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Mike Morrison: Difficult questions for DB transfers

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A few years ago I read a learned article on annuities and how the decision to buy one could be influenced by how it was presented. I do wonder whether we are seeing something similar in the whole issue of defined benefit transfers.

I am in no way actuarial but my understanding is that cash equivalent transfer values are currently high due to low gilt yields. I have had numerous acknowledgements of this, with anecdotal evidence of transfers once being around 20 times the deferred pension now being 30 times (and some even over 40).

This was crystallised when an old friend of mine rang to ask my opinion. He had previously worked for a life office but had been out of the industry for a few years. When he had left, his DB transfer value was quoted as being around £200,000 and he had been quite happy to let it tick over in the scheme inflation proofed.

He had recently received this year’s statement from the scheme, with a transfer value offer of around £500,000. To paraphrase his response, this was something he really could not ignore. But as the old adage suggests, what goes up must come down: as interest rates go up, CETVs will come down.

In essence, the advice questions for DB transfers could perhaps be framed as follows:

  1. Would you prefer a pension of, say, £40 000 per annum starting when you are 65 and guaranteed for the rest of your life, or control of £1.5m in the next few weeks?
  2. Actually, let’s be a bit more detailed: would you prefer a pension of £40,000 per annum starting when you are 65 and guaranteed for the rest of your life, or control of £1.5m, which could be reduced over the next couple of years if interest rates go up?
  3. Or refined even further: would prefer a pension of £40,000 per annum starting when you are 65 and guaranteed for the rest of your life, or control of £1.5m, which could be reduced – and, by the way, if you take the £40,000 and die there will be nothing else payable to anyone else?

Simplified, I know, but hopefully you get the point. As a consumer what would you do?

The question has been compounded by the increased attractiveness of the death benefit rules for defined contribution pensions: the removal of the 55 per cent tax charge on death and the potential to pass money on at the recipient’s marginal rate.

The heightened interest brought about by the pension freedom rules has, I think, changed the consumer mind-set, as people see the cash numbers and want access to it. As such, I am not sure the presumption that not transferring is the default position really assists.

Advice on whether to transfer or not is very important and understanding the implications of switching from guaranteed benefit to a non-guaranteed benefit is vital. However, I would argue that doing so means accepting that some people might want to transfer because the numbers look so good and that post-transfer advice is just as important – if not even more so.

In its recent policy statement the FCA states it will be considering changes to the transfer value analysis rules. This is to be welcomed if what emerges makes it easier to compare benefits that could be achieved by the DB scheme and accepts a critical yield based on annuity purchase at the normal retirement age of the scheme is not now as realistic as it once was. Hopefully there will also be recognition that the softer qualitative issues are as important as the quantitative.

This must also be accompanied by an understanding that we need to consider the new framework in which consumers see pensions and understand their needs and requirements. If we can get the advisory regime right, then what better chance to show the real value of financial advice?

Mike Morrison is head of platform technical at AJ Bell

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Comments

There are 6 comments at the moment, we would love to hear your opinion too.

  1. Good article Mike. Under the new rules the qualitative issues are more important than the quantitative. Your friend will be able to access £375K tax free in 15 years and he will probably do exactly that, to buy a Lamborghini or pay off his mortgage. But he won’t retire and probably won’t need any income from his remaining fund until 67 or 68 and he will carry on paying in to it in the meantime. TVAS systems and the advice process need an overhaul to cope with the new regime.

  2. £40,000 pa or £1,500,000 lump sum. What is this? £40,000 pa is 2.67% of £1.5m. If the £40,000 pa income is linked to inflation, then if the investment growth rate matched the inflation rate it would take over 39 years to run down the £1,500,000. That would make the person in the example 104! The simple fact is this. Pensions are dead. You just have a range of investment types with different tax regimes applying.

  3. What about the client rather than the numbers?
    Do they have dependents?
    How is their health?
    What portion of their overall wealth does the potential pension represent?
    Oh, and what does the most recent “covenant review” say about the “guaranteed benefit”?

  4. Agreed: good article.

    P.S. I reckon Mike’s photo must have been taken at the same time as he was reading the article on annuities.

  5. Well said Mike!

    Now please scrap the requirement for a £3,000 piece of paper to allow me to access my money.

  6. OK Ken. If you know of an investment that is as certain to match inflation every year, with the same certainty that the pension income will be paid, please sign me up. Using a pension guarantee to secure a lifetime income allows the investor to have so much more freedom with their other assets once the essentials are planned for. There’s no right or wrong answers but you can’t write off pensions for everyone just because the returns aren’t exciting.

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