DB to DC Transfers

The volume of requests for a transfer value statement from members of DB pension schemes continues to rise. For the first nine months of 2017, TDC has received 33% more requests for transfer value statements than in the corresponding period for 2016. We anticipate this increased interest in DB transfers continuing for the rest of this year and throughout 2018.

Although more members are requesting transfer statements, the proportion of members who then go on to transfer their benefit entitlement out of the scheme remains low. Some commentators are reporting a conversion rate of 1 in 3 but we see a much lower figure. Only about 10% of members requesting a transfer value statement will accept it and transfer out.

How is the transfer value calculated?

The yields on long term fixed interest investments have been below 2.0% for over 15 months now. It is these low yields that are often used to derive the investment return, or discount rate, in the cash equivalent transfer value (CETV) calculation. Use of a lower discount rate results in a higher CETV calculation. A simple example of a CETV is shown below.

Discount rate of 4% pa, CPI inflation of 2.5% pa, RPI inflation of 3.5% pa

The member has built up a pension of £9,000 pa when he leaves the scheme at age 50. His normal retirement age is 65.

15 years of revaluation at CPI inflation will increase the pension benefit to approximately £13,000 pa at age 65. An annuity rate of 25 is applied to give a value at retirement of £325,000. This is then discounted back over 15 years at 4% pa to produce a CETV of £180,000, which equates to 20 times his pension of £9,000 pa.

Some commentators are reporting CETVs of 30, 40 or even 50 times the pension benefit. A very generous basis for the CETV calculation with these high multiples!

Financial advice

If the CETV is over £30,000, the member has to receive independent financial advice from an authorised financial adviser before the trustees will allow the transfer value to be paid. High quality financial advice from an adviser who has extensive experience of DB transfers does not come cheap. There is a wide range of fee structures in place by the advisers who are active in the DB transfer market. Members should expect to pay a fee of at least 1% of their transfer value, possibly capped for higher CETVs. Some advisers provide and charge for a two stage process covering the initial transfer value analysis with recommendation (to transfer or not to transfer) followed by the advice on where to invest the transfer value, if the transfer is to go ahead. Members should take care to avoid excessive fees for the second stage relating to investment of the transfer value in a DC pension plan.

Legislation and regulation of DB transfers

Primarily to reduce the frequency of pension scams, in August 2017 the Government (DWP and HM Treasury) published proposals to limit the statutory right to a transfer to where the receiving scheme is a personal pension scheme (authorised by the FCA), an occupational pension scheme with a genuine employment link to the member or a master trust (authorised by the Pensions Regulator). Furthermore, the Government is reviewing overseas transfers and the registration of new pension schemes and is planning to ban pension cold calling. The details of these changes are being discussed with the pensions industry and are unlikely to be implemented before April 2018. Trustees and members interested in a DB to DC transfer should remain vigilant!

The Financial Conduct Authority (FCA) is also twitchy about DB transfers. In June this year, the FCA published proposals to strengthen the framework for pension transfer advice, including the requirement to provide all advice as a personal recommendation. In addition, the Transfer Value Analysis (often referred to as the critical yield calculation) is to be replaced with a comparison to show the value of the benefits being given up.

And finally, as part of its wider review of the workings of the pensions “freedom and choice” legislation of April 2015, the Work and Pensions Select Committee confirmed at the end of September that it will examine transfer activity amid concerns over potentially unsuitable advice being given to members of DB schemes.

On 3 October 2017, the FCA published statistics from its review of 88 DB transfers that had a recommendation to transfer. The FCA found that (only) 47% of these recommendations were suitable!