UK defined benefit cash equivalent transfer values hit new highs in 2016 as a result of record low UK gilt yields.
If a person has a defined benefit (DB) pension in the UK and wishes to consider transferring that pension to an alternative type of pension (like a self-invested personal pension (SIPP)), an application is made for what is known as a cash equivalent transfer value (CETV). A CETV is calculated by the DB scheme and is essentially the cash value placed on a person’s pension benefits if they were to transfer to a different plan and give up their rights under the existing DB scheme. Rather than receiving an annual pension from the DB scheme, the individual would receive a cash lump sum to invest in an alternative plan.
By way of example, in the July 2016 Xafinity Transfer Value Index, if a 64 year old who at retirement at age 65 would receive a £10,000 p.a. pension (which would increase each year with inflation), a CETV for such a pension was calculated at £227,500*. This was a £2,000 increase to the June 2016 figures. While this is only example, it clearly demonstrates the impact that lower UK gilt yields are having on CETV calculations.
Higher CETVs have increased the number of people considering transferring from their DB schemes to alternative forms of pension in order to access the capital value of their UK pensions and enjoy the new UK pension flexibilities introduced in April 2015. Whether or not a person should transfer their DB pension to something like a SIPP will depend upon a number of important factors which should be carefully considered with a financial adviser.
Growing interest in DB pension transfers will give rise to increased pressure on DB schemes at a time when they face record high DB pension deficits. Analysis by Hymans Robertson, the UK pensions and risk consultancy firm, concluded that the Bank of England’s decision to cut interest rates and begin a new quantitative easing program on 4 August 2016, has increased UK pension liabilities by a staggering £70bn to £2.4 trillion. This raises the aggregate UK DB pension deficit up to £945 billion, the highest deficit ever recorded.
Recent headlines in the UK have highlighted cases where increasing DB scheme liabilities are putting some companies at risk of insolvency, thereby impacting member scheme benefits. However, the impact of the drop in UK gilt rates will impact DB schemes differently depending upon the funding plans they already in place. Each DB scheme needs to be assessed individually and careful consideration should be given to whether a person’s DB pension could be at risk in the future. That being said, it is clear that the debate will continue around the ability for DB schemes to survive in the future and what action (if any) the UK government will need to take to assist schemes going forward.
*Different DB schemes calculate CETV’s differently so a person may receive a CETV quote that is significantly different from this quote.