You would have to have been living on the moon over the past few months not to have seen the huge amount of press about pension transfers. Reading it you would be lead to believe that all individuals are gullible idiots and that all financial advisers are scurrilous rogues. Whilst undoubtedly there may be some who fit in to these categories it is far from all. So what is actually driving individuals to consider transferring their defined benefit pot to something with a much less certain outcome?
There is no doubt from my experience that individuals have a more unhealthy pessimism about their life expectancy than statistics would justify and a greater sense of expectation about how they can manage money than experience would suggest.
A starting premise for financial advisers when providing transfer advice is to begin with the assumption that it is not in the individuals best interests to transfer out of a defined benefit arrangement. However with more than 100,000 people having transferred out of DB schemes over the last year (according to Royal London), £10.6bn transferred in the first quarter of 2018 and no sign of a slow down - why has transfer activity increased so significantly in recent years?
Undoubtedly the pension freedoms and choice introduced in April 2015 are the single greatest reason for the increase in transfer activity. On transferring liabilities to a defined contribution scheme, individuals can access a range of flexibilities including:
- Purchasing an income (always available but no longer a requirement)
- Taking their fund as cash subject to tax charges
- Entering into a drawdown arrangement whereby an income can be taken each year and the fund remains invested
There are also changes to death benefits whereby residual funds pass to dependants tax free on death before age 75 (previously taxed at 55%).
With this in mind, many individuals have looked to access these flexibilities. Individuals may also feel that they get better value from transferring if:
- They are single and would not benefit from a spouse pension on death from a defined benefit arrangement. Transferring to a defined contribution scheme means they can access the full value of their accrued benefits with nothing lost on death;
- They are in ill health and have a lower life expectancy where greater value can be derived over a shorter term.
If an individual already has sufficient pension savings elsewhere or their spouse has material savings, then transferring part of a defined benefit to a defined contribution arrangement could provide a fund that can be taken more flexibly facilitating early retirement, a new career or even a release of early value to children or grand children.
Releasing funds to deal with debt may be more attractive than securing long term income and for those in financial hardship and accessing pension savings via a defined contribution arrangement may be their only option.
Shape of benefits
The provision of a set income increasing by a fixed rate with a spouse benefit may not provide an individual with the shape of benefits they may need or want. The ability to take more income early to facilitate early retirement for example, and lead a lifestyle in the earlier years of retirement may be a strong driver.
Value for money
With interest rates still at very low levels and inflation relatively high, transfer values are much higher than they might have been historically and as a result, are being seen as good value. Multiples of 30-40 times the individual’s pension are not unheard of.
Discharging pension scheme liabilities via transfer values is a lower cost option for employers and as such incentivised employer sponsored transfer exercises are still prevalent in the industry. Individuals may view a transfer value already set at an attractive level but with a further enhancement, as too attractive to turn down.
Overall the perception that transfer values are now providing good value for money is resulting in more individuals now considering this as an option.
Finally, individuals in a defined benefit scheme with a high risk sponsor may feel that remaining in the scheme presents a risk.
Some individuals may also feel that they can manage their money better and invest their defined contribution fund in such a way that they get more at retirement.
Ultimately the decision is a highly complex one hence the requirement for anyone with a transfer value about £30,000 to receive independent financial advice is a sensible one. There are a huge amount of issues that should be considered and individuals should do what is right for them based on their own circumstances. Without this expert guidance people may make decisions which are unsuitable based upon inappropriate, misleading or indeed no information which may ultimately lead to bad outcomes.