Kirsty Lister, Financial Planning Associate at Chiene + Tait Financial Planning, explores the possible impact of interest rate rises on pension transfer values
The transfer of Defined Benefit (DB) pensions into Defined Contribution (DC) schemes continues to offer a financially attractive option for many individuals but how long will this last?
Since the introduction of UK Government policy reforms, which have given pension holders a much higher degree of financial flexibility in planning for their retirement, many who have been part of a DB scheme have looked into the prospect of transferring.
Those who are in this position have the option of moving their existing pension pot into a DC scheme, where benefits can now be drawn down from age 55. Before the rule changes, it was often not possible for people in DB schemes to access any funds before retirement without being substantially penalised for doing so.
Recent circumstances meant transferring from DB to DC schemes was often an astute move because pension-holders could cash in on high transfer values. Many were offered multiples of up to 40 times their projected post-retirement income as the long spell of low interest rates inflated the cost of the potential income these DB schemes would have had to pay out. The prospect of further rate rises could, however, put an end to these generous transfers.
Last November the UK saw its first interest rate rise in more than a decade and, while there is debate on the precise timing for it, many are predicting further rises lie ahead.
At the end of 2017 inflation grew to 3.1 per cent, its highest level in six years. Although it dropped by 0.1 per cent last month, it remains well above the Bank of England’s two per cent target, prompting a growing belief interest rates will rise again at some point over the next year. With this outcome likely to impact on the record high pension transfer values that are being paid out, DB pension-holders considering a transfer should be seeking further guidance on their own situation as a matter of urgency.
In the current climate of low and stagnant interest rates, we have advised a number of employees in key Scottish sectors, including those in financial services and energy who have benefited from pursuing the transfer route. In one case from last year, an individual who worked for a renewable energy company for almost 20 years and was latterly earning an annual salary of £82,000, was offered a cash equivalent transfer value (CETV) of £1,459,000 to move into a DC scheme.
Another pension-holder who worked as a manager with a well-known UK high street bank since 1993, earning an annual salary of £55,000, was offered a CETV of £542,000 for shifting their pot into a DC scheme earlier this month.
While these examples show the potential benefit of pursuing a transfer, pensionholders must also consider the downsides because the risk when making such a move shifts from the scheme to the individual. Unanticipated economic and political events can adversely impact on the value of DC pension schemes. This potential volatility must therefore always be factored into planning assumptions that are part of this process.
It’s also important to recognise that not all DB pensions are transferable. For those that are, the values are usually dependent on the ages and number of members in the scheme and its funding position. Every pension holder’s circumstances vary, so getting bespoke independent advice is always essential because there are pros and cons that must be considered, depending on an individual’s wider financial situation and their personal retirement plans.
As you can see from the examples provided, transferring from a DB pension into a DC scheme may enhance an individual’s financial flexibility by securing them an attractive transfer value. Under the Government’s new pension freedoms, the DC regime could also provide a better solution for many individuals, especially those who want to get access to some of their funds before they retire.
No one knows for sure when we will see further interest rate rises, but when we do it will likely have an impact on transfer values. That means there could be a very limited window for action for those who are currently part of a DB pension scheme but may wish to investigate whether they should pursue the transfer option.
If you have a pension query, contact Kirsty today at email@example.com.