It is now a little over a year since the pension freedoms came into force so what has happened with final salary pension transfers in that time? After an initial flurry of activity (most likely based on individuals who had prepared in advance of the reforms) the marketplace has settled down a little.
According to Selectapension, the number of people making an enquiry about a switch from a defined benefit (DB) to a defined contribution (DC) scheme increased 106% year on year in the 3 months following the introduction of the reforms.
Final Salary Transfers And The Pension Reforms – A ReCap
The intention behind the pension reforms was to introduce more flexibility for individuals when considering their pension options. The Chancellor said “Pensioners will have complete freedom to draw down as much or as little of their pension pot as they want, anytime they want. No caps. No drawdown limits. Let me be clear, no one will have to buy an annuity.”
As a result defined contribution pension holders can access a pension drawdown arrangement (on reaching age 55). This delivers a wide range of potential benefits but also increased risk. With the scrapping of the 55% tax on inheritance from a pension fund, it gave those accessing pension drawdown the ability to pass on any remaining pension fund to beneficiaries on their death free of tax although withdrawals from the pension fund could be subject to income tax at the beneficiary’s marginal tax rate depending on the pensioners age at death.
The pension freedoms specifically do not apply to those with a defined benefit (final salary pension) to access the reforms it is first necessary to ‘transfer’ to a defined contribution scheme.
The Impact On Final Salary Pension Scheme Trustees
Final salary pension schemes have long been the envy of those with defined contribution schemes and transfer out of such a scheme before April 2015 would not, in most cases, have been recommended. With the introduction of the pension freedoms that situation changed for certain individuals.
For many, the best choice remains staying with their final salary scheme and for those that do transfer, there are risks. There is evidence that trustees of final salary pension schemes who were used to long term stability and a very low rate of transfers were not ready for the reforms. They encountered a new administrative burden when responding to transfer requests and significant member communication issues.
Trustees have an obligation to keep members informed on their options. The challenge is to strike a balance between information that is sufficiently general to satisfy the needs of a wide range of individuals, is unbiased and (possibly most important) protects the trustees from future action by individuals who may claim they were not adequately advised of their options.
The Problem For Financial Advisers
As part of the pension reforms, any individual with a pension fund value of £30,000 or more considering a final salary pension transfer was compelled to seek out advice independent of the scheme. In many cases, this has inadvertently acted as a barrier to choice.
All independent financial advisers operate within a strict regulatory regime policed by the Financial Conduct Authority (FCA). As a result, many financial advisers have taken the decision not to advise on final salary pension transfers as a matter of policy. It can, therefore, be difficult for individuals who wish to consider a transfer to find an adviser (with the appropriate permissions and experience) who is willing to discuss a transfer.
The Final Salary Pension Transfers Valuation (TVAS) Issue
TVAS (Transfer value analysis) is a calculation comparing the investment return required from a personal pension fund to provide the same benefits as those given up by transferring. The calculation is standardised and based on a number of assumptions.
For the inexperienced, a TVAS report can be difficult to interpret as there are a number of factors to be considered, not least the Critical Yield. This simply is the return required to match the benefits at the normal retirement date of the scheme. A high critical yield would usually lead an adviser to suggest an individual stays with their final salary pension scheme rather than transfer but there are many who argue that relying on critical yield alone is not a valid approach.
There is a valid argument that the assumptions made in the TVAS calculation do not represent the reality of today’s inflation rates and investment returns. Critical yields still have a place but only, it is argued by some, as part of the overall assessment not the most critical factor in that assessment.
It is clear a lack of information (be it from Trustees, Advisers or Government) is holding back those individuals whose needs may be better served by executing a transfer. That information must clearly outline both the benefits and the risks. However, only a year on from the reforms progress has been made and as time passes and individuals, advisers, trustees and regulators all gather more experience then the option of final salary pension transfers may be more readily available to those individuals where careful analysis shows a transfer is the best way forward.
The information in this article does not constitute financial or other professional advice.