Pension provider Scottish Widows stated recently that in the second quarter of this year requests for its transfer value analysis report service increased 182 percent over the same period last year. The cash transfer value of a pension is obviously a key input when deciding if it is best to transfer out of a final salary pension scheme (or not) but how is it calculated?
What Is The Cash Transfer Value Of A Pension?
The cash transfer value of a final salary (defined benefit) pension is the cash sum offered in exchange for a pension entitlement. Based on a complex calculation (see below) a specific sum will be offered but for analysis purposes transfer values are often rounded up to give a multiple of the annual final salary pension entitlement.
Until mid 2015, the average multiple across many schemes may have been 20 times the annual entitlement (giving a cash transfer value of £400,000 in return for a pension entitlement of £20,000 per annum) but transfer values on some final salary pension schemes have increased in recent months. Multiples of up to 50 times the final salary annual entitlement have been seen in some schemes.
How Is The Cash Transfer Value Calculated? – Key Principles
The basic cash transfer value calculation is based on establishing (at the date of calculation) what cash lump sum will be required to buy an equivalent pension in the marketplace to the one offered by the final salary pension scheme. That sum is then discounted according to how far the pension scheme member is from retirement.
The method used to calculate the cash transfer value is established in the rules of each individual scheme. The trustees of the scheme are responsible for ensuring that those rules are applied properly and consistently. Any cash transfer offered is ultimately at the discretion of the trustees.
To help them discharge their duties trustees will typically take advice from actuaries to determine the value (in cash terms) of the final salary pension scheme being given up. The trustees must take a balanced view to provide a fair transfer value to the member considering leaving the scheme and protect the value of future pension entitlements for those who remain.
The Cash Transfer Value Calculation
The cash transfer valuation calculation must be based, in part, on what may happen in future and that requires assumptions to be made. It can only, therefore, be the best estimate.
The calculation is made by first establishing what the member’s final salary pension would be worth (including valuing its benefits) at retirement age. An assessment is then made of what sum would need to be invested now to grow to that value by retirement age. This is the transfer value.
To make this calculation the actuary needs to know personal circumstances such as age and health. They also need to take account of mortality rates to make an assessment of when you (and your spouse) may die. They must evaluate the investment profile of the pension, potential future interest rates, the potential future growth rates on various investments, probable inflation rates and potential demographic changes.
Possible Amendments To The Transfer Value
Many final salary pension scheme rules include a provision to reduce (or increase) the cash transfer value in certain circumstances. If the scheme is poorly funded and/or running a significant deficit it may be decided to reduce the transfer value to ensure enough remains in the pension fund to pay all members pensions in the future.
Alternatively, some schemes may decide they wish to encourage transfers (without impacting on other members of the scheme) in an effort to reduce the future liabilities for pension payments. They may, therefore, decide to increase the cash transfer value on offer.
Calculating the cash transfer value of a pension is, therefore, a complex exercise based on a number of assumptions on what may happen in future. Transfer values from scheme to scheme and individual to individual can vary significantly as a result of scheme rules and personal circumstances used as inputs to the calculation. Should you have any questions about the pension transfer value you may receive then please call us on 0800 043 8341 or simply complete the contact box below. You may wish to consult our Pension Transfer FAQ section.
The information in this article does not constitute financial or other professional advice. You should not take action on the basis of this article without seeking regulated independent financial advice that addresses your specific circumstances.