Defined Benefit Pension Transfer Values Have Fallen

Some clients have gone to their Defined Benefit pension providers and obtained a transfer value, and they are concerned that their transfer values have gone down. They have erroneously come to the false conclusion that they have “lost money” and to put their minds at rest I have taken some time investigating so that I could try to explain.

Firstly I refer to my website which clearly states that Defined Benefit transfers are suitable for less than one in ten and perhaps I understated because that may be one in fifty. Therefore, the reduction in transfer values will only affect you if you are one of the minority for whom a transfer is suitable, and in addition you are considering doing so. The vast majority of people with DB pensions are unaffected because their pensions in payment are guaranteed and the underlying transfer value is virtually irrelevant.

DB transfer values were at a record high in 2021 and in many cases since they have fallen by 25% or more. It would not be untypical for a 2021 TV of say £400,000 to now be valued at only £300,000

So, what makes your DB transfer value change?

There are many factors but probably the key reason at this time is rising interest rates. After ten years of low interest rates the Bank of England has raised interest from an all-time low of 0.1% to 3.5% within the space of a few months with the possibility of this rate going higher. As a consequence of higher interest rates, the DB scheme is now earning more interest on the deposits that it holds to support your pension with the result that the cost to them of providing your pension is lower. The earned interest means that they no longer have to hold as much money to support your pension and it logically follows that your transfer value is lower as a result.

LCP consultancy provides us with several insights on how transfer values change. Their research points out that “pension schemes have discretion over how they set the transfer values and that there can be a large variation from one scheme to the next in the transfer value offered for an identical pension”. They then go on to say that their research shows that for those ten years out from retirement, the amount offered by some schemes can be double that offered by others. They identify the following factors:

• The age of the member – other things being equal, the transfer value for any given member will tend to rise as they get closer to retirement; this is because the scheme assumes that the investments used to back the pension promise will make an investment return, and as the member ages there is less time for that return to be made, and so the amount needed to back the member’s pension promise tends to increase, so the transfer value tends to increase
• The “generosity” of the pension scheme – over time, many pension schemes are derisking their investment strategies and this is also the regulatory direction of travel; a pension scheme with lower risk investments will tend to offer higher transfer values than one with higher risk investments; the LCP research finds that for those ten years out from retirement there has been an average improvement of over 10% in the generosity of transfer values for any given pension over the last 3 years when compared like-for-like; this appears to be primarily because schemes have been derisking their investment strategies, and this is an effect that LCP expect will continue into the future
• The longevity of members – where members on average live for a long time, pensions are more expensive to provide, and so transfer values tend to be higher, and vice versa; if the Covid-19 pandemic leads schemes to reduce their assumptions about the life expectancy of members, this will tend to lead to a modest reduction in transfer values.

LCP cautions that DB scheme members should be careful not to ‘panic buy’ and transfer their DB pension on the assumption that transfer values will only go in one direction. Many schemes have become more generous in their transfer values a trend that they see no reason to reverse, and an individual member’s transfer value may increase as they get closer to retirement.

In summary the factors that affect transfer values, both positively and negatively, include:

• Interest rates
• Inflation levels
• Gilt yields & stock market activity
• Member’s age in relation to scheme retirement age
• Scheme funding position

Typically, the guidance is to avoid transferring out of your scheme and to stay put if your retirement is still a long way off. If you’re under the age of 50 it’s generally not advisable to consider a transfer because the risks and costs involved can be prohibitive.

You should also be aware that pension trustees manage pension funds and guarantee inflation adjusted members’ pension income for life and inflation rates put up their costs of providing those pensions. Therefore, whilst transfer values should offer a fair representation of value, pension trustees first priority is securing the health of the pension scheme for its active members and as their costs rise it makes sense that they would attempt to discourage people from transferring by offering falling transfer values.

In my research for this blog, I read somewhere a pension specialist who said: “most people have the luxury of time; they don’t need to make an immediate decision. Markets are cyclical and they may suffering a painful economic time at the moment, but it won’t last forever?” These are very wise words, and you should heed this advice.

If you are considering the viability of a transfer, there is another factor that many do not take into account in that the DB pension trustees will only guarantee the transfer value for 3 months. Some clients obtain their transfer value and then wait for a month before they engage a pension transfer specialist (PTS) to provide them with advice. The remaining two months are usually insufficient to obtain the required information to provide advice so that by the time they have gone through the necessary stages a new transfer value has to be requested and the pension trustees may charge a fee. There is no guarantee that the TV will have not reduced in the intervening period. Even worse in some cases the DB scheme will only provide one transfer value per year, and you may have to wait another 9 months or more to ensure that the revised TV still makes a transfer acceptable. The correct procedure is to engage your PTS first who will investigate your situation fully before applying for your transfer value. If you have not followed this procedure and the TV reduces in the interim, then unfortunately you are the only one to blame because the FCA requirements have to be followed and these take time. I remember one case where the TV value actually increased but that was the exception. The three month guarantee also stresses the importance of engaging a PTS who has very efficient processes in place in order that each stage is completed as efficiently as possible.

What about those of you who transferred when the TV values were high?

So, what if you have already transferred your DB pension to a DC scheme? You have given up your guaranteed benefits and you are now in the hands of the markets. If your investment portfolio has fallen by 25% your £400,000 pension transfer has now fallen to £300,000 which is equivalent to the suggested transfer value mentioned above.

This is a complex subject and I hope that I have provided sufficient explanation for those of you who stayed in your DB scheme and have not transferred to a DC pension plan to show that you haven’t “lost money” after all.