Gold plated final salary pensions: is the shine coming off?
The recent rise in defined benefit transfers prompts Joe Robinson to consider why this is happening and when a transfer is right.
Final salary defined benefit (DB) occupational pension schemes continue to be regarded as the gold plated pension scheme in the UK.
With the promise to pay a guaranteed and usually index-linked pension for life they are rightly regarded as the standard against which all other pension schemes are measured.
Based on years of accumulated service and final or career average earnings they reward long serving members with considerable retirement benefits guaranteed for life.
However, the costs for UK employers to maintain these schemes are challenging. The recent DWP Green Paper suggests the annual costs have risen from around 24% of salary in 2009 to 50% in 2016. As a consequence of burgeoning costs many employers have taken the decision to close such schemes to new and existing employees.
Why the recent explosion in DB transfers?
A leading Financial Services company in the UK have disclosed that the number of transfers out of DB schemes they administer had increased six fold since 2014.
Recent figures from the Pensions Regulator show that 80,000 DB transfers took place over the 12 months to March 2017.
There are several factors driving this increase:
- Falling gilt yields
- Lower expected investment returns
- Improved life expectancy
- Pensions Freedom.
The most significant of these has been the decline in gilt yields. The economic and political uncertainty of recent times, not least the Brexit decision of June 2016, has driven gilt yields significantly lower. As DB schemes have a requirement to match their liabilities by using gilt holdings, the effective cost of providing the guaranteed pension benefits has increased. This, in turn, has led to increased transfer values for members looking to transfer.
In some cases these increases have been substantial. Typical transfer sums can now be 25-30 times the value of the annual pension given up. It is also not uncommon for more generous schemes that are well funded to offer 40-50 times the annual pension as a transfer value.
It is important to note that gilt yields will fluctuate and in periods of uncertainty they can do so with a high degree of volatility and these movements could have a significant impact on transfer values.
Source: Retirement Advantage
As many UK employers have closed access to their DB schemes they have also sought to reduce the investment risk of the pension scheme’s underlying assets with a marked shift away from equity exposure in favour of gilts and fixed interest. This investment shift would expect to generate lower returns in the longer term and translates into member’s transfer values increasing.
We are generally living longer in retirement and as DB schemes promise to pay pensions for life this is also creating a situation where transfer values are higher to reflect this improving longevity.
DB schemes: excluded from Pensions Freedom options
While many may be best served staying within the confines and security of the DB scheme there will be others who view the fixed payment structure as unsuitable and would accept a transfer out - effectively sacrificing the financial security of a guaranteed income to provide a more flexible retirement solution.
Under current pensions legislation DB schemes are excluded from the Pensions Freedom options which have been widely available to Defined Contribution schemes from April 2015.
A key driver for those considering a transfer is the opportunity to flexibly access their pension benefits using the Pensions Freedom options. As such, it is possible to alter income levels to suit one’s needs and to manage tax liabilities in a more controlled environment. For others, it is important to ensure that, on death, their pension assets are available to their dependants and wide class of beneficiaries. As pension assets sit outside inheritance tax this can be an effective strategy to pass assets to the next generation.
Is a DB transfer right for me?
There is no doubt that the decision to move away from a DB scheme is a complex one and in some cases the biggest financial decision you will ever make. For this reason the FCA require members with a transfer greater than £30,000 to seek advice from a Pension Transfer Specialist who is suitably qualified to undertake advice in this specialised field.
The entire advice process can be a hugely complicated one and can take several months to complete. It is imperative that you understand the risks involved, as they are considerable, and that you are in a fully informed position prior to making a final decision.
This article is not intended to constitute personal advice and no action should be taken, or not taken, on account of the information provided.