Providers and trustees have defended their unwillingness to accept partial defined benefit transfers.
Partial DB transfers are often seen as the Holy Grail of retirement planning. A partial DB transfer may be best for the member and is lower risk for an adviser. However, a slew of difficulties in proceeding means that often an all-or-nothing, take-it-or-leave-it offer is all that is available.
Director at administration specialists Trafalgar House Daniel Taylor says current demand does not justify the work required in some cases.
Taylor says: “They are difficult to explain, record and execute and for members, the considerations of a DB transfer are mind-boggling already. Add partial transfers into the mix and you might as well be talking in tongues.
“What makes them even more unattractive to schemes are the costs of setting them up and delivering them to members compared with the number of members taking the option. It’s not a case that schemes can simply start delivering partial transfers overnight. Advice needs to be taken on the method, assumptions and communications. All that comes at a cost and unless the uptake of the option is significant enough, schemes may never recover the initial set-up and running costs.”
Some trustees feel their duty is solely to administer the scheme rules as they stand and that their schemes were intended to provide pensions, not to promote transfers. Partial transfers usually require changes to the scheme’s rules and administration processes. Trustees and sponsors need to make a positive decision to offer them and think through all the mechanics, but this has not been a priority for most.
Recent research by actuarial consultants Lane Clark & Peacock showed only 15 per cent of DB schemes allow partial transfers.
LCP partner Jonathan Camfield says: “We administer hundreds of DB schemes but only a few offer partial transfers. Many schemes limit their options and communications to the statutory minimum often because of costs.”
Different parts of the accrued pension have to be treated differently. For example, where part of the pension is a guaranteed minimum pension, it is difficult to quantify what the effect of a partial transfer on the GMP obligations of the scheme would be. With small pensions, the cost of implementing a partial transfer is significant relative to the size of the pension.
Another problem is frequency of partial transfers. Clearly, there will be a cost to the scheme of providing transfer quotes for partial transfers. A recent report by Royal London and LCP says it would be inappropriate for DB schemes to be treated like “cash machines” by members.
When a member transfers out fully, one of the benefits to the scheme, employer or remaining members is that there will be no further administration costs. This is not the case with partial transfers. Where the employer pays for advice, the cost will be the same for a partial transfer but less liability and risk will be removed. The same is true of other, smaller, fixed costs like producing transfer quotes and processing the transfer.
Willis Towers Watson senior consultant David Robbins says: “Transfer factors will usually be higher than commutation factors, so offering partial transfers can increase the cost to the employer (or weaken the security of other members’ benefits) where the member wants to convert part of their pension into a lump sum.”
Taking the reins
A key challenge is deciding which parts of the pension you are transferring and which you are leaving behind. For example, what are the implications of a partial transfer for ongoing GMP rights? Do you just transfer out non-statutory elements, and who decides which?
Society of Pension Professionals president Hugh Nolan says: “A typical DB pension is split into different tranches, for example, pre-1988 GMP, post-1988 GMP, pre-1990 service, and post-1997 service. They can all attract different rates of revaluation – fixed, limited or full for GMPs, different inflation measures – often with caps – and different payment dates, like from age 60 or 65.
“Pension increases can have caps and collars and even spouse’s pensions can have conditions like no pension for service prior to 1983. The transfer value for a pound of pension varies for each tranche and it would obviously be even harder for members to assess differential values for different types of pension than it is to assess the transfer value overall.”
Nolan says there are some ways around the complexities, but these are also fraught with difficulties. The member could agree to take a pro-rata percentage applied equally to each tranche. Or they could cash out the smallest tranches first, or choose between different types of benefit.
Nolan fears these could be manipulated however. He notes: “Pension Protection Fund benefits vary by tranche too so some benefit tranches get more protection than others and we wouldn’t want schemes nor members to make choices designed to screw the PPF over.”
Hargreaves Lansdown senior analyst Nathan Long agrees some people will try and game the system to maximise their pot’s value.
He says: “Imagine you are someone with concerns about the employer backing your final salary pension. You have benefits built up both before and after 1997. If your employer cannot pay your pension, the PPF will step in, but they do not increase any pre-1997 pension, whereas they will increase any post-1997 pension in payment by inflation up to 2.5 per cent. There becomes an obvious incentive to only transfer any benefits built up before 1997.”
Schemes can’t start delivering partial transfers overnight. Advice needs to be taken on the method, assumptions and communications
He adds: “The obvious place to allow the partial transfer is to split benefits accrued before and after April 1997, but that would exclude anyone that does not have benefits that cross this point in time. As an industry, we need to be careful what we wish for. The additional complexity that comes from advising on a partial transfer can only send costs for advice higher, especially if an adviser is given a choice as to what part to leave and what part to transfer.”
KPMG pensions partner David Fairs says: “In an ideal world, you might like to offer the member a 25 per cent or 50 per cent transfer value but that is often not possible. You cannot offer to transfer part of a GMP – it’s all or nothing and similarly there might be other tranches of benefit that you would not want to split. Making a logical policy is technically challenging, it can be complex to set up administration systems to deal with this complexity and then to explain it to members.”
Breaking down the barriers
Yet some administrators are still able to manage partial transfers today by imposing strict parameters and simplifying the options.
LCP partner Camfield says: “We take a simple approach and offer one partial transfer at the point of retirement with just two or three options: a minimum amount, maximum and a middle amount.
“The minimum amount would cover transaction costs and GMPs, so at least the transfer out would include all the complex bits and GMPs. The maximum partial transfer would be less than 99 per cent – it would be cumbersome to leave just one £1 in the scheme and the minimum transfer value would have to be in the region of £100,000. Sums of £30,000 or £50,000 would just not work.”
One answer may be to use legislation to override pension scheme rules. However, PTL Independent Trustees director Alison Bostock believes it would be better to let each scheme tackle this separately in its own way, rather than add another burden for schemes to comply with.
Fairs disagrees. He says: “I do think legislation requiring schemes to offer partial transfers would be a good thing and means that members could have a less challenging decision to make. But GMP conversion or simplification of benefits to remove the complexity of different tranches of benefit would be really helpful. Ideally we would see benefit simplification being part of the Government’s forthcoming DB White Paper. It would make benefits easier to understand, mean the options faced by members would be more straightforward, members would be less reliant on expensive advice and be able to make more sensible, pragmatic decisions.”
1 in 6: Schemes offer partial transfer
1 in 10: Offer other options like a leveling pension or pension increase exchange
60 per cent: Of advisers ‘strongly support’ right to partial transfer
Less than 5 per cent: Of advisers ‘strongly oppose’ right to partial transfer
Source: Royal London/LCP