Defined Benefit transfer warning as values fall
Members with a Defined Benefit or Final Salary pension may be considering opting out to the flexibilities associated with a Defined Contribution scheme.
Transfer values reached record levels as long-term interest rates fell to lows in the late 2010s.
This is because low interest rates made DB pensions expensive to finance and so higher transfer values were offered to those willing to leave the schemes.
While transfer values have remained at high levels for several years – often exceeding the value of the family home – they have started to fall in recent months.
Pension consultancy, Lane Clark & Peacock (LCP) looked at transfer value quotations for more than 70 DB schemes, and its calculations suggest the typical transfer quote in Q1 this year was £300,000.
This is a drop from the £400,000 estimated in the final three months of 2021.
Timing the market
As interest rates continue to rise, members may be concerned that transfer values will fall further, and so they are urged not to ‘panic buy’.
LCP’s research revealed there are a variety of factors which influence transfer values, not just interest rates.
It said there can be big variations from one scheme to the next in transfer values offered for an identical pension. In fact, it found that for those 10 years out from retirement, the amount offered can be double that offered by others.
Other factors include the age of the member (transfer values tend to rise as people get closer to retirement). This is because schemes assume that the investments used to back the pension promise will make an investment return. If the member ages, there’s less time for the return to be made, so the amount needed to back the member’s pension promise tends to increase, which tends to result in a transfer value increase.
De-risking is another variable. LCP explained that a pension scheme with lower risk investments will tend to offer higher transfer values than one with higher risk investments.
And longevity of members is another factor. The longer someone lives, the more expensive pensions are to provide. This results in transfer values tending to be higher – and vice versa. Members could see a reduction in transfer values if for example the Covid-19 pandemic leads to schemes reducing their assumptions on life expectancy.
Transferring out is a ‘big decision’
Clive Harrison, partner at LCP and author of the report, said: “Although a further increase in long-term interest rates could lead transfer values to fall, there are other factors which could go the other way.
“Our research suggests that many schemes have improved their transfer values in recent years, and that trend may well continue. We also find that for an individual member their transfer value is likely to increase as they get closer to retirement, other things being equal. This means that DB scheme members should be careful not to ‘panic buy’ DB transfers on the assumption that transfer values will only go in one direction.
“Transferring out of a DB pension is a big decision which should always be made after taking careful note of expert and impartial financial advice”.