What is a Pension Transfer?
If you have previously worked in a private sector job in the UK, you will probably have enrolled in the company’s pension scheme; either “Defined Benefit” (DB) or “Defined Contribution” (DC). Upon leaving the company (e.g. to move to another role and/or to leave the UK), you will have retained your pension entitlement, “frozen” at the point of leaving, and probably started the process of receiving annual pension statements in the post, which many expats will have left to their UK-based relatives to collect in a shoebox!
To quickly define the DB and DC pension types:
- DB or “Final Salary” pension schemes promise to pay the member a portion of their final salary at retirement (e.g. 20%), depending on how many years they worked for the company. These are increasingly rare, with companies over the last 20 years mostly moving towards…
- DC or “Money Purchase” pension schemes. These schemes are effectively a pot of cash, contributed to by both employee and employer, and invested in the stock market, usually via funds chosen from a fairly short list by the member on enrolment into the scheme.
The process of “transferring” either of the above types of pension involves:
- (for a DB scheme): realising a new pot of cash (the “transfer value”) now by giving up the promise of future annual payments in retirement; effectively releasing the DB provider from their responsibility.
- (for a DC scheme): moving the existing pot of cash (the “transfer value”) from the existing provider.
- (in both cases): placing the “transfer value” into a suitable trust arrangement and investment platform in which to invest up to retirement and beyond.
So, the destination is the same for both types of pension transfer, but some of the ramifications to be considered when making the move are different, due to the differing source.
Potential Advantages of Transferring
Given the common destination for both types of schemes, there are a range of potential common advantages in transferring, as well as DB-specific and DC-specific advantages, as follows:
Potential Disadvantages of Transferring
As with the potential advantages, there are potential disadvantages that can be categorised as DB-specific, DC-specific and common, as follows:
Is now a Good Time to Transfer?
As at the time of writing (June 2020) there is great deal of uncertainty in the global economy, so the comfort of a “guaranteed” future income from a DB pension may be very alluring.
That said, there is also truth in the “bird in the hand” saying, and given that we are living in times with extraordinarily low interest rates, DB pension providers are increasingly offering very attractive lump sums so as to free themselves from the obligation of paying pension incomes in future (which many of them can already barely afford).
Hence, the metaphorical “bird in the hand” now can, as well as being “in the hand”, be significantly bigger than the “two in the bush”!
As an example: one recent DB transfer valuation I requested for a client offered him a lump sum value now which was 40x the promised future annual income (in today’s money). Notably, the same valuation requested 18 months before (when interest rates were relatively higher) had offered only a 31x multiple.
So, one input to the decision process for a DB transfer is literally this sort of question: “would you prefer $400,000 to invest today, or a promise of $10,000 p.a. at retirement?”. The answer very much depends on the person.
Conclusion
The decision to transfer a pension, or not, is one which must be driven by data rather than emotion. A full consideration of the costs, including actuarial analysis of the “critical yield” (which gives some idea of how the proposed arrangement needs to perform to at least match the benefits of an existing scheme) is vitally important. The total costs must be weighed against the relevant benefits, and discussed in the context of a holistic understanding of the client’s circumstances and plans.
In recent years, industry practices around pension transfers have become increasingly restrictive (with the UK regulator, the FCA, mandating that transfer analysis starts with the default assumption that a DB transfer is not advisable).
Nevertheless, there is still a strong case to be made for pension transfers, in certain circumstances, and subject to the caveats above around full cost/benefit discussion. Specifically for DB pensions: with interest rates close to zero and transfer values at all-time highs, that case can be validly considered now, more than ever.
Michael Davidson is a Singapore-trained and qualified Financial Adviser with Global Financial Consultants Pte Ltd providing specialist financial advice and portfolio management services to international and local professionals in Singapore.
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*Please note that Michael Davidson is not a tax specialist or accountant and that none of the content outlined here should be taken as personal advice. You should consult your tax specialist and financial adviser to review your current financial situation and futures goals to consider whether this strategy is appropriate for you. I expressly disclaim all and any liability to any person or organisation, in respect of anything, and of the consequences of anything done or omitted to be done by any such person in reliance, whether whole or in part, upon the whole or any part of the contents of this article.
