Following the recent spotlight on company-lead incentive and exchanges exercises, it was only a matter of time before the old chestnut of cash commutation rates made a re-appearance.
According to reports, the “scandal” of cash commutation rates is costing defined benefit pension scheme members £2-3 billion pounds per year. There were also hints at industry-lead complicity and conspiracy in offering poor value to members. My reaction – why let the facts get in the way of a good story?
In most cases I have seen, commutation rates are either hard-coded into rules or are set by the trustees or sponsoring employer. Cash commutation is an option. So, unless the rules require that “equivalent value” to the pension is offered, then there is no requirement to do so. Where the rules allow discretion, it is hardly surprising that trustees or employers (or actuaries) decide against increasing the value of members’ benefits by increasing the amount of cash offered in exchange for pension.
Further advantages of the lump sum are that it is tax free and immediate. Therefore, for members who are not in good health, don’t have a spouse and pay tax, the so called “bad” deal can actually be a very good one.
One commentator’s polar conclusion was “If your life span is anything approaching an average life expectancy, you’d be better off not taking the cash.”
For me, this misses the point and misjudges the viewpoint of many members. For example, I know that, according to actuarial science, I should not elect to take a £20,000 lump sum in exchange for giving up a £2,000 per annum pension. As it stands, personally I would still take the cash but more importantly, I’d like to have the right to make the decision for myself.