Defined benefit transfers post-pension freedoms
For adviser use only
The freedom and choice reforms introduced in April 2015 give savers greater control over their defined contribution (DC) pension pots. While many people across the UK have benefited from the reforms, defined benefit (DB) schemes don’t offer the same flexibilities directly and members have found it difficult to access the freedoms their DC counterparts are enjoying unless they transfer their DB benefits to a DC scheme.
DB to DC transfers on the rise
Due to a combination of the pension freedoms available from DC, high transfer values and speculation about DB sustainability, there’s increased interest in DB to DC transfers. The government is currently looking to address the DB sustainability issue with its recently published Green Paper. As advisers, it’s crucial to remember that choosing whether to give up a guaranteed retirement income for life and other possible benefits - even with advice - is a big and complex decision for any client. After all, the transfer ‘all or nothing’ option isn’t right for everyone, and certainly could be off-putting.
Members of DB schemes can only access the pension freedoms if they transfer their DB benefits to a DC arrangement and it’s not possible for these members to access the pension freedoms directly. While transferring to DC does provide increased flexibility, there are many other considerations, namely; giving up a promised income for life, and opting to take on the risk that they might outlive their savings. In the current climate, a significant worry is that, once transferred to a DC scheme, a stock market downturn may reduce the value of savings.
Advisers have a role to play
As you know, members who would like to make a DB to DC transfer have to receive regulated advice if the value of their DB transfer exceeds £30,000. In previous years, advisers have been reluctant to offer such advice on DB transfers due to concerns about the potential liability that comes with them, as people opt to give up a guarantee. While historically, few advisers would challenge the notion that remaining a member of a DB scheme was nearly always better than transferring out, the climate is changing and with it, so must the factors taken into account within advice.
The current approach to assessing whether a transfer is suitable or not is based on the transfer value analysis (TVAS) methodology which predates the pension freedoms. This compares DB benefits being given up with what annuity could be secured from the transfer value at retirement age. If matching the DB benefit would require high investment growth (or critical yield), advisers would be very likely to advise against the transfer, unless there were mitigating circumstances to justify the transfer going ahead.
But the pension freedoms changed everything
Increasingly, people want flexibility and to have a retirement income that not only suits their current personal and financial circumstances, but that can be adapted to a change in the future. In order to make the decision, advice is essential.
It’s key that advisers look holistically at what their client is trying to achieve post pension freedoms, rather than simply focusing on the critical yield within TVAS. Everyone’s circumstances are different and the decision should be based on these specifically.
The world of DBs and the associated transfers is a moving part of the ever-changing landscape of pensions. I hope that, together with Jim Callaghan's feature, this article has provided you with an overview of the landscape as it currently stands. In next month’s edition, we will be giving you a technical update.