Transfer Value of a Deferred Pension

Hymie

I have a deferred company pension (defined benefits), which will pay me an annual pension of £7k (index linked) when I retire (I am currently age 50). My deferred company pension scheme have said that the transfer value of my pension is approximately £55k. This seems a ridiculously low value, given that the annual pension is around 13% of the transfer value.

My question is twofold; how is the transfer value of a pension calculated, can my deferred company pension scheme, quote any arbitrary transfer value, thereby ensuring it is not worth transferring out?

Secondly, once I retire, the pension scheme allows me to take a 25% tax-free lump sum. Is the tax-free lump sum, based on the pension transfer value, or a much more realistic value required to pay out the pension amount – which in my case would be well over £100k, rather than the transfer value of £55k?

dunstonh

Your questions will be answered in the scheme booklet. Ask the pension administrators for a copy.

jonathon_hart

Hi.

Normally Defined Benefit transfer values are based on what you need to invest now in order to get the same benefits at Normal Retirement date based on a number of actuarially set assumptions as to how the fund would increase, annuity rates etc. If your Normal Retirement Age is 65 then that transfer value does not look unreasonable based on a very very quick calc.

The Pension Commencement Lump Sum (PCLS) (what the Tax Free Cash is now called) is a little complicated to calculate for a DB scheme as it is affected by the scheme commutation rate (this is the amount of PCLS you get for every £1 of pension given up). It is also based around the scheme pension.

MikeJones_2

Hi Hymie,

Hymie wrote: »

how is the transfer value of a pension calculated

From 1st October 2008 new Transfer Value Regulations come out which will make the Trustees of your scheme responsible for the method of calculation, having first taken professional advice including in the main, the scheme actuary. The Pensions Regulator issued Draft Guidance in August 2008 to assist Trustees, although it was criticised in the pensions arena for its late arrival.

Evidence suggests that the new transfer values calculated after 1st October 2008 will be higher than the corresponding transfer value calculated before that date. This is due in part to increased life expectancy.

In the simplest terms, I would describe how your transfer value is calculated as taking your deferred benefit at the date you ceased to be an active member and revaluing it up to your Normal Retirement Date (NRD). A 'value' is then placed on your pension benefits at NRD. To get to the Transfer Value quoted today, the scheme use a 'discount rate' and apply that to the 'value' of your pension at NRD to come back to a current Cash Equivalent Transfer Value.

Hint: Ask your pension scheme if the transfer value they have quoted is based upon the old basis (pre 1st October basis). If it is, you could ask them for a transfer value quote on the new basis. You are only normally permitted to have one TV quote in each 12-month period, but some schemes waive this. Note, that if you did not request your TV i.e. if it was sent out to you without your request or as part of your Statement of Entitlement on leaving service, then the scheme cannot deny you another transfer value in the same 12-months.

Hymie wrote: »

...can my deferred company pension scheme, quote any arbitrary transfer value, thereby ensuring it is not worth transferring out.

No (see above).

Hymie wrote: »

...the transfer value of my pension is approximately £55k. This seems a ridiculously low value, given that the annual pension is around 13% of the transfer value.

If you took the transfer value and invested it for 15 years (I'm assuming your NRD is 65), and achieved a 7% p.a. return, then the £55k would grow to £151,746 (note that this doesn't allow for any charges which you would have to take into account if you did transfer, such as an annual management charge). Very broadly speaking, if you had £151k today and were aged 65, you may be able to secure a pension of around £7,000 p.a. (although your pension would depend upon other factors such as spouse's pension, pension increases and guarantees).

Has the transfer value been reduced? If a scheme is in deficit, legislation permits the trustees to reduce transfer values. The Draft Guidance from the Pensions Regulator discusses the merits of this. Currently (September 2008) around 20-30% of transfer values are reduced because of deficits.

You could find an IFA and ask for a Transfer Value Analysis Service (TVAS). This will reveal the Critical Yield required to match your estimated defined benefits scheme pension if you transferred it to a Personal Pension or Section 32 Buyout. Currently, average Critical Yields are around 10% - this means that if you transferred to a Personal Pension your transfer value would need to achieve 10% p.a. every year until NRD to get a pension the same as your estimated scheme pension (if you choose to leave it in your existing defined benefit scheme).

Hymie wrote: »

...Secondly, once I retire, the pension scheme allows me to take a 25% tax-free lump sum. Is the tax-free lump sum, based on the pension transfer value...

No. (see Jonathon's answer above, which is correct).

Sorry, for the long answer, but I could write a book about the questions you have raised. There's a lot more to preserved pensions than meets the eye, and according to figures out this week from the Office for National Statistics there are 9.4 million members with preserved pensions held in private sector pension schemes. That's a lot of people walking around in the dark...

I hope this has helped you. Shout out if you've got any more questions.

Mike Jones

I work in the field of Pension Education and Pension Guidance in the UK. I am a current member of the Specialist Pensions Forum as well as being a Voluntary Adviser for The Pensions Advisory Service. I work with scheme members, employers, trustees, scheme administrators and advisers on most things to do with employer sponsored pension schemes. The views expressed by me in this thread are my personal opinions. You should seek professional advice from an appropriately experienced and qualified adviser. I am not an IFA.

Debt_Free_Chick

The transfer value is, broadly speaking, what the scheme would set aside as the value of your deferred pension. It's not the amount that you would need to invest, privately, to get the same pension - for the reason that the scheme doesn't invest in private pensions.

Remember that the scheme is backed (underwritten) by the employer, so if it ever falls into deficit, then the employer picks up the bill. In a very roundabout way, that's reflected in the transfer value calculation, which is consistent with the scheme's overall funding plan, which in turn, is agreed between the employer and the trustees.

Essentially, you cannot compare the cost of buying a pension in a private plan, with the value that the scheme places on it.

If you insist, you can get a copy of the actuary's statement on the calculation of the scheme's transfer values .... but it really won't help.

Hymie

Thank you all for taking the time to answer my questions, not just from myself but on behalf of others, who I’m certain will find many of the points interesting.

By and large, you are all saying much the same thing, however I would still dispute the transfer value I have been given (not that there is anything I can do about it). My logic is as follows:-
(Notwithstanding that my deferred pension scheme does not have shareholders, flash offices or fat-cat bosses on which to lavish money).

My deferred pension is indexed linked to the RPI and will pay my partner a 50% pension should I die first (it has a few other add-ons – but they would not add much to the cost of provision).
To buy such a £7k pension for a 65 year old male would require a sum of approximately £175k. £55k would need to grow at an annual compound interest rate of 8% over 15 years to achieve this. Now you might say that this is quite reasonable, and I might agree – but this 8% is on top of the RPI inflation rate and therefore my deferred pension scheme is actually looking for a gross return of around 12% p.a. over 15 years.

If I told you that I had a guaranteed investment return of 12% - I would have a queue of people stretching twice around the planet to invest with me.

Since I am fairly confident that my deferred pension scheme will not achieve a 12% return, the consequences of this are that the scheme is likely to slip into deficit if it has assumed this growth rate for its funds. In 15 years time, although I may well be drawing a pension of £7k (equivalent to what that can buy today) – the transfer value and any 25% tax free lump sum is likely to be very low, since the scheme cannot afford to pay-out what would be a reasonable amount.

At every turn the pension investor is being shafted, while the schemes can change the rules to suit. I’m sure if I told my deferred pension scheme that money is tight and I need 30% of my pension contributions back (for no reduction in pension pay-out), I don’t think they would be very accommodating – but with things reverse, that’s all fine & dandy.

Debt_Free_Chick

Hymie wrote: »

To buy such a £7k pension for a 65 year old male would require a sum of approximately £175k.

But the scheme makes no assumption about "buying" an annuity. Most schemes don't - they simply pay out 1/12th of your pension every month, once you retire. This way, they don't have to lock up any capital, so it remains invested. The assumed rate of return of your transfer value, after retirement, is almost certainly better than the rate of return one would get with an annuity.

I may well be drawing a pension of £7k (equivalent to what that can buy today) – the transfer value and any 25% tax free lump sum is likely to be very low, since the scheme cannot afford to pay-out what would be a reasonable amount.

That won't happen. The employer is going to have to increase their contributions to make up any deficit - your entitlement will not and cannot be reduced. The only instance in which you might suffer a lower pension is if the employer is insolvent and the scheme is taken over by the Pensions Protection Fund - in which case, you should get 90% of your pension paid.

At every turn the pension investor is being shafted, while the schemes can change the rules to suit.

But if you have an entitlement to a pension and that amount is paid, how are you being shafted? The transfer value may not enable you to replace your entitlement, on the same terms, in the open market, but you're not losing out - are you?

MikeJones_2

Hi Hymie,

Can I just check - the figure you have quoted of a £7k p.a. pension is the estimated pension you will get at age 65 (i.e. it is not your preserved pension at the date you ceased to be an active member, nor is it the current value of your preserved pension)?

And when you refer to your pension being index-linked, are you talking about index linked increases during the period of deferment (i.e. between the date you ceased to be an active member and your NRD) or are you talking about increases granted to your pension in payment?

Mike Jones

I work in the field of Pension Education and Pension Guidance in the UK. I am a current member of the Specialist Pensions Forum as well as being a Voluntary Adviser for The Pensions Advisory Service. I work with scheme members, employers, trustees, scheme administrators and advisers on most things to do with employer sponsored pension schemes. The views expressed by me in this thread are my personal opinions. You should seek professional advice from an appropriately experienced and qualified adviser. I am not an IFA.

Hymie

Mike (Jones), in answer to your specific questions, the £7k p.a. pension takes into account increases (due to inflation) since leaving the company. Each year I receive a Pension statement, this amount is increased by the RPI. If inflation were 0% over the next fifteen years, I would receive a pension of £7k p.a. at 65 – say it remains constant at 3% over the next 15 years, then at age 65 I would receive a pension of £10,906.

So my pension is index linked from the date I left the company and will be index linked once I start to draw the pension.

Debt free chick claims that if my pension scheme falls in to deficit, that any transfer value will not be affected by this – this statement is in direct contradiction to that made by Mike Jones, who states that it may be reduced by up to 30% (see above).

When I paid into the pension, the terms & conditions were that I could take the pension at age 60 without penalty. The pension scheme have now moved the goal posts and apply a penalty for retiring between 60 & 65. When I was paying into the scheme, I could retire at age 50 with an annual reduction rate of 3% p.a for retiring earlier than age 60. The pension scheme have now moved the goal posts and increased this reduction to 4% p.a.

I have no control over where the goal posts will move to next - they could move considerably over the next 15 years (as they have done over the last 10 or so years), strangely never in my favour.

Debt_Free_Chick

Hymie wrote: »

Debt free chick claims that if my pension scheme falls in to deficit, that any transfer value will not be affected by this – this statement is in direct contradiction to that made by Mike Jones, who states that it may be reduced by up to 30% (see above).

Sorry for any confusion, but I made no reference to your transfer value. My comment was in relation to your pension. Interestingly, if your transfer were reduced due to a deficit, your pension entitlement would be unaffected. So, you might be offered a transfer value of, say, 80% of its full value - but your pension would not be reduced at all.

To be honest, if the transfer value were reduced due to a deficit, then there's absolutely no point in taking the TV.

Debt_Free_Chick

Hymie wrote: »

When I paid into the pension, the terms & conditions were that I could take the pension at age 60 without penalty. The pension scheme have now moved the goal posts and apply a penalty for retiring between 60 & 65.

Are you sure that this affects you? Doesn't it just affect others who don't have the benefit of the "retire at 60 with no penalty" entitlement?

When I was paying into the scheme, I could retire at age 50 with an annual reduction rate of 3% p.a for retiring earlier than age 60. The pension scheme have now moved the goal posts and increased this reduction to 4% p.a.

Early retirement reductions are rarely guaranteed. To put the change in context, when you joined the scheme your life expectancy was probably around age 72. Now, it's nearer age 80. So ... you have the same pension entitlement, but you should expect to receive more of it, for longer.