Adrian Boulding, Director of Retirement Strategy at Dunstan Thomas
Since April 2015 when Pension Freedoms & Choice triggered swathes of 55-plus year olds with Defined Contribution (DC) pensions to cash out; the regulators, government, advisers and product providers alike, have also been expressing ill-ease at the rising numbers of Defined Benefit (DB) scheme members transferring out of their ‘gold-plated’, accrued benefits-laden schemes, into relatively-stripped down DC schemes in order to access their retirement savings early.
Although there is no doubt that Pension Freedoms has created the incentive to transfer out of DB schemes to access retirement income early (and without the scheme’s actuarial reduction factors); there are several influences working together to accelerate the number of DB transfer requests now coming through. If you are wondering about the volumes we are talking about, DB transfers increased by more than 50% over the last 12-months alone, according to Royal London. The Pensions Regulator estimates that over 80,000 DB transfers were completed in the last year.
Firstly, DB transfer values are rising fast. According to the Xafinity Transfer Value Index they are increasing by between 3-3.5% per month currently. Average transfer values, according to Royal London are 25 to 30 times the value of the annual pension that the DB pension promised by way of an annuity. The difficulty of finding the financial advice required to complete a transfer over £30,000, led the head of The Pensions Advisory Service Michelle Cracknell to declare “market failure”. In many cases those that are requesting transfer valuations are all too likely to be blinded by their own personal ‘ka-ching’ moment before they can get professional help.
Why are valuations rising so fast? Actuarial regulations require that the transfer value must reflect the potential growth rates of the scheme’s assets, and as trustees have fled to ultra-safe – and ultra-low return – assets we have seen transfer values spiral upwards. Meanwhile the accounting standards that drive how DB deficits are reported in company accounts are so pessimistic that even after paying out these huge transfer values, employers see an apparent reduction in their deficit as members leave. Many DB schemes have closed to new entrants and today only 11 FTSE-250 companies still provide DB benefits to a significant number of employees, according to research by JLT Employee Benefits.
The sums on offer are now so mind-bogglingly large that many members believe they won’t be able to spend them all in their retirement lifespan. A frequently-cited reason for taking these large transfer values is the much more generous death benefits that can be achieved within a SIPP. Instead of a DB pension that dies with the member, or reduces by 50% before paying a spouse’s pension, taking a transfer value opens the possibility of leaving all the unused pension pot tax free to either the spouse, children or grandchildren.
Meanwhile, the Financial Conduct Authority (FCA) is about to close consultation on CP17/16 which is shaping a new, supposedly more modern system for advising on DB pension transfers. The proposed Appropriate Pensions Transfer Analysis (APTA) system, looks to be in line with the EU Institution of Occupational Retirement Provision Directive (IORP II) which must pass into UK law just ahead of Brexit on 13th January 2019.
Both IORP II and the FCA’s APTA seek to properly compare the accrued benefits being given up by a DB member planning to transfer out with what they might get in DC.
APTA could be supported by a prescribed comparison tool to be called Transfer Value Comparison (TVC) which will calculate the cost of buying equivalent benefits in the new DC scheme that members have elected to transfer out to. It might look like this:
At first sight you might think this will put people off transferring. The message is that if you invest your transfer value prudently and then buy an annuity at retirement you will be £20,000 worse off than if you had stayed in the DB scheme. However, as many transferees are saying: “I won’t be buying one of those expensive annuities,” I think it will do little to deter people.
It’s also likely to become less onerous to complete transfers in the next year or so. There are moves afoot to streamline the DB transfer process to reduce the average 33 weeks it takes to complete the process today, to as little as 48-hours, if the Transfers and Re-registration Industry Group standards thinking is adopted.
It is clear if you read the Origo white paper, ominously entitled ‘The troubles with DB transfers’, that there are lots of process issues which are preventing rapid transfers right now. These can be summarised as a lack of standards for data capture and transfer between parties and lack of automation and connectedness between all parties involved. But if increasing volumes of members lose out as a result of process delays, then we should expect the Ombudsman to take an unforgiving attitude towards those responsible.
In addition, there is also some evidence of a skills shortage amongst the adviser community as Origo uncovered in its in-depth discussions with a wide cross-section of Third Party Administrators and Employee Benefits Consultants handling a rising number of DB transfer requests. That said, a new DB pensions transfer specialist qualification, launched by the Chartered Institute of Insurance (CII) in July and also now offered by The Chartered Institute for Securities & investments, should help.
In addition, IORP II will likely further boost the DB transfer market, by demanding that DB scheme operators communicate all members’ ‘benefits value’ annually. There is nothing like dangling a large sum of money under a person’s nose to get their attention!
It’s not just the numbers of members transferring out that is likely to get IFAs to sit up and think, but the fact that all DB transfers which exceed £30,000 must obtain advice from a regulated adviser, as stipulated in Pension Schemes Act 2015, before the transfer value can be paid across. As the valuation multiples continue to increase, more and more transfers will go North of this threshold.
As Isaac Newton discovered, what goes up must eventually come down. But when we do get to the point that DB transfer values start to edge down, that tipping point will only drive a further increase in volumes as people scramble to get out before the current golden (transfer) age comes to an end.
Indeed, the Xafinity Transfer Value Index, which tracks the transfer value that would be provided by an example DB scheme to a member aged 64 who is currently entitled to a pension of £10,000 each year starting at age 65 (increasing each year in line with inflation), indicates most values are well above the FCA’s threshold – Xafinity’s index stood at £237,000 just last month:
IFAs should also have half an eye on a potential spike in demand for DB transfers once the Pensions Dashboard goes live in 2019. Most people agree that seeing different pots all-in -one place online will lead to an increased demand for consolidation of pension pots and, once people reach age 55, increased DB to DC transfers. The trick will be responding to inevitably increasing demand for greater flexibility, without jeopardising clients’ and their dependents’ retirement income prospects.
Adrian Boulding is Director of Retirement Strategy at Dunstan Thomas
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