The Government was keen to allow those with defined benefit pensions access to the same freedom and choice as those with defined contribution savings. That is why we have new rules that allow transfers to proceed once a member of a DB scheme has received advice. However, the planned reduction of the lifetime allowance from next year puts one very large spanner in the works.
Due to current discount rates used to calculate DB transfer values, transfer values from some (well funded) schemes are higher than ever before. Anecdotally, I have heard of transfer values of over 30 times the promised DB pension (at age 60) for people currently in their early fifties. That means someone with a DB pension of just £30,000 might receive a transfer value of close to £1m.
While they remain in the DB scheme, the valuation of their £30,000 pension against the lifetime allowance is £600,000. Even with inflation increases of 2 per cent a year over a 10-year period, the value at retirement will still only be about £730,000: well within the current lifetime allowance.
Move to a DC scheme and the fund is immediately in danger of breaching the lifetime allowance.
While the Government plans to index the lifetime allowance upwards in line with CPI inflation from April 2018, this will not provide much help. Again, assuming 2 per cent inflation, someone retiring in 10 years time will have a lifetime allowance of £1.15m.
However, assuming their £1m transfer value grows at just 2 per cent above inflation net of charges, their comparable DC pot in 2025 will be nearly £1.5m, leaving £350,000 of their savings exposed to the 55 per cent lifetime allowance charge.
This is a hefty price to pay for freedom and choice, on top of taking ownership of their own longevity, inflation and investment risk.
When pensions were “simplified” in 2006, DB and DC were supposed to have been placed on a level playing field. But that playing field has become increasingly tilted towards DB savings at the expense of DC savings.
The irony is that these cuts, aimed at reducing the cost of pension tax relief, constrain DC pensions most. But DC pensions enjoy just one-quarter of the tax relief received, with the rest going to DB.
Using a more optimistic, but still realistic, nominal growth rate of 6 per cent a year net of charges, someone aged 50 today, retiring at 60, needs to consider a potential lifetime allowance breach if their transfer value is £640,000 or more.
Some advisers who specialise in DB transfers had been gearing up for a boom in demand for advice requests. But if the market is restricted to transfer values between £30,000 (under which no advice is required before transfer) and £640,000 (above which lifetime allowance charges could accrue) the boom may not be as pronounced as expected.
Before expending the huge effort required to collect and analyse values before giving advice, advisers may want to have a conversation with potential clients first. Those with larger transfer values keen on personal control may not be so enthusiastic once they understand a large part of their eventual pension pot could be subject to tax at such a penal rate.
John Lawson is head of pensions policy at Aviva