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Our viewpoint

What do record
low bond yields mean for defined benefit transfer values?

Last week the yields on UK government bonds fell to a new all-time low with long-dated fixed interest yields falling below 1.0% pa. For many pension schemes this has resulted in further falls in their expected best estimate returns and hence transfer values have, once again, reached all-time highs.

For some schemes, transfer values at retirement age are now as high as 45 times a member’s annual pension! This creates transfer values that will appear extremely attractive to members and their advisors – and in some cases they now are.

For example, a member in such a scheme could take their transfer value and then receive 25% as tax-free cash (which in this case would now be more than 10 times their initial scheme pension and could often be double the amount available tax-free from the scheme). Their residual fund could then simply be invested in cash (with very little investment risk, and no capital risk) and this would be enough to support the payment of an inflation linked income each year, matching the expected residual pension that would have otherwise been paid from the scheme, for a very long period, in fact to slightly beyond their life expectancy. On the face of it, this is an astonishing deal, created by very low yields and the legal vagaries around the interaction of commutation and transfer values.

However, this does come with a health warning. Importantly, taking this approach doesn’t compensate the member for all the risks they are taking on – for example they could live significantly longer than typical life expectancy, or inflation could be higher than expected, or the expenses charged to their transferred pension pot could be much higher. In addition, it may not leave sufficient funds for financial dependants after the member’s death. Transfers values also vary widely by scheme and by the member’s age (see LCP benchmarking). Nevertheless, the attractiveness of transfer values has never been higher.

Given these record high transfer values it is important that members are given appropriate guidance and advice on their options. Members with transfer values above £30,000 are required by law to take financial advice before they can transfer but it is concerning that the FCA continue to find the standard of advice to be poor and now estimate £2bn of harm to consumers each year from poor advice. To reduce these risks for members (and manage reputation risks for schemes and employers) many schemes are introducing additional support for their members by providing additional information and education (including online tools) and/or providing access to a specialist financial adviser where the scheme can monitor the quality of advice. Some schemes are also reviewing their member option terms to consider whether they remain appropriate in the current environment.

To learn more about the state of the transfer market and partial transfer options, register for  our breakfast briefing on the issue on 1st October with Sir Steve Webb.