The most important single financial decision facing the baby-boomers of middle England today is what to do with their defined benefit pension rights. It is – alas – a binary decision as few schemes offering split transfer values; the choice is “should I stay or should I go”.
For those who have private wealth, the system used to calculate the transfer value of a right to a defined pension benefit is odd. The value is not linked to the growth of assets within a pension scheme, but to the cost of meeting the pension promise (your liabilities).
In the arcane world of actuarial science, a shift of measure by which these liabilities are re-valued (say from RPI to CPI) can impact a lifetime of payments profoundly. Equally, a fractional change in the discount rate used to calculate the cost of your liabilities can translate into material differences in transfer value calculations.
Explaining this to people used to reviewing the value of their wealth using an online funds portal can be very difficult! For many baby-boomers (and I am one), the messages we get about our defined benefits and our retirement wealth are contradictory and confusing.
The financial adviser is faced with a number of challenges in helping a client with the binary decision; put in simple terms they are
- to explain the risks of relying on capital to provide a lifetime pension
- to explain the risks within a defined benefit pension scheme that pensions won’t be paid in full
- to balance the certainty of a defined pension paid till death against the flexibility of the capital reservoir available for drawdown.
In my experience, people bring to their decision making a variety of prejudices built up over a lifetime saving. These create innate preferences for one decision or another. Helping people to understand what is an objective assessment of a particular risk and what is a financial hunch is difficult, especially where the prejudice is born out of a shared loss.
People who manage defined benefit schemes are justifiably concerned about the quality of information getting to their members. At one extreme are the defamatory statements made by expatriate advisers such as this;
Pension funds in the UK are in major trouble as the promises made cannot be met and upheld source; https://www.ukpensionguru.com/#questions
This adviser, working out of Geneva, is able to draw on de-contextualised statements from figures such as Alan Rubenstein (CEO of the Pension Protection Fund or PPF) who last year told the Telegraph that watching pension schemes enter his Fund was “like a slow-speed train crash”. This emotive language is picked up by personal financial journalists eager for a story.
Last April, the Daily Telegraph published an article (containing the quote from Rubenstein) that contained in its headline “my company pension scheme paid £70,000pa, now it pays £17,500.
It is extremely difficult for a financial adviser not to side with this prejudice against defined benefits, especially where the bulk of the work that can be done for the client would be done if a transfer value were taken and money managed as part of the client’s wealth.
Indeed, with many schemes valuing pension liabilities with reference to gilts , transfer values now offer a much lower challenge to the wealth manager who may need to get little real return on assets to meet the critical yield.
But the challenge of meeting client expectations increases over time. The initial enthusiasm for a transfer value that can be up to forty times the pension given up needs to be maintained over time.
Defined benefit schemes are used to managing benefits over generations, many of the schemes which my firm advise have had fiduciary responsibility for the management of the pension promise for 50 years or more. These are the time horizons that many facing pension decisions in their 50’s should be contemplating for themselves.
We would urge people approaching the years in which pension freedom first come available, to think long and hard about taking defined benefit pension rights away from the fiduciary care of pension schemes and their trustees.
We would also counter the scaremongering from UK PensionGuru, the Daily telegraph and the pension establishment itself. The vast majority of UK defined benefit pension schemes are in much better health than is reported by the PPF.
The notional deficit of the 7000 defined benefit schemes is calculated using a gilts based discount rate. Recalculate the funding position of these schemes using the best-estimate returns on their actual assets and you find the critical yield needed for these schemes to meet their liability is 0.6% below inflation. (source First Actuarial)
Far from increasing, the number of schemes entering the PPF has actually declined over the past three years. Corporate insolvencies are currently running at 0.4% pa for enterprise employers (source Brighton Rock).
The worst case scenario can befall someone yet to draw their defined benefit pension , whose pension scheme fails , is that it enters the PPF. For those with pensions that are more than the PPF compensation cap (for a 65 year old around £37,500) , the PPF will not provide additional compensation above 90% of the cap, these are the people who may consider a high proportion of their pension to be at risk.
But we need to be realistic about this “high risk”. The BHS pension scheme has recently announced that of the 19,000 members who are going into the PPF, only 16 had benefits that exceeded the cap. Ironically, they will be the biggest beneficiaries of the £363m that Philip Green could pay into the scheme.
The risks facing private individuals with DB pension benefits entering the PPF are real enough.Pensioners will only receive statutory revaluation of pensions in payment, those below the cap awaiting their pension to come into payment will receive 90% of the pension they’d been promised. But no-one, can expect to be left bereft if their pension scheme goes bust.
If the risks facing deferred pensioners have been overstated, the benefits of their impending pension have been understated. I am an enthusiast for my pension, so much so that I chose not to take my tax-free cash so that I could take my pension in full.
I now enjoy the prospect of an increasing income paid without any tax complications for the rest of my life (and of providing a reduced pension for my partner if she survives me).
For someone with limited aptitude for managing money, the certainty of this income is already improving my quality of life!
Knowing that I will still be receiving this income in years when my faculties may be deteriorating is a further comfort.
I looked hard at my CETV which needed only a 3.2% return to meet the TVAS critical yield. I decided against taking my transfer value because I had private wealth that I could call on if I needed it but had no access to income were I to choose or be required to stop work.
My binary decision was influenced by other factors, the Lifetime Allowance among them. But above all else, I took the decision based a holistic view of how I wanted to live my later years.
I am no longer a financial adviser, but I still recognise the value of financial advice. I am very grateful to my financial adviser for the life-coaching he gave me. It enabled me to see the wood for the trees. Ironically, his work talked him out of a steady income stream managing my pension wealth. For that I regard him as a true professional.