How to complain about poor DB lump sum commutation factor / inequality?

Albermarle

As hinted at above , it is better to come from the angle that having a substantial DB pension means you are one of the lucky ones, and complaining about commutation factors is basically a luxury problem that the large majority of the public would be glad to have .

Brynsam

NottinghamKnight said:

The answer is to take the pension when it makes sense for you to do so according to your personal circumstances. Your employment contract states they will pay a set amount per year, you were never promised a lump sum and if the offer they have provided is poor then don't take it. This is all a consequence of the wider financial landscape, transfers out from db schemes (db pensions are of course rare as hens teeth now in the private sector) would rarely have been considered until a few years ago.

Your employment contract won't state any such thing. At most it will refer to something vague like 'membership of a pension scheme, details of which will be provided separately'. 

itsmeagain said:

Now.... recently the scheme had a review of how competitive/fair they they were being to its members and significantly improved the early retirement reduction factors. I wondered if there was anyone policing DB schemes that I could complain to, in view of encouraging them to review the commutation factors, or if they free to do whatever they want?

If your scheme has recently reviewed its factors (including commutation?), then nothing more you can do. You don't have to commute if you don't think it gives good value for money/suits your circumstances. 


Commutation factors are notoriously poor value in many schemes - something which has come under the spotlight when people nearing their scheme's Normal Retirement Age compare a transfer value with the tax free lump sum if they commute part of their pension. Some schemes have been addressing this disparity by improving commutation factors, others have taken the view that members don't have to commute if they don't want to and intend to take no action.

itsmeagain said:

Hi there. This will probably demonstrate that I don't know what I'm talking about but here goes....!
I'm in a company DB scheme that's offering a transfer of just over £1m, that would permit a tax free lump sum of £250k.
If I keep the DB, they'll only give me £130k lump sum in exchange for 1/4 of my pension (commutation factor of 13 at age 55).

You're asking a very sensible question.

If you transfer out with a £1m transfer and then immediately take a lump sum, it could indeed be £250K. If you then tried to buy a comparable annuity (i.e. a pension on the same terms as the index-linked benefits offered by your DB scheme), you won't get anything like the same level of pension. (Yes, I know you could go into drawdown, but I'm trying to give you a simple way to understand the apparent anomaly.)

shinytop

itsmeagain said:

Albermarle said:

£130K lump sum is a commutation factor of 13 ( normally is around 20)  Which indicates a pension before reduction of £40K .
Considering you are <55 a CETV of only £1million is pretty stingy for giving up a £40K pa pension , presumably inflation linked .
In both cases it looks like taking the pension in full looks the best bet .

The pension is £36,746 at 65 or £27,809 @ 55 (few months time).

That looks like an actuarial reduction of less than 2.5% per year; if so that's on the generous side.  

itsmeagain

NottinghamKnight said:

The answer is to take the pension when it makes sense for you to do so according to your personal circumstances. Your employment contract states they will pay a set amount per year, you were never promised a lump sum and if the offer they have provided is poor then don't take it. This is all a consequence of the wider financial landscape, transfers out from db schemes (db pensions are of course rare as hens teeth now in the private sector) would rarely have been considered until a few years ago.

Not sure if we're on the same subject here. Ever since I joined the scheme, the members have been able to take a lump sum. This is a copy/paste of the relevant section in my company DB pension guide...

TAKING A TAX-FREE CASH SUM

You will have the option to give up some of your pension

in exchange for a one-off lump sum that is not taxable.

You can take up to a quarter of the value of your pension

as a tax-free cash sum, but you can decide to take less

than that or none at all. If you’ve paid AVCs, this may

affect the amount of tax-free cash you take. Click here

for more information.

THINKING ABOUT RETIREMENT

This section has some information about your

retirement options and how your benefits are paid.

You will receive all the information you need well

before you are due to retire.

You will have the chance to choose the amount of tax-free cash sum you want to take,

when you retire. If you take a tax-free cash sum, your monthly pension will be lower,

depending on how much cash you decide to take and how old you are when you retire.

itsmeagain

shinytop said:

That looks like an actuarial reduction of less than 2.5% per year; if so that's on the generous side.  

Completely agree. I was going to take my AVC for a few years to defer taking my DB, thus getting a better early retirement factor on my DB at a later date. After they reviewed the ERF's my DB at 55 jumped £4k overnight, so I'm going to take my DB. Shame they didn't improve the commutation factors on the lump sum!

itsmeagain

Brynsam said:

Commutation factors are notoriously poor value in many schemes - something which has come under the spotlight when people nearing their scheme's Normal Retirement Age compare a transfer value with the tax free lump sum if they commute part of their pension. Some schemes have been addressing this disparity by improving commutation factors, others have taken the view that members don't have to commute if they don't want to and intend to take no action. You're asking a very sensible question.

If you transfer out with a £1m transfer and then immediately take a lump sum, it could indeed be £250K. If you then tried to buy a comparable annuity (i.e. a pension on the same terms as the index-linked benefits offered by your DB scheme), you won't get anything like the same level of pension. (Yes, I know you could go into drawdown, but I'm trying to give you a simple way to understand the apparent anomaly.)

Thanks Brynsam. This maybe over simplified, but if they are prepared to pay me £1m to get rid of 4/4 of their liability (full transfer), then why aren't they prepared to pay close to £0.25m to get rid of 1/4 of their liability (lump sum)?

Albermarle

itsmeagain said:

Brynsam said:

Commutation factors are notoriously poor value in many schemes - something which has come under the spotlight when people nearing their scheme's Normal Retirement Age compare a transfer value with the tax free lump sum if they commute part of their pension. Some schemes have been addressing this disparity by improving commutation factors, others have taken the view that members don't have to commute if they don't want to and intend to take no action. You're asking a very sensible question.

If you transfer out with a £1m transfer and then immediately take a lump sum, it could indeed be £250K. If you then tried to buy a comparable annuity (i.e. a pension on the same terms as the index-linked benefits offered by your DB scheme), you won't get anything like the same level of pension. (Yes, I know you could go into drawdown, but I'm trying to give you a simple way to understand the apparent anomaly.)

Thanks Brynsam. This maybe over simplified, but if they are prepared to pay me £1m to get rid of 4/4 of their liability (full transfer), then why aren't they prepared to pay close to £0.25m to get rid of 1/4 of their liability (lump sum)?

I am not an expert , but I think it is because the way the lump sum has to be calculated to stay within HMRC rules.
Also CETVs are going through a period where they are unusually high due to current financial market conditions.
It could be that in 10 years time , someone in a similar situation to you could be entitled to the same DB pension but the CETV on offer could be significantly lower than one million.

itsmeagain

Albermarle said:

I am not an expert , but I think it is because the way the lump sum has to be calculated to stay within HMRC rules.
Also CETVs are going through a period where they are unusually high due to current financial market conditions.
It could be that in 10 years time , someone in a similar situation to you could be entitled to the same DB pension but the CETV on offer could be significantly lower than one million.

You may be right, but there's no mention of the HMRC rules causing the inequality here.... https://www.jameshambro.com/insight/comment/tax-free-lump-sum/

Silvertabby

Apples and oranges.  The HMRC 25% maximum tax free cash in respect of DB schemes is calculated thus:

20 x annual pension plus 1 x any automatic lump sum  x 25% (before applying the commutation factor).

However, this doesn't tally with the figure you quoted - a pension of £27,809.  Is  there any automatic (pre commutation)  lump sum?  If so, what is it? 

Brynsam

itsmeagain said:

Brynsam said:

Commutation factors are notoriously poor value in many schemes - something which has come under the spotlight when people nearing their scheme's Normal Retirement Age compare a transfer value with the tax free lump sum if they commute part of their pension. Some schemes have been addressing this disparity by improving commutation factors, others have taken the view that members don't have to commute if they don't want to and intend to take no action. You're asking a very sensible question.

If you transfer out with a £1m transfer and then immediately take a lump sum, it could indeed be £250K. If you then tried to buy a comparable annuity (i.e. a pension on the same terms as the index-linked benefits offered by your DB scheme), you won't get anything like the same level of pension. (Yes, I know you could go into drawdown, but I'm trying to give you a simple way to understand the apparent anomaly.)

Thanks Brynsam. This maybe over simplified, but if they are prepared to pay me £1m to get rid of 4/4 of their liability (full transfer), then why aren't they prepared to pay close to £0.25m to get rid of 1/4 of their liability (lump sum)?

See Silvertabby's answer, but also note they aren't getting rid of 1/4 of their liability. For example, any spouse's pension is normally based on the pre-commutation pension (i.e. as if you'd taken no tax free cash at all), so they'd still be on the hook for that, whether or not you take a tax free lump sum. Add on the fact that they still have the 'uncertainty factor' of keeping any part of your benefits in the scheme, and the not-very-understandable starts to make a bit more sense - but as already said, commutation is often not 'good value' for members.