What has been the catalyst?
Mainly the introduction of pension freedoms in April 2015. These headline grabbing changes and the new flexibility they offer are only available to members of defined contribution schemes. In order to access them, Defined Benefit (DB) scheme members are required to transfer to a personal pension such as a self-invested personal pension (SIPP). Another factor has been a steep rise in transfer values.
What has caused this dramatic rise in values?
It is all to do with falling gilt yields: they result in a higher cost for schemes to provide the income promised to members. Tesco recently calculated that each 0.1% drop in yields adds £312 million to its liabilities.
When a transfer might be considered
In the past, the overriding factor was the ‘critical yield’ – broadly the rate of return you would need to earn on the transfer value just to break even. This is almost always much higher than what can be achieved ‘risk free’.
However, the pension reforms have become a valuable way of passing on inheritance. A DB pension generally dies with you and your spouse. By transferring to a SIPP, you have money that remains in a pension wrapper which can potentially be passed onto your beneficiaries without any IHT implications.
If the DB scheme is only a small part of your overall wealth, or if you have impaired life expectancy, or you are single and have no requirement for the spouse’s pension payable on death, it might be beneficial to transfer out.
Pension safety net
DB pensions aren’t always as safe as we’re led to believe. The collapse of BHS has exposed the challenge of paying DB pension in future, especially for those schemes with huge funding deficits. The Pension Protection Fund (PPF) provides a safety net but only 90% of your pension is protected with an overall cap at £32,500 a year. Anything above this is lost. And BHS isn’t the only example. The PPF owns ten per cent of the Monarch airline group after a restructuring in 2014.
A key concern for many is running out of cash. 80% of people under-estimate their life expectancy.1 A 65 year old male has an average life expectancy of 86 (21 years) but a 1 in 4 chance of living to age 94 (29 years) and a 1 in 10 chance of living to age 99 (34 years). On transfer a member is giving up ‘guaranteed’ benefits for a lump sum with which they are then taking the investment risk. You, rather than your employer, are now the risk taker. For some, no matter what other benefits a transfer might offer, that is a step too far. Others consider the risk worth taking for the potential benefits gained.
I am thinking of transferring, what do I do now?
Professional advice is a vital part of the process, starting with the assumption that ‘staying put’ is the right solution. Transferring should only be considered if your situation merits it. Anyone can ask their pension trustees or administrator for a transfer value once a year, free of charge. The offer then normally lasts for three months barring an exceptional change of circumstances, so enquiring shouldn’t cost anyone a penny.
» New EQ Guide: Final salary pensions: stay in, or transfer out?
» If you have any questions about the above, please do not hesitate to contact us.