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Sweet surrender

Transfers from defined-benefit schemes to some form of money purchase have generally been in the doldrums in recent years. This is probably for a variety of reasons. Advisers must be specially qualified to operate in this market, there is a lot of nervousness about possible misselling and the transfer values being quoted have often required high critical yields in the transfer value analysis system.

But change is in the air. The Government is consulting on a replacement for the old actuarial guidance note GN11, which is now past its sell-by date as a minimum basis for transfer value calculation. There is also growing anecdotal evidence that a number of employers are now offering sweeteners to members to encourage them to transfer benefits out of the defined-benefit scheme. These sweeteners can take two forms – an increased transfer value or cash-in-hand payment. Either way, there would be a deadline for transfer.

An increased transfer value for a temporary period will probably involve the employer making a special contribution for each member who agrees to transfer out. In contrast, a cash-in-hand payment goes direct to the member and bypasses the pension scheme.

I have seen at least one case where the employer has claimed that the cash-in-hand payment is free of all tax for the recipient. Is the deal likely to be good for the member? The company must think it is a good deal for itself, otherwise why go to such lengths to offload the defined-benefit liability?

But what is good for the company is not necessarily good for the member. Many members may be former employees whose only interest in the future well-being of the company may be its ability to meets its pension liabilities. In looking at the transfer value and sweetener, the member may think that the bird in the hand is attractive because of uncertainty about the employer’s future solvency.

This is a valid consideration but do not forget that the Pension Protection Fund now exists so the member should regard the worst-case scenario as the benefits it would provide. If the member has very big benefits and the employer goes bust before the member’s normal retirement date, there could be a big cutback. Otherwise, PPF benefits could be less than scheme benefits because of indexation restrictions, standardisation of ancillary benefits or – perish the thought – the PPF going bust since it is not underwritten by the state. But I think we have to question whether the Government of the day could allow the PPF to go bust. Modern TVAS systems allow for PPF benefits.

What are the dangers in this situation for members and their advisers? The whole point of the exercise is that risk is being passed from the employer and scheme on to the member. Is the transfer value plus sweet-ener sufficiently great to compensate for that risk? That is precisely what the TVAS is supposed to measure.

The next question which arises is whether the input into the TVAS should include the sweetener. In absolute terms, the answer must be yes, because the sweetener is real money today. However, if it is cash in hand, will that money still exist to help the member in retirement or will it be used to increase their current standard of living?

If the FSA is ever going to say that cash-in-hand sweeteners should not be input at face value into TVAS analysis, then now would be a good time to make that statement. A lot of pressure is being put on the member’s adviser in this situation and they will need to think very clearly and document the advice process very fully.

I understand that there is one situation where the member may not necessarily receive advice and that is where the transfer is not to a contract-based pension but to a money-purchase occupational scheme. I have not discussed the role of the trustees of the ceding scheme in all this but they may wish to think carefully about the information they pass to the member. Let us hope none of these cases ever end up in dispute after the event. More to the point, let us plan to make sure there is no cause for that to happen.

Stweart Ritchie is director (pensions development at Scottish Equitable)


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