How significant is Critical Yield

pip895

When considering a transfer from a final salary scheme how much store should you put on the critical yield.

In my case the value is very high >10 but it seams a little obscure as the timescale is short and there is no way I would consider buying back the policy I have. The original transfer value multiplier was large > x 40 and the advice is to transfer.

Should I worry?

Malthusian

Why do you want to transfer out?

Critical yield is like APR. It is an indication of how likely the transfer is to be a good idea (or otherwise), in the same way that APR indicates how expensive a loan is, even for loans which aren't on an annual basis.

Even if there is no chance that you will want to buy an annuity with inflation-linking and spouse's pension, it is still a good indication of whether you are likely to be better off or not by transferring. In the same way that the Annual Percentage Rate is still a good indication of how expensive a loan is, even if it's a payday loan which isn't designed to be held for a year.

Short answer, if you're considering a transfer with a critical yield that high, there needs to be a good reason.

Anyone who tells you that the critical yield is irrelevant should be treated with extreme caution.

pip895

Although I see what you mean I have difficulty in seeing how it can be bad value for money. If I were to take the transfer cash and not even invest it then I would be able to pay myself at the rate that the DB pension would until I was 80 at which time it would run out. If I assume I can get 4% on average (not 4% over inflation just 4% net of charges) then I would not run out of cash until aged 97.

If rather than paying myself 5% more every year as my DB pension would I just matched inflation at say an assumed 3% then my investments would merely have to match inflation to keep me going to 100!

If we have a continuous low inflation low return environment for the next 30 years and I live a long time then I will loose out but in almost all other scenarios I will be better off transferring. My own bet is for high inflation with lowish returns - if I can just match inflation on average then I am better off transferring.

Malthusian

pip895 wrote: »

Although I see what you mean I have difficulty in seeing how it can be bad value for money. If I were to take the transfer cash and not even invest it then I would be able to pay myself at the rate that the DB pension would until I was 80 at which time it would run out.

That would suck a bit for your 80 year old self.

You've said the CETV is unlikely to run out if you withdraw 3% or 4%, which is very likely true, but how much money do you actually need to withdraw each year to live on?

You say you've been given advice to transfer - did the suitability letter address the fact that the critical yield is unlikely to be achieved, and set out the reasons why it doesn't matter that it won't?

pip895

The report is 50 pages long + appendixes - yes its all covered - there are several critical yields calculated this one though corresponds to the option I would chose if I decided not to transfer - retire at 60 and no lump sum.

It seems to be telling me more that annuities are ridiculously poor value rather than anything very useful about my transfer.

pip895

Malthusian wrote: »

That would suck a bit for your 80 year old self.

Not really I have other monies + why would I continue taking money at an escalating rate if things are going so badly?

bostonerimus

pip895 wrote: »

Although I see what you mean I have difficulty in seeing how it can be bad value for money. If I were to take the transfer cash and not even invest it then I would be able to pay myself at the rate that the DB pension would until I was 80 at which time it would run out. If I assume I can get 4% on average (not 4% over inflation just 4% net of charges) then I would not run out of cash until aged 97.

If rather than paying myself 5% more every year as my DB pension would I just matched inflation at say an assumed 3% then my investments would merely have to match inflation to keep me going to 100!

If we have a continuous low inflation low return environment for the next 30 years and I live a long time then I will loose out but in almost all other scenarios I will be better off transferring. My own bet is for high inflation with lowish returns - if I can just match inflation on average then I am better off transferring.

You are not factoring in sequence of return risk or the possibility of spikes in inflation. An index linked DB plan protects you from those risks as well as longevity risk. CETVs are tempting because of today's low interest rates and there is a strong probability that with a sensible portfolio and disciplined withdrawals you'll be able to fully fund your retirement and leave some money to your heirs. But it's not 100% guaranteed and if you do cash in you need to understand how your plane might fail and to know how to keep it on track for 30 or more years.

bostonerimus

pip895 wrote: »

The report is 50 pages long + appendixes - yes its all covered - there are several critical yields calculated this one though corresponds to the option I would chose if I decided not to transfer - retire at 60 and no lump sum.

It seems to be telling me more that annuities are ridiculously poor value rather than anything very useful about my transfer.

With interest rates so low what you gain in CETV you'd lose in low annuity rates if you bought one. I can see an argument for partial annuitization of the CETV to provide a guaranteed income floor and combine that with the flexibility of drawdown from the rest of the pot. But annuity rates are bad right now and maybe laddering the annuity would be a good idea rather than buying a lifetime one.

If you have "other monies" keeping the DB plan might be a prudent move as it diversifies your retirement income streams. The income floor comes from the DB plan and that can be thought of as a fixed income allocation in your portfolio and then you can invest the other monies aggressively safe in the knowledge that the DB pension will always keep the wolf from the door.

pip895

bostonerimus wrote: »

You are not factoring in sequence of return risk or the possibility of spikes in inflation. An index linked DB plan protects you from those risks as well as longevity risk. CETVs are tempting because of today's low interest rates and there is a strong probability that with a sensible portfolio and disciplined withdrawals you'll be able to fully fund your retirement and leave some money to your heirs. But it's not 100% guaranteed and if you do cash in you need to understand how your plane might fail and to know how to keep it on track for 30 or more years.

I would agree but my plan isn't index linked- it raises by 4.9% regardless - which in todays environment seems incredibly generous - but not so good if inflation is averaging above 7% as it well might.

Nothing is ever 100% guaranteed and I realise there is a not insignificant chance I will be worse off - just there is a bigger chance I will be better off as far as I can tell.

pip895

bostonerimus wrote: »

With interest rates so low what you gain in CETV you'd lose in low annuity rates if you bought one. I can see an argument for partial annuitization of the CETV to provide a guaranteed income floor and combine that with the flexibility of drawdown from the rest of the pot. But annuity rates are bad right now and maybe laddering the annuity would be a good idea rather than buying a lifetime one.

If you have "other monies" keeping the DB plan might be a prudent move as it diversifies your retirement income streams. The income floor comes from the DB plan and that can be thought of as a fixed income allocation in your portfolio and then you can invest the other monies aggressively safe in the knowledge that the DB pension will always keep the wolf from the door.

I do like the idea of diversified returns but we have a couple of rental properties and full state pensions that give us some of that. If annuities improve I might consider them - just now they look a lot like throwing money down the drain.

bostonerimus

pip895 wrote: »

I do like the idea of diversified returns but we have a couple of rental properties and full state pensions that give us some of that. If annuities improve I might consider them - just now they look a lot like throwing money down the drain.

Rent and SP are great income sources. You have a plan similar to mine....which I obviously think is great.....like minds etc. My retirement plan was to use my rental property and DC drawdown as income until my SP started and then I would be able to basically stop regular drawdown. However, I had the chance to trade some DC money for a DB pension and did it because it was very good value. So now my basic retirement income is decoupled form the markets and I live on rent and pension and when SP starts that will just go into the investment portfolio. It's very nice to have cheques coming in that are not based on market returns.

In your situation you already have the DB plan, but without knowing your income needs and the relative sizes of your income sources and make up of your portfolio it's not possible to give a very informed opinion on what you should do. But you do need to be conservative and so should plan for a long life, some poor market returns and some higher than average inflation...stress testing is key.