When considering a final salary pension transfer it is important to ensure the industry jargon is explained to you in full. What is critical yield is a question we are often asked.
The “critical yield” figure provides guidance on how much your investments (after charges) will need to achieve (after transfer) to match what you would have received from your final salary scheme.
The critical yield is usually calculated using an automated system known as TVAS (Transfer Value Analysis System). The system bases its calculation on a number of assumptions including expected inflation and changes in average earnings. As many of the assumptions are likely to change and are open to interpretation their values are specified by the Financial Conduct Authority (FCA) to ensure consistency.
The critical yield is usually considered together with the CETV (Cash Equivalent Transfer Value) and delivers an indication of risk. If the critical yield shows that the rate of return required on investments to match what would be available from a final salary pension is at or around the returns that could be achieved from low-risk investments such as Gilts then the risk is relatively low.
Conversely, if to achieve the critical yield potentially higher risk investments are required then the risk is higher. It should be noted that the method of calculation used to establish critical yield has its critics and it does have its drawbacks but it remains a useful indicator.