If you have pension benefits from an old private sector final salary pension scheme, they could be much more valuable than you think. So, how much is the right to a £5,000 a year prospective pension actually worth in cash equivalent transfer terms?
One of the answers to that £5,000 question – and there are many – is ‘a transfer value of 30 times the pension, in other words, £150,000’.
If you’re surprised, then you are not alone.
Two years ago, such a transfer value figure would have been virtually unbelievable. Back in 2014, a multiplier of around 20:1 was common, making a £5,000 final salary pension worth around £100,000 if you were to transfer the fund close to retirement. The ratio of 20:1 ties in with HM Revenue & Custom’s basis for valuing a pension for tax purposes − £1 of final salary pension is generally treated as being worth £20 of your lifetime allowance. So why the big increase in transfer values?
The impact of interest rates.
The main reason for the increases is the sharp drop in long term interest rates. For example, in early October 2014 the yield on the benchmark 30 year UK government bond (gilt) was marginally above 3.0%. Two years later the yield on gilts had halved to just 1.5%. Final salary pension schemes use long term yields to assess the value of their pension liabilities and so the value of those liabilities increases when bond yields fall. One side effect has been a large rise in company pension scheme deficits. The pros and cons of transfer.
There have even been suggestions in parliament that employers should be allowed to break their pension scheme promises in an effort to bring down deficits and escalating contribution levels. Some schemes have also increased their transfer values to encourage members with deferred pensions to leave, taking their escalating pension liabilities with them. Exchanging £5,000 of pension for £150,000 of pension fund can have several advantages:
- The maximum tax-free lump sum you can draw is likely to be much higher - £37,500 instead of £23,076 assuming a typical 15:1 commutation basis.
- You will be able to take advantage of the pension flexibilities introduced in 2015, allowing you to draw as much of the fund as you wish, when you wish.
- Death benefits will often also be superior, particularly if you are single. Any pension fund remaining at death is normally inheritance tax free and the recipients also escape any income tax charge if you die before age 75. However, there are significant disadvantages, too:
- You lose the promise of a known amount, usually with in-built increases once payment begins.
- You no longer have the back-up security provided by the Pension Protection Fund, if your employer fails.
You will almost certainly not be able to turn the transfer value into a lifetime annuity equivalent to your scheme pension unless you are in very poor health. For example, to match a single life index-linked pension for a 65 year old requires a transfer multiplier of over 37:1.
The decision on whether to transfer is complicated. If your transfer value is more than £30,000 – which could mean a pension of £1,000 a year – under government rules your pension provider must make sure that you have taken regulated financial advice based on your own circumstances before allowing any transfer to be made. We think that makes sense for any transfer.