How to convert an AVC fund to an annuity?

MarkyMarkD

Thanks for your comments, DFC.

Your point about retirement ages is fair - I moved from an employer with a 65 retirement age to one with a 60 retirement age, and consequently got less years in the new scheme than I gave up in the old.

But in line with your comment

You do not benefit financially from a transfer. What you get in the new scheme is financially equal in value to what you had in the old scheme.

I stand by my comment that you WILL benefit from transferring if your salary increases by more than inflation. That's a fact - like for like (DC to DC).

If you are transferring from DC to DB, then OK as you say you are giving up the investment upside. But everyone with any nous recognises that the certainty of DB is worth far more than the loss of upside on DB. So if you have any opportunity to switch from DC to DB, I would seize it with both hands.

erb

on 06. Nov 2004 at 23:37, peterfleet wrote:

Suppose Erb was advised, because say Erb was within 5 years of normal retirement age, to take early retirement pension from the former employer's scheme while also continuing in work and contributing to the current employer, would the Equitable Life AVC fund still be hit by the MVA deduction?

In all probability, yes  :(

He would need to look at the terms of the AVC contract, or at least ask the administrators to confirm the position.

Erb's comments - I would not considered the early retirement option as the occupational pension from my previous employer would be significantly reduced because of taking the pension early.  Also, the pension income added to current earnings has tax implictions possibly taking some of them into higher rate.

BTW I did ask for a transfer value a few years ago from my previous employer's pension administrators but it did not include anything for the Equitable Life AVCs making me think this was separate.  It now apeears from comments above the transfer value should include the Equitable AVC less the penalty for early encashment.  I will be watching for this in the recent transfer value I have requested.

Pal

Erb

AVCs are often quoted seperately but only because the AVC company usually sends a seperate statement. Make sure that you have an AVC transfer value statement before you make any decision to transfer any of your pension.

But in line with your comment I stand by my comment that you WILL benefit from transferring if your salary increases by more than inflation.  That's a fact - like for like (DC to DC).

But by the same token you will lose out if your salary increases at a lower rate than the actuary has assumed in their calculation.

The comparison with inflation is misleading. Most actuaries assume that your salary will increase about 2% faster than inflation on average, and you have to beat that in order to benefit from transferring.

As DFC says, at the time you transfer, the two benefits are worth exactly the same amount of money, irrespective of what scheme you are moving from or to.

If you are transferring from DC to DB, then OK as you say you are giving up the investment upside.  But everyone with any nous recognises that the certainty of DB is worth far more than the loss of upside on DB.  So if you have any opportunity to switch from DC to DB, I would seize it with both hands.

You may believe this to be true, from your prespective based on your circumstances, but it will not be true for everyone. I have seen DC schemes where the contribution rate is far in excess of that required to fund the DB benefit being given up. They are rare, and the individual members do need a bit of financial sense to avoid investing badly, but it means that you cannot give a blanket statement that DB is always better than DC, especially for younger workers.

Of course the only way to really know is to wait until retirement and work out which one gave the biggest pension, but unfortunately its a bit late by then.

Personally I have never heard of employers matching added years with a previous employer's scheme unless they are forced to by a sale and purchase agreement, or it is part of a Government scheme transfer club.

MarkyMarkD

But by the same token you will lose out if your salary increases at a lower rate than the actuary has assumed in their calculation.

The comparison with inflation is misleading.  Most actuaries assume that your salary will increase about 2% faster than inflation on average, and you have to beat that in order to benefit from transferring.

As DFC says, at the time you transfer, the two benefits are worth exactly the same amount of money, irrespective of what scheme you are moving from or to.

If you leave your benefits in the original scheme as deferred, they will increase by RPI at the most.

If you transfer them into the new scheme, they will increase by your salary rate of increase.

The comparison with inflation is NOT misleading. It is correct.

If the two schemes make the same assumption regarding future salary growth, and have the same payment rate (e.g. /60th) then they will give the same number of years and what I have pointed out will apply.

The true comparison is NOT with the actuary's assumption (if the two schemes made the same assumption) but with RPI.

You may believe this to be true, from your prespective based on your circumstances, but it will not be true for everyone.  I have seen DC schemes where the contribution rate is far in excess of that required to fund the DB benefit being given up.  They are rare, and the individual members do need a bit of financial sense to avoid investing badly, but it means that you cannot give a blanket statement that DB is always better than DC, especially for younger workers.

The schemes you are talking about are incredibly rare. And even if the DC scheme has notionally better benefits, they are uncertain. Certainty is worth a great deal where pensions are concerned.

Personally I have never heard of employers matching added years with a previous employer's scheme unless they are forced to by a sale and purchase agreement, or it is part of a Government scheme transfer club.

I know one company which absolutely does this. And as I state above, if both schemes make the same assumptions about future salary growth, and have the same benefit arrangements, they will end up giving the same number of years by default (apart from the impact of salary increase between the two jobs).

Pal

If you leave your benefits in the original scheme as deferred, they will increase by RPI at the most.

If you transfer them into the new scheme, they will increase by your salary rate of increase.

The comparison with inflation is NOT misleading.  It is correct.

No it is not correct, and this is why:

When an actuary is valuing a preserved defined benefit to calculate a transfer value they assume that it will increase in line with inflation to work out what pension will be payable at retirement. Basically they then multiply the pension at retirement by the life expectancy (allowing for pension increases in payment and investment returns the scheme will receive during retirement) to come up with a lump sum value of the pension at retirement date. This value is then discounted back by an assumed investment return (usually equities) to get a current transfer value.

If you switch to a DC scheme you have to beat the transferring actuaries investment return in order to make it worthwhile transferring.

If you are transferring to a DB scheme, the process is a bit longer. The receiving actuary takes the transfer value that has been quoted and works it forward using an assumed investment return (often equity based). This is the amount of money that they believe that the receiving scheme will have at your retirement date.

They then take your life expectancy, allow for post retirement investment returns and pension increases, and work out what pension they could afford to buy using that money at retirement. Most pension schemes then give this figure as a fixed pension at retirement in return for the transfer value.

Those rare schemes that still give added years then make an assumption about how fast your salary will increase between now and your retirement. They then put the fixed pension at retirement and your expected salary at retirement into the normal pension calculation formula (e.g. 60ths), in order to calculate the number of added years pensionable service that they can give for the transfer value received.

At no point in this calculation is any reference made to inflation by the actuary calculating the added years, and the value of the added years given is exactly the same as the transfer value on the day the calculation is carried out. As a result, the only way you can gain from transferring into a DB scheme is to outperform the salary assumption made by the receiving actuary.

Outperforming RPI is not enough as most actuaries will assume salary increases a couple of percent above inflation, often around 5% p.a. at the moment.

If the two schemes make the same assumption regarding future salary growth, and have the same payment rate (e.g. /60th) then they will give the same number of years and what I have pointed out will apply.

No they won't. The transferring scheme actuary does not make any assumptions at all about your salary increases because you have left their employment and are no longer receiving salary increases. The transfer value is calculated by reference to inflation and investment returns. The added years is calculated using salary increases and investment returns.

In theory if the two scheme designs were exactly the same and the two actuaries used the same mortality assumptions and investment return assumptions you would end up with less added years in the receiving scheme than you actually had in your previous scheme because of the difference between the inflation assumption and the salary increase assumption.

Only if the actuary was assuming that your pay increases would be the same as the transferring actuaries inflation assumption would you end up with the same figures. You would still need to beat the recieving actuaries salary assumption in order to gain a larger pension from transferring.

The schemes you are talking about are incredibly rare.

They are rare but perhaps not as rare as you might think. Most DC schemes pay fixed rate contributions, and at younger ages (below about 30) the rates paid are normally worth far more than the equivalent DB benefit.

It is a little known fact that most younger members of DB schemes do not benefit at all from any company contributions, as their own contributions (typically 5% of pay) are in excess of that required to pay for their own benefits at retirement on an actuarial basis. In effect they are cross subsidising the older members, although obviously this is not often communicated to the younger members of a scheme!

And even if the DC scheme has notionally better benefits, they are uncertain.  Certainty is worth a great deal where pensions are concerned.

While I tend to agree, this is obviously an opinion and depends largely on the individual concerned. Certainly those who are likely to receive good payrises are better off in a DB scheme. However many minimum wage employees might be better off in a DC scheme. Unfortunately however someone on a minimum wage is unlikely to have the investment knowledge to successfully run a DC scheme to their advantage, so in many cases a DB scheme may be a better option, even though the expected benefits are likely to be lower.

I know one company which absolutely does this.

Presumably the scheme has a very large deficit or does not give very high pay increases to its staff. Or possibly both. Local Government would be an example.

Debt_Free_Chick

Pal,

In my case it would be a transfer into the civil service pension scheme and yes my previous employer is in the club (pardon the phrase).

I first considered transferring 6 years ago when I had to change jobs but then my new salary was much lower than my old salary so thought it best to keep with my deferred pension.  In that 6 year period promotion and salary increases mean earnings are higher than in my previous job.  Consequently, I regret not transferring at the outset.

Ignore all our other debates about the pros & cons of transferring. The Transfer Club is the one arrangement where you can transfer on a completely like for like basis - but do check early retirement/ill health retirement terms as there may be variations between the two schemes.

You may still be able to transfer and get a year-for-year credit in your new scheme*. Contact the administrators for your new scheme and make enquiries.

* The reason being that all the benefits are funded by the taxpayer, as I'm sure you know. Had you not left the first scheme, you would have had a pension based on whatever your current salary would be. So, arguably, you are not costing the taxpayer any more than you would have done, had you not left your first scheme

erb

WOW I didn't know that such a simple question at the outset would result in such a complicated debate.

I would like to thank all those who have contributed to this discussion and I am sure this will prove useful to all those who read it.

I can now see why pensions need simplifying as the lay person has no chance of understanding the system and workings.

Thanks again.

peterfleet

I was guilty of starting this thread, so I thought I would compound it by adding a tax wrinkle.

There was a tax situation that caught a friend. He had left a very well paid job a few years before his Normal Retirement Age and decided to do less well paid work for the couple of years before drawing his DB pension at his NRA.

His retirement date was in a November and he began his discussions before that date with his employer's pension admin unit to agree a lump sum and receive his defined benefit pension pay monthly. The pension admin took ages and his first pension pay backdated to his November retirement date was delivered to his nominated bank account in the following May.

The result of this was a higher tax bill overall because the backdated pay, although due in the previous tax year, was paid in the new tax year and pushed him into the 40% band. The Inland Revenue would not budge, and the pension admin unit, backed by the pension scheme trustees effectively said tough. I don't know what legal redress, if any, he could get. We are talking about over £2,000 of extra tax caused by this.

Pal

If your friend is confident that the delay was not his fault (i.e. he completed all the forms, provided certificates on time etc), then he should use the Trustee's internal dispute resolution procedure claiming maladministration by them. If they still refuse, go and see opas, and then if necessary report them to the Pensions ombudsman.

Delays do happen sometimes but November to May (if it is the administrators fault) is pathetic.

peterfleet

Thanks Pal. I will pass your comments on. I don't know if he has got the stomach to push this further, but I would certainly do it if I were in his shoes.