DB Pension considerations before rejecting transfer

NSG666

jamesd said:

NSG666 said:

Anyhow, I've got a deferred DB pension with Peugeot and have always thought DB pensions are like gold dust and should be hung onto. A few years ago Peugeot paid for an optional review with an IFA to see whether it would be better to keep the DB or switch it elsewhere and the answer, along with some calculations, came back to leave it. So I did.

AVCs are investment-based so the outcome depends on the investments that you choose to use with them and what it any income you choose to take and how.

Transfer values have probably increased substantially in the last several years. The calculations probably assumed that you would use the transferred capital to buy an annuity, roughly equivalent to throwing away almost half of the value.

It's unlikely that safe withdrawal rates and their flexibility in timing while assuring that you'd need to see something worse than has happened in the last 120 years before even cutting back to the DB payment level is required was considered.

Safe withdrawal rules (methods) vary in their approaches from including uncapped inflation increases to starting higher and skipping them occasionally if you happen to live through less good times. Same success rate, one using more flexibility than the other and able to use that flexibility instead of having to assume the worst case seen. One might start at 3.5% of transfer value, the other at 5%, same success rate, 99-100% of historic cases. Failure would mean an income drop lower than specified in the drawdown rule, but unlikely to fall as low as DB.

DB vary a lot but generally provide much lower income, typically at the moment a bit more than half as much, lower spousal pension and no inheritance value, typically also having inflation increases capped at 5%, except in the public sector.

The combination of much higher income and ability to vary that over time to take more when younger, better spousal benefits and likely inheritance need to be compared to the simplicity of the DB option and it's generally more certain income.

State pension deferral is a very efficient method of buying more guaranteed income, with uncapped inflation increases. Some annuity buying to cover core needs can also be used.

Thanks for your reply. I must say that I've had to read it several times and Google "What does Safe Withdrawal Rates mean" to try and get the gist although in fairness your last 3 paragraphs probably raise the major issue that I'd not expected.

I'd worked on the incorrect assumption that DB pensions could not be beaten without significant risk and best left alone unless in exceptional circumstances. From what I've understood from your reply, it seems that in many (most?) cases the current CETVs are such that an overall higher but slightly riskier income can be obtained by transferring out of the DB scheme.

Thanks again

Albermarle

NSG666 said:

jamesd said:

NSG666 said:

Anyhow, I've got a deferred DB pension with Peugeot and have always thought DB pensions are like gold dust and should be hung onto. A few years ago Peugeot paid for an optional review with an IFA to see whether it would be better to keep the DB or switch it elsewhere and the answer, along with some calculations, came back to leave it. So I did.

AVCs are investment-based so the outcome depends on the investments that you choose to use with them and what it any income you choose to take and how.

Transfer values have probably increased substantially in the last several years. The calculations probably assumed that you would use the transferred capital to buy an annuity, roughly equivalent to throwing away almost half of the value.

It's unlikely that safe withdrawal rates and their flexibility in timing while assuring that you'd need to see something worse than has happened in the last 120 years before even cutting back to the DB payment level is required was considered.

Safe withdrawal rules (methods) vary in their approaches from including uncapped inflation increases to starting higher and skipping them occasionally if you happen to live through less good times. Same success rate, one using more flexibility than the other and able to use that flexibility instead of having to assume the worst case seen. One might start at 3.5% of transfer value, the other at 5%, same success rate, 99-100% of historic cases. Failure would mean an income drop lower than specified in the drawdown rule, but unlikely to fall as low as DB.

DB vary a lot but generally provide much lower income, typically at the moment a bit more than half as much, lower spousal pension and no inheritance value, typically also having inflation increases capped at 5%, except in the public sector.

The combination of much higher income and ability to vary that over time to take more when younger, better spousal benefits and likely inheritance need to be compared to the simplicity of the DB option and it's generally more certain income.

State pension deferral is a very efficient method of buying more guaranteed income, with uncapped inflation increases. Some annuity buying to cover core needs can also be used.

Thanks for your reply. I must say that I've had to read it several times and Google "What does Safe Withdrawal Rates mean" to try and get the gist although in fairness your last 3 paragraphs probably raise the major issue that I'd not expected.

I'd worked on the incorrect assumption that DB pensions could not be beaten without significant risk and best left alone unless in exceptional circumstances. From what I've understood from your reply, it seems that in many (most?) cases the current CETVs are such that an overall higher but slightly riskier income can be obtained by transferring out of the DB scheme.

Thanks again

Basically there are two schools of thought 

ONE - As above - CETV's are currently high . Based on historical data about investments and long term performance, you should be able to take a bigger lump sum and around 4 to 5% of the pot as annual income adjusted for inflation, and still be left with a pot to leave to your heirs . The 4 or 5% should equate to more than the DB pension.

TWO - The above scenario is not 100% guaranteed, so you are safer to stick with the DB pension. Also the above scenario needs more management.

It revolves around the level of risk which is difficult to quantify, and is a matter of opinion, plus also the type of personality you are. 

Finally the financial authorities have made it more difficult to actually transfer a DB pension , due to concerns over people spending the pot too quick or investing it poorly ( and past scam problems ) and then claiming compensation /welfare benefits when they get older.

NSG666

Albermarle said:

In about 3 years time I intend to start taking the benefits from the DB pension

I have a DB pension that I want to draw upon in c.3 months

Can you just clarify if it is 3 years or 3 months , and say when you intend to take the DB pension is this the 'Normal Retirement Age ' or are you taking it earlier than that ?

Hi Albermarle I hate it when the OP drip feeds info so was trying to keep it simple but the reality is there are several permutations.

I was planning on taking the pension at age 60 in 3.5yrs time but we are looking into moving to and becoming tax resident in Portugal. Once tax resident in Portugal the 25% tax free lump sum that we enjoy in the UK is replaced by a flat 10% tax rate so if and when the time comes I might be better off taking my pension earlier if I want to take the tax free lump sum whilst still UK tax resident.

When I did the edit I hadn't grasped what jamesd was saying and did the edit to try and make the situation more imminent. I was trying to simplify using a hypothetical situation but obviously made it worse.

The thing is I wasn't expecting some of the detailed answers I've received I was just expecting 'you need to look at this' then I'd go off and research what 'this' means in my specific situation.

NSG666

Albermarle said:

NSG666 said:

jamesd said:

NSG666 said:

Anyhow, I've got a deferred DB pension with Peugeot and have always thought DB pensions are like gold dust and should be hung onto. A few years ago Peugeot paid for an optional review with an IFA to see whether it would be better to keep the DB or switch it elsewhere and the answer, along with some calculations, came back to leave it. So I did.

AVCs are investment-based so the outcome depends on the investments that you choose to use with them and what it any income you choose to take and how.

Transfer values have probably increased substantially in the last several years. The calculations probably assumed that you would use the transferred capital to buy an annuity, roughly equivalent to throwing away almost half of the value.

It's unlikely that safe withdrawal rates and their flexibility in timing while assuring that you'd need to see something worse than has happened in the last 120 years before even cutting back to the DB payment level is required was considered.

Safe withdrawal rules (methods) vary in their approaches from including uncapped inflation increases to starting higher and skipping them occasionally if you happen to live through less good times. Same success rate, one using more flexibility than the other and able to use that flexibility instead of having to assume the worst case seen. One might start at 3.5% of transfer value, the other at 5%, same success rate, 99-100% of historic cases. Failure would mean an income drop lower than specified in the drawdown rule, but unlikely to fall as low as DB.

DB vary a lot but generally provide much lower income, typically at the moment a bit more than half as much, lower spousal pension and no inheritance value, typically also having inflation increases capped at 5%, except in the public sector.

The combination of much higher income and ability to vary that over time to take more when younger, better spousal benefits and likely inheritance need to be compared to the simplicity of the DB option and it's generally more certain income.

State pension deferral is a very efficient method of buying more guaranteed income, with uncapped inflation increases. Some annuity buying to cover core needs can also be used.

Thanks for your reply. I must say that I've had to read it several times and Google "What does Safe Withdrawal Rates mean" to try and get the gist although in fairness your last 3 paragraphs probably raise the major issue that I'd not expected.

I'd worked on the incorrect assumption that DB pensions could not be beaten without significant risk and best left alone unless in exceptional circumstances. From what I've understood from your reply, it seems that in many (most?) cases the current CETVs are such that an overall higher but slightly riskier income can be obtained by transferring out of the DB scheme.

Thanks again

Basically there are two schools of thought 

ONE - As above - CETV's are currently high . Based on historical data about investments and long term performance, you should be able to take a bigger lump sum and around 4 to 5% of the pot as annual income adjusted for inflation, and still be left with a pot to leave to your heirs . The 4 or 5% should equate to more than the DB pension.

TWO - The above scenario is not 100% guaranteed, so you are safer to stick with the DB pension. Also the above scenario needs more management.

It revolves around the level of risk which is difficult to quantify, and is a matter of opinion, plus also the type of personality you are. 

Finally the financial authorities have made it more difficult to actually transfer a DB pension , due to concerns over people spending the pot too quick or investing it poorly ( and past scam problems ) and then claiming compensation /welfare benefits when they get older.

Thanks for your input. I'm just getting some up to date figures then I'll need to see whether they are significant enough to even consider a transfer.

jamesd

NSG666 said:

Thanks for your reply. I must say that I've had to read it several times and Google "What does Safe Withdrawal Rates mean" to try and get the gist although in fairness your last 3 paragraphs probably raise the major issue that I'd not expected.

I'd worked on the incorrect assumption that DB pensions could not be beaten without significant risk and best left alone unless in exceptional circumstances. From what I've understood from your reply, it seems that in many (most?) cases the current CETVs are such that an overall higher but slightly riskier income can be obtained by transferring out of the DB scheme.

There are two ways to calculate a withdrawal rate that can be sustained for life.

One is to use historic sequences, so you look at someone starting in say 1937 with a specified investment mixture and the highest percentage of the initial capital that can be sustained for the specified number of years is the rate which works for that case. Do that for every possible starting year in the range - say 1900 on - and pick the lowest rate that worked in every case. That's the 100% success rate safe withdrawal rate based on historic data for that investment mixture and the investment rules being used.

The other way uses expected investment results and lots of simulation runs that are effectively random combinations. Since this ignores market realities about what is possible I don't favour it personally but it's a valid approach. It tends to produce safe withdrawal rates that are 0.3 or so less than the historic approach.

These rules aren't locking you in like an annuity purchase and you can recalculate at any time and adjust if that seems sensible.

Two common rules are:

"4% rule" is based on the original US research by Bill Bengen which gave a bit over 45 as safe for a 50L50 mixture of US equities and medium term government bonds. In later work he added some small cap stocks (less big companies but still a thousand or so employees) and that came to 4.5% and that's what he now calls his rule. Those are for 30 year planning periods. The rule takes your starting capital and takes 4 or 4.5% of that as your income, increasing with uncapped inflation every year. Very simple. If you go back to the results for each starting year the US average is actually 7%, not 4%, the worst case. So with this rule you start way too low for typical performance and usually need to increase income over time if you want to use your money. Since people's spending tends to decrease as they get older that's non-ideal but it is very simple. It's possible to look at starting market conditions and assess what's likely to work above 4% and currently Blll Bengen thinks around 5% starting level will work. UK results are a bit lower, around 0.3 deducted from the US one. These also ignore costs so you subtract around a third of the total cost level to allow for that (not 100% of cost because in the bad cases there's less money invested as the pot decreases and costs are not 100% of starting capital).

Guyton-Klinger rules are a bit more complicated but in exchange for that work once a year start at 5.5% (before costs) instead of 4%. These rules normally increase with inflation but skip that after bad years. They also add an extra cut or increase sometimes after particularly good or bad periods. These adjustments are what allows the higher initial rate. Provided you have some income flexibility this rule set gets out more of your money than the 4% rule and helps you to do it at younger ages because it starts out less pessimistic.

Current private sector DB pensions tend to pay out around 3-3.5% of capital and that never increases if you live through less than worst historic case times, while the drawdown rules normally do increase.

When you use drawdown rules you might start out by checking your state pension and multiplying that by the number of years until you reach state pensions age. Deduct that from your starting pot and then use the reduced pot for the drawdown rules calculation. Then you start at the state pension plus drawdown rule level because you've set aside the money for the state pension bit.

Similarly, you can say you want an extra 10k each year from retirement to age 75 if you like and adjust for that. Or you could do what Jon Guyton (of the GK rules) does in his investment practice: allocate enough capital for the desired income for life and use the rest of the capital for discretionary spending, to be spent whenever desired on whatever is desired, knowing that once it's gone it's not going to be replaced. Even more flexible when it comes to being able to spend when you're most likely to be able to exploit the extra spending.

It's not necessary to use 100% success in a plan. The UK worst case is starting just before the second world war. Switch to 95% or 90% success and you remove many of the effects of the war but you'll still notice if you lie through one and can adjust if you do. The results is a higher initial withdrawal rate.

You can also consider how likely you are to really be alive at the end of your planning period and how flexible you are and this can lead to picking significantly lower success rates that also depend on how much of your core spending is guaranteed. If you're very flexible and your core spending is covered by the state pension you don't really need to care about drawdown "failure" because it doesn't hurt you much. In such a case someone might pick anything from 28-50% success rate, meaning not running out before the end of the planning period, but in exchange might start at (50% or so for the historic average performance) or higher. If you don't see that average you'd either run out or have to take extra cuts... but you might be starting at 7% withdrawal rate with plenty of room for them before your income gets cut to the DB level.

Because this planning is based on the investment capital and withdrawal rates, if you die before the end of the planning period, your spouse can just carry on taking 100% of the planned income. At second death the remaining capital is left for inheritance. Since prudent plans tend to be for things like age 95, the roughly ten percent chance of still being alive level for a man, the chance of substantial inheritance being left is high, more than 90% of deaths for that choice of end point.

Of course the planning is flexible and you can plan for 85 and gradually lowering income to take you to 115 if you like. That sort of planning is likely to involve deferring claiming the state pension because it's increased by 5.8% for each year you defer and the increase is inflation linked for life. So start at 10k and defer for 5 years and it's increased to 13,256 a year. Ten years to 16,512. If you defer long enough to cover your basic income requirement you end up with a very safe long life plan, using the state pension as your longevity insurance. Since you start with the capital pot you and a spouse can both do this deferring, again helping the position of the spouse if they are second to die.

Annuities also become increasingly good value as you get older and by around age 85 they are matching the worst case safe withdrawal rate, thereby becoming quite a good buy to simplify your finances in later life. But because the pay rate per Pound spent buying is improved you'll still have lots of capital left over compared to trying to buy the same income when much younger.

When writing about transfers many will say that you can run out before death and that's true... but it assumes that you've failed to make and follow a proper plan or that you've lived through something worst than the last 120 years and failed to adjust or be prudent with tings like state pension deferral or some annuity buying. Transferring out of DB isn't something for the financially imprudent to do, it requires a degree of financial discipline and planning to be a good move.