the DB pension scheme’s assets
- The Employer’s commitment to the scheme, effectively their duty to continue funding
- Current and historic solvency of the scheme
- Current and future projected liabilities (current pensioner payments and future expected)
As a financial advisory firm, we are currently receiving increased enquiry levels from clients who have received recent TV offers and are finding it difficult to assess if these values offer a true reflection of their entitlement. As a general rule of thumb, if the current Transfer Value offered is in the region of 18-20x the annual DB payment (promise), then it is worth closer scrutiny.
I am 51 and have a DB Pension and the last Transfer Value is only 10x, what should I do?
Probably nothing at this point, provided you are comfortable with the Employer’s commitment to the pension scheme, i.e.it is well funded, or at least meeting its minimum Funding Standard (MFS), and the employer has demonstrated its commitment to the pension scheme.
The good news is that your DB Transfer Value could be expected to grow by circa 6% per annum up to age 55 years, and by circa 8% in the 7-8 years before the NRA. So, as you move closer to the normal retirement age of your DB Scheme, the TV should be expected to increase. Remember, even if you are happy with your promised DB payment, you cannot access this amount early until the scheme’s normal retirement date.
A Transfer Value gives you the opportunity from age 50 onwards to:
- Drawn down 25% of the Value in tax-free cash at an earlier age
- Re-invest the remaining 75% value in an ARF (Approved Retirement Fund), which can be expected to grow dependant on your investment risk appetite
- Flexibility to access the ARF Fund from age 61 years onwards, at a 4% minimum distribution
- Potential to grow the remaining fund (75%) back towards 100%+ of the TV (market performance dependant)
Reasons you should stick with an existing Defined Benefit Pension
- If you work for a financially strong company, whose pension scheme has always achieved its minimum funding standard (solvency), and where management have consistently demonstrated their commitment to the Pension scheme.
- He/she is a few years away from retirement, with an attractive Defined Benefit scheme and has no requirement for additional or variable income.
- The post-retirement options of an ARF involves a degree of re-investment risk, while the client values a certainty of Income payment for the full duration of their retirement.
- The DB holder is not confident that the reinvested Transfer Value can match the existing DB guarantee and is intolerant of investment risk.
- As stated earlier, providing the scheme is solvent and that long term Eurozone bond yields remain low, if a holder delays the transfer value, the closer they get to retirement the higher that Transfer Value should
So, the great unknown as we write (June 2021) is, how long will interest rates remain low and will the abundance of QE and cheap money in financial markets, affect inflation rates and pressure Central Banks to raise interest rates?
Reasons you should take a Transfer Value
- You are of the view that that current Eurozone interest rates are likely to move upwards in the short term (6-12 months), negatively affecting transfer values i.e. that we are currently at a ‘sweet spot’ unlikely to be repeated for some considerable time.
- You have concerns about the health (solvency) of the scheme or the employer’s commitment.
- You have other fixed sources of income for security i.e. rental properties, a state pension etc.
- The DB transfer value is attractive (20x or higher), but also has a limited acceptance time
- The DB transfer value has increased by the employer offering an ‘Enhanced Transfer Value’ – an uplift paid by the employer above the actual TV of the scheme’s assets.
- You want to manage your own pension benefits (investment strategy), or to have access to pension benefits at an earlier date than the DB’s normal retirement age.
- You are single and place less value on the spouse’s benefit.
- You would like any unused benefit to pass to your next of kin.
Summary and action
With government bond yields at historic lows have increased the quantum of transfer values in recent times, as the discounted rates used in these calculations are linked to these low, sometimes negative, yielding government bonds. With inflation expectations now gaining momentum, now is timely for DB Pension holders to review their transfer value offers.
It would difficult to move interest rates lower than they are at present so we see this as highly unlikely. We see there being a greater probability that pension transfer rates will rise, which would have the inverse effect on Defined Benefit transfer values.
If you would like to hear more detail on the options available to you and to discuss your transfer values, please don’t hesitate to get in touch.