A final salary pension scheme has long been regarded as the gold-plated route to a comfortable retirement. But since the Brexit vote, some financial advisers and their clients are thinking the previously unthinkable. With cash transfer valuations hitting record highs, it seems there has never been a better time to cash in.
On the whole, Brexit-related market turbulence has been bad news for pension savers nearing retirement who are seeking a secure income. Since the end of June, annuity rates have plunged to new lows and company pension deficits have ballooned, both casualties of the market storms triggered by the UK’s decision to quit the EU.
Yet members of traditional company retirement schemes are experiencing a “Brexit bonus”, in the words of one adviser. In a less well-publicised development, offers made to some savers to cash in their “defined benefit” pension, also known as final salary or career average, have reached new highs since the June referendum.
This side-effect of Brexit-related market volatility has led some transfer valuations — the offers made by pension schemes to swap future income for a cash lump sum — to increase by tens of thousands of pounds in months.
In some cases, cash sums equivalent to more than 30 times the projected annual income on retirement have been offered to pension scheme members. Advisers are revisiting past transfer recommendations as the offers on the table have become more enticing.
But the development is sparking concerns that savers, dazzled by the prospect of such a huge cash windfall, could be tempted to make decisions they will regret later.
Deals get sweeter
About 15m people are members of defined benefit pension schemes, run by some of the country’s biggest private sector employers as well as the public services.
Unlike the riskier workplace pensions offered to most people today, defined benefit pensions promise to pay a guaranteed income for life, based on a final, or career average, salary.
The income rises each year with inflation, and will continue to be paid to a surviving spouse or civil partner — typically two-thirds to half of the original policy.
While most people take the company pension when they retire, many in the private sector (and some public sector workers) can request to take their pension entitlement as an upfront lump sum instead.
Since the Brexit vote in June, these “transfer valuations” made to those who want to swap a future final salary pension for cash upfront have jumped a 10th, say advisers. With some offers improving by tens of thousands of pounds over a matter of months, those in final salary schemes approaching retirement are considering whether it makes financial sense to cash in the pension now.
“Transfer valuations in general are about 5 to 10 per cent higher than they were before the Brexit vote,” said James Baxter of Tideway, the final salary pension transfer specialists. “This summer is showing us the highest transfer offers ever made. It is looking like a Brexit bonus.”
Mr Baxter says in one recent case, a 60-year-old member of a large energy company’s pension scheme experienced a 12 per cent “Brexit boost” to his defined benefit transfer offer.
In March he was offered a transfer value of £1m for an expected annual pension of £31,000 linked to RPI (capped at 5 per cent) that came with a 50 per cent widow’s pension. But just four months later, in July after the Brexit vote, the same valuation had risen 12 per cent to £1.12m.
“Many people are quietly shocked by the revaluations they are getting,” said Mr Baxter.
Others concur with his view that there has been a “Brexit effect” on valuations. “I had a client who had requested a transfer valuation prior to Brexit and it was £1.7m,” said Gary Smith, financial planner with Tilney Bestinvest, the independent advisers. “However, after Brexit he requested another valuation and it was £85,000 higher. This guy was very financially astute and was acutely aware that it was worth revisiting his transfer valuation after the EU vote.”
Revisiting past advice
Over the past year, the number of individuals exploring cashing in their final salary pension entitlement has increased, largely due to reforms that have given millions of savers freedom to spend their pension funds as they wish. But in many cases, those seeking a professional opinion on whether they should cash in have been advised to sit tight in their scheme.
However, the recent improvement in transfer values is leading some advisers to revisit past recommendations. “I have actually tasked our pension specialist to look at all final salary cases where we have recommended a ‘No’ in the past 18 months,” said Richard Lord, chartered financial planner and managing director of Bartholomew Hawkins, chartered financial planners. “We are both of the same opinion that values will increase. Our advice may change on some of these.”
Mr Lord cited a recent example of a client whose £540,000 transfer value, quoted three years ago, had increased by 50 per cent. “They received a new statement at the start of this year where it had increased to £740,000,” he said. “We then requested a further value in May and it was £818,000.”
Savers who opt to transfer their final salary pensions should also be aware of the tax implications. When you reach your scheme’s pension age, a quarter of a transferred pension can be typically taken tax free. Assuming the remainder of the pot is held in drawdown, you will be taxed on whatever you take from it, as income or a lump sum, at your marginal rate.
The link to gilts
So what has prompted the sudden rise in transfer valuations? The key driver has been the sharp fall in AA-rated corporate bond yields, which in turn track 15 to 20-year gilt yields. These yields are what many defined benefit pension schemes use to value their future pension promises.
Pension schemes refer to these yields to produce a Cash Equivalent Transfer Value (CETV) in today’s money on the future pension benefits a member has accrued. When gilt yields and corporate bond yields fall, the cost to the scheme of paying for future pension promises rises. So, theoretically, the cash sum you are offered today for your future pension could also rise.
Punter Southall, the consultants, estimate some transfer valuations are about 80 per cent higher than they were in 2012, and 25 per cent higher than the past year, mirroring movements in gilt yields (see graph).
But those obtaining CETVs today are seeing spikes in their valuations compared with just a few months ago as gilt yields fall to record lows in the aftermath of the EU vote in June.
“Based on our experience, and considering current conditions, it is highly likely that transfer value factors are at record levels,” said Deborah Cooper, a partner at Mercer, the pension consultants. “UK gilt yields are at their lowest-ever level. This means that transfer values per £1 of pension are likely to be at record levels.”
When discussing transfer valuations, advisers refer to a rule of thumb calculation known as the “multiple”, which is how much £1 of the expected defined benefit pension will convert into cash.
Up until a year or 18 months ago, income multiples of 20 were the norm. This meant that if you were projected to receive a £10,000 a year pension, you might expect a £200,000 lump sum if you swapped the income for cash upfront.
However, these multiples have shot up to more than 30 in some cases. “I have a client who was offered [a] £116,000 lump sum for a £3,500 pension, which is a multiple of 33,” said Mr Smith of Tilney Bestinvest. “This is the highest I have seen. Prior to that the highest I had seen was around 30 times.”
Will transfer offers go higher?
Given the effect that plummeting gilt yields are having on final salary cash transfer offers, many will be wondering if the trend will continue.
“Never say never,” said Ms Cooper of Mercer. “Although gilt yields imply that interest rates in future will increase, it is still possible they could get lower.”
Robert Briggs of Briggs Murray Actuarial, which specialises in pension transfers, agreed that valuations could go higher in theory if long-term yields from fixed interest investments went lower. But he cautioned that each scheme actuary would be taking a long-term view and the CETVs generated “may not reflect this” for many schemes.
“In the current transfer market, we consider Brexit volatility will have far less impact on scheme members than actually having the correct information for comparison purposes,” he added.
Once a transfer valuation has been issued, it is valid for three months, after which the member will need to apply for another quote.
Exceptions to the Brexit bonus
It is not a given that all pension schemes will pass on a Brexit bonus to leavers, particularly if the scheme is poorly funded.
“Each scheme actuary has their own views and ‘assumption sets’ — which forms the basis of the CETV calculation,” said Mr Briggs. “As the scheme actuary, they have the responsibility to ensure the basis is in the best interest of all scheme members — not just those wishing to transfer.”
Mr Briggs said the “majority” of CETVs his firm comes across were “not overly generous”. “However, some schemes are consistently less generous whilst others are more generous,” he added. The basis for CETVs was only set by the scheme actuary every three years and “infrequently changed”, he said.
But advisers say this contrasts with their experience of a Brexit uplift on quotes made shortly before and after the EU vote. They say some of the most generous transfer offers are cropping up in the financial services and insurance sectors.
I have a client who was offered [a] £116,000 lump sum for a £3,500 pension, which is a multiple of 33. This is the highest I have seen
“We’ve also seen big offers from the supermarket chains such as Tesco,” said Mr Baxter. “One bank was making the most generous offers we’ve seen, with some people getting cash offers of 34 or 35 times pension income.”
No alerts over transfer boost
The financially savvy and those who have hired a professional adviser may be aware of the benefits of revisiting past transfer valuations. But most members will not be aware if their position has improved.
This is because pension schemes are not obliged to tell their members if transfer offers have become more — or less — generous. That could be seen as encouraging members to take action when it is still viewed as best for most to stay in the scheme.
In spite of the spike in valuations, the Pensions Regulator says that for most members it is “still likely in current conditions to be in their best financial interests to remain in their defined benefit scheme.
“The provision of clear, timely information from trustees and the use of independent regulated financial advice should enable members to make informed decisions that suit their personal aims and circumstances.”
The government requires only those requesting to transfer a pension worth more than £30,000 to first obtain regulated advice. Savers with smaller transfer values are not subject to the advice requirement.
Irrespective of whether transfer values continue to climb, advisers say it is “vital” anyone considering cashing in a pension — regardless of transfer value level — understand what future benefits they might be giving up.
“The guarantees (including escalation and spouses benefits) that these schemes offer are invaluable for most people,” said Keith Richards, chief executive of the Personal Finance Society.
“But in our experience, there continues to be a high level of naivety as to the true value of a final salary scheme. Irrespective of transfer value levels, it is vital that specialist advice is sought because of the potential financial consequences in the long term.”