One thing I’m telling all my clients at the moment is to read beyond the headlines to fully understand the economic impact of the reaction to Coronavirus. I hope that if you’ve made it this far beyond headline of this article that you’ll read on to find out what I mean.
If you have a defined benefit pension in the UK (also known as a final salary scheme) then you’ll know that you can make a request to your scheme for a Cash Equivalent Transfer Value (CETV) to effectively convert a future defined benefit payable to you in retirement into a defined pot of money that can be invested as a pension and accessed flexibly from the age of 55.
The defined benefit that you will receive in retirement (typically from age 60 or 65) is determined by your years of service as a fraction of 60 multiplied the salary you received when you left (hence why it is called a final salary scheme).
Years of service = 10
Salary at date of leaving = £60,000
Defined benefit pension = (10/60) x 60,000 = £10,000
Therefore, your pension at date of leaving is £10,000 with increases applied in line with inflation so that its ‘real value’ (i.e. what you can afford to spend it on) remains the same. By requesting a CETV and converting into a pot which you can invest you could achieve growth greater than inflation to potentially give yourself a larger pension in retirement but also accept the risk of investment loss.
Transfer values can vary from scheme to scheme and there is no fixed formula or guaranteed way of knowing what the CETV will be before you request it. However, what we do know is that transfer values are negatively correlated with interest rates. When interest rates are LOW, transfer values are HIGH (and vice versa).
This is because your defined benefit pension is paid out of a much larger pot along with all the other members of the same scheme. This pot is could be hundreds of millions of pounds and is managed by the scheme trustees who must simply make sure that the pot is large enough to cover all of the sums owed to its members – both those currently in retirement and those in ‘deferment’ who will receive their pensions in future years. In simple terms, the pot is an asset that must meet the liability of the members.
Managing such a large pot mean minimising risk as any downturn such as we are expecting in the stock market currently could have serious long-term implications. Final salary pension schemes will therefore invest heavily into government bonds and fixed income investments which are seen as safer investments with lower volatility and steadier returns.
As yields fall on bonds it effectively means that final salary scheme trustees will determine that they need a larger pot in order to meet their liabilities which naturally leads to higher transfer values.
Earlier today (March 9th) UK government bonds fell into negative territory for the first time ever as this press release from Reuters confirms.
Requesting a transfer value from your scheme is not the same as confirming that you wish to transfer – merely that you wish to explore it as a possibility. All schemes are obliged to produce one for you on an annual basis free of charge but even if you have received one in the last 12 months you can usually pay them for another (usually around £250 plus VAT).
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UK PENSIONS AND DEFINED BENEFIT TRANSFERS
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