Pensions Stick or Twist – the final salary pension conundrum

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Blackjack or Twenty-One is the world’s most widely played casino game and, like all gambling pursuits, is, of course, a game of chance. For those who may have forgotten the rules, each player is trying to beat the dealer by building a count as close as possible to, but not, exceeding 21. Initially, two cards are dealt to players and dealer. Then further cards can be either bought or twisted for free. As you would expect, the best hand is an ace and a '10' or picture card, which scores 21. With any other hand, however, the player must assess the chance of drawing a card that will take the value of the hand to 21 or at least beat the dealer – also known as The Bank – who tantalisingly has one card face down and the other face up.

I’m not as enamored as others seem to be about a game in which it is only a matter of time before your money is handed over to the casino even if, occasionally, some people do win. What does intrigue me about Blackjack is the neat mathematical coincidence that the odds of making 21 points with the first two cards are 21 to 1.

The number 21 also pops up in retirement planning, given that a male who has reached the age of 65 today can, according to the Office for National Statistics, reasonably expect to live for another 21 years. The relevance of this fact is becoming a reality for the 11 million people who have a final salary pension and need to make a decision before reaching retirement age whether to take a guaranteed lifetime pension or, instead, to accept a lump sum transfer in lieu of the pension. In a way, this is similar to a game of Blackjack, where the first two cards do not add up to 21, the options are either to stick with the cards that have been dealt and take the income, or to twist and take the life expectancy gamble.

In our post-Brexit world, transfer values have been on the increase; they have been fuelled by falling gilt yields, interest rates nudging 0% and further money supply tinkering by central bankers via Quantitative Easing. Combined with the recent pension freedom rules that allow full access to pension pots from the age of 55, it is no surprise that there has been a marked increase in the number of clients reviewing their pension options.

Let us consider the case of a 65-year-old who has been offered a transfer value that is 21x the value of the pension. In this case, if the transfer is accepted, the equivalent pension could be drawn from the lump sum for 21 years if the investment return on the transfer is equal to inflation. For the sprightly 65-year-old with a family history of longevity and risk aversion, the best option would be to stick. On the other hand, the gambler with significant other assets and an eye on using the pension for estate planning may still be tempted to take the opposite view.

But what if the transfer value is 35x the pension? Statistically, there is only a 1 in 14 chance that a 65-year-old male will live to be 100 so there is a 13 out of 14 (93%) chance that a higher income could be drawn for life without taking a significant risk.

Unlike Blackjack, the outcome is not a pure gamble – some investment risk would need to be taken to achieve an RPI-linked return and, therefore, the completely risk adverse investor should always stick with the guaranteed pension. Then again, some current transfer values are so high that they are almost the equivalent of a card-player being dealt in the first instance an ace and a king. I have seen multiples as high as 70x from the Bank of England Pension Fund, which means that twice the income offered by the scheme could be payable from 65 to 100 for an RPI-linked investment return.

If life is a game against the dealer, the transfer values being offered by pension trustees certainly give the player more time to try to beat the bank.

Ross Glanfield – Latest Blog Posts

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