Poo-bah

There’s a debate going on between Al Rush, Jo Cumbo, Steve Webb and a number of others with regards partial transfers from defined benefit schemes.

Want to go 50:50 with a “final salary” pension transfer? Ford will soon let employees cash in half their pot, and receive a regular income from the rest, reports @JosephineCumbo #pensions https://t.co/dPkkJYA0RE

— Claer Barrett (@ClaerB) October 25, 2018

It’s all got very self- congratulatory

What a fantastic thread & debate this is.@AlanJParr – take a look.

— Wes Wilkes (@WesJWilkes) October 24, 2018

I have reservations!

It’s worth pointing out that anyone with a funded defined benefit promise has not just got the right to a Cash Equivalent Transfer Value but also to a partial transfer at retirement through what is known as “tax-free cash commutation”. The formula that works out how much tax free cash you can take from a Defined Benefit pension is one of the most complicated and least understood in “pensionland”. But despite no-one knowing whether they are getting good value from taking a partial transfer from DB to cash, almost everyone takes the money.

It is after all tax-free and it comes as cash!

The amount you can take as tax free cash depends on two things, firstly your service in the scheme and secondly the “commutation factors” decided upon by the Trustees with help from their actuaries. If we can simplify, the typical entitlement to tax free cash should be around and about a quarter of the defined benefit but the pension you actually get can vary enormously depending on the rate of exchange (commutation) between income given up and cash given.

If for instance, the commutation factor is 1 for 10 and the tax-free cash entitlement is £50,000, you end up giving up £5,000 pa (indexed and usually with spouse’s benefits) for the rest of your life.

If however, the commutation factor is a more generous 1 for 20, then, you only lose £2,500 pa. Enter the voice of reason….

But hang about. The commutation factors for CETVs are not in the 10-20 range, but often exceed 40 times the pension being given up – how come?

There really isn’t a common sensical answer to this question, but it’s worth me trying to cut through the mumbo- jumbo and explain.

The commutation factors are set at what the actuaries and trustees think is prudent for the scheme; as most schemes are in deficit, trustees and actuaries are likely to give away as little as possible (e.g. without members kicking up a fuss). Because members are so beguiled by the tax-perk, taking tax-free cash is considered a “no-brainer” for most people.

So trustees have been able to give lousy commutation factors, because nobody’s asking what good looks like. Tax-free cash from DB schemes is usually a rip-off sponsored by HMRC.

On the other side of the coin, the CETV is set to the best possible member decision, which unsurprisingly is – not to take the tax-free cash. Bizarrely, those who choose to take all their pensions as a cash equivalent are deemed unlikely to have taken tax-free cash.

So all the positives to scheme funding of people taking the lousy tax-free cash calculation are lost to the scheme when the actuary calculates the CETV.

This is of course utter madness

The combination of offering CETVs at the best possible rate for members and offering Tax-Free-Cash at the worst, means that many people can do better taking tax free cash from a transfer than from the scheme as a partial transfer at retirement. Which is bonkers!

What’s triggered the debate on twitter is that Al Rush has been to see Ford Europe who have told him they will be offering people half and half deals on pension transfers (see FT article linked above). That means that people can liberate half of their pension entitlement via a CETV and take the balance at retirement. Of course this means that they will be doing two partial transfers as they are likely to commute from the remaining half- leaving them with thin gruel as pension and a lot of spendable cash.

Like the good consultant I am – I (formally) “commend” Ford for offering this option. I am delighted for all the IFAs (especially Al) who are jumping for joy at the financial planning opportunities this further complexity affords them. I hail Steve Webb – who is of course the IFAs friend – now that he is at Royal London) beams cherubically (as the grand poo bah of partial transfers).

But (on this blog) I remain unconvinced.

I’m unconvinced in the main, because the tax-free cash commutation was always meant to provide all the freedom an ordinary person could want.

I’m unconvinced because what I fear is going to happen is that clever tax-planners are going to use partial transfers as a way to extract fees by arbitraging against the pension fund CETV v TFC.

I’m unconvinced because fine administrators that JLT/Mercer are, I suspect they will struggle to administer the Ford partial CETV offer (and will have to charge a lot to do the work).

Finally, I’m unconvinced that partial transfers aren’t just another way to salami slice defined benefit schemes in the great “de-risking” exercise that is in fact re-risking everything onto unsuspecting people who don’t know the risks they’re taking on.

But what do I know?

I know this, I took my pension from Zurich financial services, I did not take a transfer and I didn’t take any tax-free cash. Read into that what you like