I urge you to listen this excellent podcast (skip to 1 minute to avoid the ad). It’s led by Jo Cumbo and has the thoughts of a couple of IFAs (who I don’t know). At 13 minutes long it can only touch the surface of a busy subject.
Pension transfer values have never been higher and occupational defined benefits pension schemes have never been more under pressure. Pension Scheme Administrators are being inundated by transfer value requests, resulting primarily from financial advice suggesting there may never be a better time to get out.
If you want to get the chapter and verse you can go to the Money Advice Service who have a lot of not very snappy stuff which you can access here.
But you are reading this blog to get insider insights and my personal views so please read this first!
My view is that there are a lot more reasons to be careful than are stated in the Podcast, the MAS advice or by (most) financial advisers.
A common myth (dispelled)
Unfortunately the Podcast perpetuates a common myth that at CashEquivalent Transfer Value of a defined benefit pension comes from the employer. It doesn’t – it comes from the trustees and that’s a very different thing. The IFA may have made a slip of the tongue but he should have got it right. What an employer and trustee consider “fair value” can be quite different things.
The trustees answers to the members, the employer to shareholders (or equivalent). The trustees’ idea of fair value is likely to be more member friendly!
Everything I say about CETVs is predicated by my view that they are fair value- even if they may not be a good idea.
Most of us swap pension for tax-free cash without a thought.
People often think that the only way you can take a cash equivalent to your pension , is by taking a full transfer (CETV). This is wrong. Most people in defined benefit schemes take tax free cash ; generally this is considered a no-brainer, but it isn’t.
As the Podcast says (rather often), CETVs are very attractive now as they can offer a cash equivalent valued at 40 times the pension. This reflects the fair value of what is being given up. However the rate of exchange between pension and tax-free cash can be as low as 10 times the value of the pension. People take tax free cash because it is tax free, but if you are giving up 50% + of the value of your pension for the privilege, you should be asking yourself “is it worth it”.
If you have been paying AVCs , you may be able to take the AVCs as cash, in which case you should get fair value on the AVCs. Don’t forget you can still get 25% tax fee cash from any pensions you have built up in DC pensions (workplace or otherwise).
Swapping pension for tax-free cash may be a good idea, but very often it isn’t.
What about the special offers?
From time to time , members of defined benefit pension plans are made special offers to give up their pension. Most people know about Enhanced Transfer Values, where the trustees are allowed (with general agreement from the employer) to increase the transfer values for a limited period. A lot of people have taken these values in the past (and a lot of advisers would be very nervous if those who did realised what the normal transfer value would have risen to , if they hadn’t).
Another type of special offer is known as “pension increase exchange”. Here the special offer is a transfer or even a cash payment made available in exchange for the member giving up increases on a pension. Since increases on pensions are currently very low , these look very attractive offers (though you are taking a bet that inflation doesn’t take off in the future).
The important thing to remember is that however attractive the cash equivalent, what is being given up is the certainty of the money being paid. There is no certainty that you will be able to manage your money better than the trustees and beat them at their game, indeed the cards are stacked against you.
As the podcast states, the fair value relates to the average person. While no-one likes to think they are average, there are very few people who can predict that they will have below average life expectancy in their sixties and a lot of people who take the wrong bets on their marital status pre and post retirement. Certainty comes at a premium and that premium has a much higher value than those marketing “special offers” imply.
The IFA who likes you to consider , “Good value as an individual and relevant to your personal circumstances”, may be preying on our natural tendency to underestimate how long we will live and our dependent’s need for dependent’s benefits.
Special offers usually come with a catch – why else would you be being sold them?
What about the employer covenant?
It’s generally thought that where someone has a large defined benefit, they are most at risk from being in an occupational DB pension. This is based on the reduction in benefits they’d suffer if the scheme went into the pension protection fund.
But this is a very simplistic view. For a pension to be large enough to be reduced it needs to be £30k pa or more. But a CETV on £30kpa pension is likely to be more than £1m – the current Lifetime Allowance. What you may be doing by swapping an uncertain pension for certain cash equivalence is increasing the certainty of paying 55% tax. Your pension – so long as it stays that, is valued at 20 times the pension for LTA purposes, your CETV is valued at 40 times.
The disparity may be even bigger with some early retirement pensions which are even more valuable as CETVs but still get the very low 20 times valuation against the Lifetime Allowance.
The scaremongering over BHS will panic some people into taking CETVs.
CETVs may reduce the risk of a clip from the PPF, but they exchange it for the certainty of punitive taxation on the unprotected transfer.
Don’t panic – stay put and only move if you have special circumstances.
One of my college friends (an actuary) has recently died. He spent the last few years of his life living off a CETV which he drew down at a tremendous rate. He knew what he was doing, he knew he was dying.
He is the exception that proves the rule
The perversity of pension freedoms is that they encourage to live hard die young, pensions encourage us to live healthily and long.
People who jump to get the current high transfer values are probably right in thinking they won’t go higher (though interest rates could fall and push them up). But a decision taken in 2016, may have implications for you in 2056.
Please don’t be panicked into taking a CETV , sacrificing your pension increases or even taking tax-free cash. Think about your long-term future, try to think of yourself as average (or better) and think of your family.
Finally – take this advice – which I give you for free -as no-one else will give it you!
The best way to maximise your pension is to have one and stay healthy!
I have no intention of dying young if I can help it and will be buying pension, taking my defined benefits as pension and I won’t be exchanging any pension for tax-free cash.
I consider my pension an excellent incentive not to over-drink, smoke or be lazy in retirement.
If you want to be really savvy and have a pension or an annuity, for heaven’s sake stay fit and don’t put your health unnecessarily at risk.
Jo’s produced a full article on this which you can find at www.ft.com/money