Defined benefit schemes call for new guidelines

12 December 2016   By Samantha Smith

DEFINED benefit (DB) pensions are witnessing a rapid increase in transfer value, leaving many of the 6.7 million people with a DB pension tens of thousands of pounds better off than they were a year ago.

pension nest egg
Credit: SpeedKingz/

According to a report published by the mutual insurer Royal London, some holders are being offered a lump sum worth 30 times more than what their DB pensions would pay out annually, and have seen transfer value increases of 12% a year.

Yet the insurer also add that selling a DB pension is something to be contemplated only if a holder is in genuine need of a lump sum or wants greater flexibility, since it can lead to a loss of financial certainty and security.

Because of this risk, they're therefore calling on the Government to allow holders to "slice and dice" their DB pensions, so that they can exchange part of them for one-off payments while still retaining the safety nets they provide.

Inflation protection

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And given that DB pensions guarantee a specific income to their holders irrespective of stock market fluctuations or economic swings, this safety net is indeed worth keeping in the vast majority of cases.

This is because, rather than being tied to the value of stocks like defined contribution (DC) schemes, the value of a DB fund is determined by an employee's final salary or their career average earnings.

Added to this, most DB schemes have "inflation protection" measures built into them.

As such, a starting pension of £20,000 a year would have risen to £24,282 after 20 years if the scheme included an inflation protection clause running at 2%.

Low interest

It's partly in terms of such protection that Royal London have explained the meteoric rise of the transfer value of DB pensions in recent months.

They state that, in conjunction with inflation protection, the cause of this rise stems from the UK's low interest rates, which ensure that DB pensions offer a better return than many other savings accounts.

Because the rate is now at an historic low of 0.25%, "the transfer values being offered in exchange for DB pension rights have soared to record levels", Royal London affirm.

As Steve Webb, their Director of Policy, informed us, this would suggest that "if interest rates were to rise significantly then we would expect to see transfer values come off their current peak."

Yet despite the distant possibility of a reduction in values, the company are nonetheless urging caution to holders when it comes to using the current window of opportunity to swap their pot for a cash equivalent transfer value (CETV).

In particular, their guide outlines five reasons to transfer a DB pension and five reasons not to do so.

Those who might want to have a serious look at a transfer include those who want flexibility to reshape their benefits ... and those who are interested in being able to pass on unspent pension wealth to the next generation if they die relatively early.
Steve Webb, Royal London

For example, one of these reasons to transfer is the fear that the "employer who sponsors your final salary pension scheme is at risk of becoming insolvent". As we've reported in the past, insolvency would result in the pension pot being transferred to the Pension Protection Fund, which often pays out less to those on higher incomes and those furthest away from retirement age.

Meanwhile, the first of the five reasons to transfer is "flexibility", which can be obtained by selling a DB pension and using the lump sum to open a DC scheme, which unlike DB schemes is covered by the recent Pension Freedoms.

As a result, a DC pension holder can withdraw parts of their pot while leaving the rest invested, whereas any DB holder wanting to obtain cash has to give up their entire pot.

New Pension Freedoms?

It's because of this "all-or-nothing choice" that Royal London are calling on the Government to introduce new pension freedoms covering DB schemes as well.

Steve Webb, their Director of Policy, told us, "a new right for workers to 'slice and dice' their company pension, leaving some as a regular income and taking some as a cash lump sum, would offer new options".

But added to this, the insurer want Government to introduce new rules and regulations also "in order to help" employees with DB schemes to "decide whether to transfer them into a cash alternative".

At the moment, these employees have been somewhat neglected by governmental pension policy, with many unsure as to what they can do with their pensions and whether it would be beneficial to transfer their funds.

However, while there isn't an up-to-date Government policy on DB transfers, advice can be obtained via such bodies as the Pensions Advisory Service (due to be reformed), and via the guide put together by Royal London themselves.

And while transferring a DB pension can be a good idea in particular circumstances, the insurer informed us that, ultimately, "those who dislike risk and like a quiet life and a guaranteed income should almost certainly stay where they are".

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