02 Nov Should I stay or should I go now? Is it ‘time out’ for DB pension transfers?

“If I go there will be trouble,

If I stay it will be double….”

One of our Pension Transfer Specialists, Michael Hall, looks at DB pension transfers – and whether it’s the right time to transfer out.

A ‘Clash’ of opinions over DB pension transfers

Every now and then a song seems to encapsulate an idea or conundrum that we are grappling with.  When my children were younger, I often would infuriate them by bursting into a 1970s or 80s hit to reflect the subject of our conversation.  The Clash’s 1982 smasher was a poignant one, particularly when it came to difficult relationships.

With the surviving members of the band now reaching State Pension age transferring pensions may not be on their minds anymore, but it is certainly one that younger boomers are grappling with.  For many years we were in a golden era of ultra-low interest rates, expensive annuities and high transfer values. This meant the maths could tip the balance in favour of defined benefit (DB) pension transfers.

How things have changed over the last 12 months. With the recent rises in interest rates, inflation at a rate not seen since the fall of the Berlin Wall (when the Foo Fighters were on Top of the Pops), the impact on transfer values has been somewhat staggering for clients who took the trouble to get a transfer value as little as 6 months ago.  Reductions of 25% or more are not uncommon. What last year might have seemed like a no brainer is now not such an easy decision.  Many clients, and no doubt a few advisers, may be kicking themselves for not seizing the opportunity to lock in the value in 2021. (And possibly cursing under their breath at a Pension Transfer Specialist (PTS) who was just following the Regulator’s Guidelines).

Weighing up and explaining to clients the risks and benefits of giving up guaranteed benefits for greater flexibility or control has always been a challenge.  Quite rightly the process is strictly regulated to ensure clients do not start off down the one-way street to flexibility too quickly.  There are a few scenarios where it’s black or white – such as client’s unrealistic retirement expectations or poor health – but the DB pension transfer world is more often one of more than 50 shades of grey.

The default position is of course that keeping scheme benefits is invariably the best option.  It is incumbent on the client and PTS to show why and how relinquishing the guarantees will deliver a demonstrably better outcome.  With transfer values down the tubes, for an IFA whose core activity isn’t DB, it could be tempting think it’s just not worth exploring this area of business.  It’s easy to assume the advice will now be to remain in the scheme anyway so it’s not worth referring clients with preserved DB benefits to a Pension Transfer Specialist.

Or is it?

Why review a DB scheme when the answer will probably be ‘Don’t Transfer’ anyway?

Assumptions are rarely a good starting point.  Procrastination and inertia are easy options, and an understandable reaction when faced with a complex situation.  But inaction comes with risks too. So it’s important not to do clients a disservice by putting on the back burner what is potentially a valuable asset, trusting that the decisions around considering DB pension transfers might be easier in the future.

But are we ready for the difficult conversation with a client who says we should have examined the transfer option sooner? Improving clients’ understanding of what they have, including the pros and cons of holding this or that asset, is an important part of that job and for me a rewarding one.  So, it’s worth considering what factors will impact on future transfer values to help clients understand  what the risks of delaying might be, as well as the benefits.

External pressures – interest rate, inflation & market volatility

“Why has my transfer value gone down so much?”
“I am a year older – you said it should go up nearer to retirement”.
“The scheme must be in trouble; I don’t want to end up in the Pension Protection Fund.”

Rates close to zero since the 2008 banking crisis – and of course ‘printing money’ via Quantitative Easing. Probably the biggest factor that gave us such eye watering CETVs in recent years was the plummet in interest rates. Low interest rates mean Gilts become more expensive. Long term Gilts are the backbone of DB pension schemes and if they have to pay more for them, the transfer value will inevitably reflect.

One area that many clients are unaware of is the link between interest rates and transfer values.  This can lead to misconceptions. Many think transfer values only went up so much due to buoyant stock markets in recent years, and some worry theirs has gone down in response to plummeting share values. Some have even expressed fear that their pension benefits could be cut.  The inverse correlation between Bonds and Gilts prices and CETVs is not always an easy one to grasp.  So it’s important they understand that rising yields play into the reduction in transfer values much more than market volatility.

We all hope that the efforts of the new Chancellor and the Bank of England will, before too long, get their act together and bring inflation down to a more ‘normal’ level.  We have seen action recently to buy back £60bn of long-term gilts – aimed at steadying rising yield. But this is a drop in the ocean in the £2.1 trillion Gilt market, so it’s unlikely to have much impact on the transfer market.

More importantly, provided recent interest rate hikes are temporary, a future reduction will hopefully bring some life back into the value of DB pension transfers.  But what are the chances of an interest rate reduction any time soon?

With inflation still in double digit territory, they could go up further or at best say where they are for some time. This will at best keep a lid on transfer values and could push them down further.

Share prices are of course not totally irrelevant.  A client who transferred last year when CETVs were high might still be feeling the pinch seeing their fund value fall sharply since transferring. I imagine many IFAs are having difficult conversations with investment clients about the need to maintain a long-term view, time in the market vs market timing etc. For the bold this may seem like a market opportunity.

Internal factors

Working in the other direction are influences that will tend to push up the transfer value the longer you wait, and, in this area, we do have a bit more certainty with the figures.

Early reduction factors

Typically a scheme will take into account how far a client is from their Normal Retirement Date (NRD) and reduce the transfer value accordingly.  Every scheme has its own factors, but a reasonable benchmark is a reduction in the pension of 4-5% for every year it is taken early.

Revaluation rates

The rate at which the deferred pension increases may depend on when the client left the employer and will often have differing rates for GMP & non GMP Pre and Post 97 benefits.  Pre 1988 GMP goes up by 8.5. a year, which is pretty good for a risk-free return.

Inflation caps

Most schemes will cap inflation increases to a maximum which will limit any future increase in the CETV.  For example, post 2005 benefits only go up by CPI capped at 2.5%.  However, a couple of big schemes have limits as high as 12% or even uncapped RPI increases which will look pretty valuable in the current climate.

Scheme funding

One positive we have seen is an improvement in scheme funding levels. Struggling schemes are allowed to reduce transfer values to protect other members so it could be worth revisiting clients where poor scheme funding has previously been reflected in the CETV.

Client requirements

With all advice we need to focus on what the client is looking to achieve.  A big focus with pension transfer advice is ensuring the desire for flexibility does not lead to the client giving up financial security later in life. Unfortunately, most schemes still don’t allow partial transfers, so we have to consider whether an annuity should be part of the solution.  This is particularly relevant where the spouse’s pension may not be needed, and lump sum death benefits are a priority.

It has been easy in recent years to dismiss annuities as poor value for money. But they are looking more attractive.  If interest rates go up further, they  could increasingly help meet the conflicting priorities of flexibility and security. Using the fund to ‘fill the gap’ between State Pension and later life spending with a tailored annuity might just tip the balance in favour of a transfer.

So, what’s the answer… Should I Stay or Should I Go?

Well, as ever it’s down to the individual. But the sooner a client gets their ducks in a row, the better, and it’s important to decide early what role any DB pension is going to play in their long-term planning and what the options are to get the most out of what might either be their most valuable retirement asset or maybe something surplus that could tip the balance allowing them to stop work a few years early.

And this is where a specialist DB pension transfer partner is of such value. At PX we will take on the difficult assessment of whether a client can afford to give up a guaranteed pension.

It’s fair to say in the current environment a recommendation to stay is more likely, particularly in borderline cases. But at least the client will be much better informed on the true value of their DB pension and how it can best be used to get them the retirement they are looking for.

The decision to transfer should not be made without taking financial advice from a pension transfer specialist. If the value of your pension exceeds £30,000, it is a legal requirement to take financial advice before a transfer can be implemented to ensure that this decision is in your best interests.

Exploring DB pension transfers is PX Pension Transfer Specialist, Michael Hall