There are approximately 6,000 DB (defined benefit) pension schemes in the UK with around eleven million members. Evidence shows the number of DB to DC pension transfers is increasing but how long is that situation likely to continue? We take a peek into the future.
Pension Transfers – What’s Happened To Date
The pension freedoms (2015) gave defined contribution (DC) pension holders more control of their pension funds. They also made it practical to pass remaining pension funds on to beneficiaries without a significant tax penalty. However, the pension freedoms do not apply to members of defined benefit (DB) schemes. To access the potential benefits of the pension freedoms DB pension holders must transfer to a DC pension scheme.
Several economic and political factors have driven pension transfer values to an all time high on many DB schemes. This has made a pension transfer an attractive option for some. Of course, a pension transfer is not the right route for everyone and there are risks.
The Financial Conduct Authority (FCA) standard position remains “ in most cases you are likely to be worse off if you transfer out of a defined benefit scheme, even if your employer gives you an incentive to leave.” Helpfully, they do also state “However there are risks to staying too”
Regulation and Availability of Advice
It is a legal requirement for an individual to seek financial advice on a potential transfer if the transfer value is £30,000 or more. Only a relatively small subset of the total financial adviser population have the relevant permissions to provide that pension transfer advice.
Although there is evidence more advisers are trying to secure relevant qualifications and permissions the value of experience of the transfer process should not be underestimated. If demand for pension transfers does increase in future there could be a limit on the availability of high quality advice.
All financial advisers must have insurance in case there is a problem that results in a client’s complaint (and compensation claim). With transfer values at a high point the financial risk (to insurers) is higher and hence so are their premiums
Some advisers avoid transfer business as they do not wish to pay the increased premiums. With all the media hype (much of it one sided) about British Steel pension transfers and the potential for claims, this situation can only get worse, further restricting the availability of advice. A survey by the Association of Consulting Actuaries in Summer 2017 found 60 percent of employers reported DB scheme members were having difficulty finding financial advisers prepared to offer advice on DB to DC pension transfers.
Ongoing DB to DC Transfer Demand
There are over five million members of defined benefit pension schemes in the UK who are yet to retire. As stated above the interest in DB to DC transfers started to increase, post the pension freedoms, in 2015. In the year ending March 2017 there where 67,700 DB to DC transfers (source). This year that figure is expected to increase substantially, perhaps by over 50 percent.
A recent Association of Consulting Actuaries survey showed 47 percent of DB pension scheme sponsors say that pension transfer requests currently exceed 5 percent of the membership. The percentage of the total who do transfer will depend on several key drivers but given the current low level of awareness of pension transfers it is reasonable to assume the transfer rate may well exceed 10 percent of the total DB pension membership. Pension transfer demand may, therefore, continue someway into the future.
What May Change
There is a direct link between interest rates and pension deficits. As interest rates rise pension deficits tend to fall. Interest rates rises also impact on the pension transfer values calculations. As interest rates rise pension transfer values also tend to fall.
Interest rates in the UK have recently risen by 0.25 percent and the Bank of England has indicated modest increases will continue over the next few years. In theory, this should force down both pension deficits and transfer values.
However, there continues to be a high degree of uncertainty what will happen to markets over the medium term. The impact of Brexit (if any) is difficult to quantify as negotiations continue. In an uncertain World, there is the potential for major political events that could send markets into freefall.
Any ‘all time high’ position is unlikely to last forever and pension transfer values have remained at a high point for several months. It is reasonable to assume that pension transfer values will fall back to historic levels although it is difficult to predict when that may be.
The DB pension transfer situation remains uncertain. The pension freedoms delivered (possibly unintentionally) potential reasons to transact a DB to DC pension transfer. Since then a variety of factors have both driven up pension transfer values and increased DB pension deficits giving those aware of the situation more to consider.
There is some political pressure to row back on the pension freedoms. The FCA, stung by the criticism levelled at them over the British Steel situation are subjecting Financial Adviser firms to ever greater scrutiny. Putting the pension freedoms Genie back in the bottle will be difficult but changes to legislation are possible.
Legislation changes could drive a short term spike in transfer activity as some seek to take the opportunity before the door closes. More likely, there may be an ongoing steady increase in demand for DB to DC pension transfer assessments.
Alternatively, economic conditions may drive down transfer values. Negative media coverage could make many reluctant to investigate the potential opportunity the pension freedoms delivered. It is impossible to predict what will happen.
With the increase in resources required to cope with ever greater regulation, constant negative media coverage of Independent Financial Advisers who conduct transfer business and increasing insurance premiums if DB to DC transfer demand does increase in the coming years there could be few financial advisers prepared to satisfy that demand causing a significant advice gap.
Past performance is no guarantee of future returns. This blog is intended to provide a general review of certain topics and its purpose is to inform but NOT to recommend or support any specific investment or course of action.