The Panacea of Partial Transfers – or don’t put all your eggs in one basket

Richard Smith

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There have been a plethora of news articles in recent weeks commenting on the sharp increase in the levels of transfer values available from defined benefit pension schemes. Whilst these values have dropped back from their peak, they still remain substantially higher than they had ever been previously to this. The sometimes eye-watering sums on offer are now tempting even the most prudent to consider cashing out their benefits. However, some commentators are warning members against losing the longevity protection provided by a DB scheme and taking on all the investment risk themselves. What are members to do?

Subject to a few exceptions, anyone who is a member of a funded defined benefit pension scheme and has not yet started to draw their benefits, has the right to “transfer out” their pension and pay the cash value into another pension scheme. Doing this gives members much more flexibility in how they take their pension – increasing the cash available (even potentially taking it all as one large cash sum), re-shaping the benefits to release more value in the early years of retirement, and could also lead to significant increases in survivor benefits if the member were to die early.

It’s not all good news though – there are risks attached, not least the risk that the member will outlive their savings, and not have enough left over to spend the latter years of their life in the comfort that they might have hoped. The pros and cons of taking a transfer value have been debated at length, and ultimately it is a very personal decision. It will be a very good decision for some, and a poor decision for others. That is essentially why anyone wishing to take a transfer in excess of £30,000 must take independent financial advice from a qualified professional.

What has become apparent after the Government tore up the rulebook and DC members are no longer required to purchase an annuity with their pension pots is that the demand for transfers has soared, as members look to access the flexibility that is now available. However, many are put off by the “all or nothing” nature of the transfer – in order to benefit from the positives, members must expose themselves to all the negatives and will lose all the protections that their defined benefit pension currently offers.

It doesn’t have to be like this though. Sensible investment is all about diversification, or not putting all your eggs in one basket. This theme is central to much advice around investments, and life more generally. Why should pension transfers be any different?

Are partial transfers the solution?

The old-fashioned transfer value approach could be criticised for precisely this – if you want to transfer your pension, you must transfer all of it and take your chances. This approach was largely driven by the complexity of splitting DB pensions into two or more pieces, and quite simply the old, clunky administration systems operated by the 20th century pensions industry just weren’t up to the task which rather put paid to the concept of partial transfers.

Happily, that is no longer the case. Administration systems have moved on, and can now calculate split pensions and partial transfer values as a matter of course. Enlightened trustees can now, at the push of a button, offer members a deal to take some of their pension money out of the Fund in order to take advantage of the pensions freedoms, whilst at the same time having the reassurance of retaining an element of final salary benefit. This has many attractions for the members – who can do what they like with a sizeable chunk of their benefits whilst keeping some guarantees, as well as both the sponsor and trustees – who are providing members with what they want whilst at the same time de-risking the Fund. A real win-win-win.

The right to a partial transfer is not automatic; trustees would need to make an active decision to permit this. Pension funds offering partial transfers are still in the minority, but they will surely become more popular, very quickly, as the benefits become apparent. The only thing holding many trustees back is the ability of their administration systems to cope, as many of the “market-leading” providers still use out of date systems. However, market forces will act to change this over the very near future, and it is not much of a gamble to predict that we will soon see partial transfers becoming part of the pensions mainstream.

Richard Smith

Post by Richard Smith

Experienced pensions actuary and expert in accounting for pension costs, liability management exercises, dealing with the pensions issues arising from M&A activity and scheme funding.