When we review transfer cases, we consider three different elements of the advice. The first two are:
- the suitability of a recommendation to transfer;
- the suitability of the target plan and funds.
However, assuming that both of these elements are considered satisfactory, a third question is sometimes relevant … “Why now?”
It might well be right for the client to transfer in order to be able to take retirement benefits from a drawdown plan rather than from the DB scheme but, if the client is not intending to draw benefits in the near future, does that move from safeguarded benefits need to be done now, rather than closer to scheme normal retirement age (NRA). This question is especially pertinent where the client is not even close to 55, the earliest age at which (s)he COULD access the benefits. Why would a 45 year old transfer now because (s)he might be best served by a drawdown plan in 10,15, 20 years?
The rationale in the suitability report is often unclear on why a transfer needs to be done now, assuming we ignore a desire to complete the business now rather than at some distant future point.
Where the ‘why now?’ question is addressed, the reason is usually one of the following.
- Client wants to protect the ability to have death benefits as a lump sum instead of as income for dependants;
- The transfer value is believed to be at an all time high and ‘can only go down!’.
Protect the fund
The death benefits ‘problem’ is often what we call a product led objective rather than a genuine client need. If it is a genuine concern for a client, who still should have a drawdown AT retirement, then there is a strong argument for deferring the transfer until closer to NRA (minimising charges and maximising the time spent in a safeguarded environment) and, in the meantime, protecting the fund, or an appropriate fraction of it, through suitable life cover. We find that life cover is often mentioned in passing and discounted summarily, the impression being that it is a means of ticking a compliance box rather than being considered as a serious option.
The Transfer Value is at an all time high!
We have seen a lot of this over the past couple of years, with advisers anticipating interest rate rises and a consequent decrease in transfer values and conveying a closing down sale scenario to clients – best transfer asap because the TV could go down. And indeed it could have … but generally it didn’t! On the contrary, TVs have fluctuated for sure, but have often increased over the past couple of years. So what is going on here? Let’s try to explain the wider environment as it affects TV levels.
What is a Cash Equivalent Transfer Value (CETV)?
A CETV is the capitalised value of pension benefits that a scheme offers to a member in the event of that member wishing to transfer their benefits from a safeguarded environment to a flexible, non-safeguarded environment. There was a marked increase in the value of CETVs in the period from June 2016 until late 2016, at which point CETVs appear to have fluctuated within a range. It was this period that appeared to have created the impression that CETVs were ‘sky high’ and could only go down!
Why CETVs Change
There are several factors that cause a CETV to change, some lead to an increase and some to a decrease. The various factors were considered by actuaries, Hymans Robertson in a Telegraph article (July 2017). A summary of the factors is shown below:
- Proximity to retirement
Typically, a CETV will increase as a client approaches retirement as there is less time for the money invested to achieve the assets required in order to meet the payments which the scheme promise to the client. This usually leads to an increase in CETV.
- Investment strategy
As pension funds have closed to new members they have steadily shifted assets out of shares and into bonds. As a result the expected returns are likely to have fallen. If a fund moved from having equal parts bonds and stocks to a majority of bonds, that could dampen returns by around half a percentage point a year, for example. This would increase our 50-year-old’s transfer value by 16pc, according to Hymans.
- Scheme assumptions
A scheme makes a number of assumptions around factors such as inflation (RPI and CPI) and life expectancy. These factors can have a large impact on CETVs. For example, if a scheme reduces its inflation assumptions, then the amount of money needed to purchase the promised benefits will reduce. Alternatively, if the scheme increases its assumptions around life expectancy of members within the scheme, then this would increase the amount of money needed to purchase the promised benefits and the CETV would most likely increase.
- Changes in known inflation
Schemes are required to revalue (pre-retirement) benefits based on actual increases. As such, an increase in inflation can result in an increased CETV.
- Scheme funding
A scheme may reduce the value of the CETV on offer based on its funding position. It is common for DB schemes to be underfunded, although for many schemes, this will not impact the transfer value, and the Financial Conduct Authority has outlined that this should not typically be considered as a reason for transferring out. However, if the scheme is chronically underfunded, then the trustees may apply a ‘fair value’ factor, in order to maintain equity between members that transfer out and those that remain. This would reduce the CETV. Should the scheme improve its funding position in the future, the trustees may choose to remove this reduction.
- Changing Gilt Yields
Many schemes now use low-risk Gilts to provide investment returns as this gives a level of certainty over returns. An increase in interest rates typically results in an increase in Gilt yields as a result of the capital value reducing, requiring less to be invested to achieve the same level of benefits for a member. Interest rates have been at historical lows in recent years but this is inevitably going to change at some point and would result in higher Gilt yields, most likely reducing transfer values in the future. Hymans Robertson suggests that an increase of 1% in Gilt yields could result in a reduction in transfer value for a 50 year old of up to 25 percent.
Is now a good time to transfer?
One way to measure transfer values over time is to use the XPS Pensions Group Transfer Value Index which uses the transfer value of a fictional 64 years-old DB scheme member entitled to an inflation-proofed £10,000 annual pension starting at age 65. The Telegraph commissioned an article considering whether it was a good time to transfer and making reference to “Incredibly generous transfer offers”. At the time the article was written (July 2017), the transfer value using the index was around £230,000 and has increased to around £250,000 in March 2019, essentially meaning that all things being equal, the transfer value would have increased by £20,000.
Going forward, it is likely that transfer values will be impacted by Brexit developments in the short term, and therefore predicting whether transfer values will increase or decrease will continue to be a challenge for advisers.