A lot is said in the media about how good company DB pensions are and that it is rarely good to transfer it to a SIPP. I disagree. Sometimes transferring is very good, sometimes it’s very bad.
I transferred a company DB pension based on 12 years service calculated at 60ths of final salary. The transfer value was reasonable with a multiplier of about 15 – I could use sensible growth rates to work out that it could provide a similar pension, so that meant no overwhelming opinion either way. (Well, maybe slightly in favour of transferring because I’d calculated using the natural yield, so I’d hope to get similar income without touching the capital). BUT at the time the stock market was unusually low and so in the first year I got a big growth. Since then I have had higher growth than I had expected. At the moment I am very pleased to have transferred that pension, though a stock market crash might change my opinion.
I recently considered transferring another company DB pension. The multiplier wasn’t great (just over 11) but I felt it was borderline and I liked the prospect of control and some other advantages. In the 13 years before I can access it, it increases at CPI instead of RPI which means I lose 0.5 to 0.8% per year. I asked a financial adviser to do me a recommendation so I could then choose to transfer or not (assuming based on my maths that I would transfer). She discovered that I can access it in-full 5 years earlier than I expected. That changed my maths. I am keeping the original pension. Plus I had the pleasure of catching up with several old friends who also still have the same pension and who were delighted to find that they could access the pension 5 years earlier than they had expected.
I know of people who asked their company about transferring frozen DB pensions. A multiplier of 26 for one of them makes a very interesting prospect. Consider that their default pension start age is 62 and life expectancy might be 88, that’s 26 years. So even if they only achieve growth in line with RPI they could take 1/26th per year, and with higher growth than RPI they are ahead. One of them got independent advice and it was to stay in the company scheme – the adviser focused on the option of growing the transfer value to retirement age and then buying an annuity, which is not particularly lucrative. As far as I can see, IFAs do not get sued or prosecuted for favouring low-volatility secure pensions. Fortunately there are SIPP providers who will accept transfers even when the adviser says not to transfer.
It ought to be possible to create a graph to show whether a transfer is worthwhile. But the many other effects make it rather a personal graph.
I guess the main variables are:
- Multiplier (the transfer value is how many times the annual pension in today’s money).
- Years until the date when you can take it in full.
But also consider that there is an effect from:
- The assumed “growth rate above RPI” is a major choice to make before modelling this. (Actually you could graph Multiplier vs Rate to see what rate breaks even, rather like a critical rate calculation.) It needs to be net of charges.
- The time from now until your life expectancy.
- Whether you will take natural yield or consume the capital.
- Is it growing at CPI not RPI until you start to take it. (If so, reduce the stated annual sum by 0.5-0.8% per year to see the effect in today’s money).
- Does it include a spouse’s 50% pension (it’s more valuable if your spouse is much younger, but consider that in contrast a SIPP pension on natural yield can effectively provide a 100% spouse pension subject to inheritance tax rules).
- Is there a tax-free lump sum (either by commuting some pension, or as a free extra).
- What is the commutation multiplier. This might offer a second opportunity to do a transfer, maybe at a better rate than you are being offered now. In any case, the commuted limit is often 25% (which could be taken tax free).
- Does it offer other benefits such as bridging the gap to the start of state pension, or free financial advice.
- Is the person a confident investor who understands and accepts the risks. What rate of growth might the person get, considering how they are likely to invest?
- Is this (1) a major part of the person’s pension income and if it fails the person has problems, or is it (2) a minor addition to a person’s already-large portfolio?
There are some advantages in transferring:
- Your growth might be higher than the company assumed, especially if the company was very pessimistic.
- You can time when you transfer, so you enter the market at what you hope is a low.
- From actual retirement to the start of state pension you probably have an income gap, and a SIPP can be managed to fill the gap.
- You can manage the sum in drawdown to end up with a lump left when you die, so your spouse or children get 100% of what remains, not 50% or 0% from a DB pension.
- If you have poor life expectancy, transferring is more in your favour.
- The company might pay you a (taxable) sum to incentivise you.
- The government occasionally changes rules to reduce the cost of DB pension (such as the change from RPI to CPI) to help companies afford DB schemes, which reduces benefits.
- You can spend extra earlier in your retirement and spend less in your 80’s and 90’s. You could do this by controlling payments from drawdown, or by taking a flat annuity.
But there are disadvantages in transferring:
- As mentioned above, DB pensions occasionally change terms to your advantage if you stay with them (usually only when they get unexpected good investment returns).
- Some DB pensions offer to bridge the gap from retirement to state pension with an annual sum equivalent to state pension.
- Your investment might not grow as well as you hope.
- You might transfer near the top of the market and take a big hit when it falls.
- You need to make sound investment choices (or be lucky) and live with the fluctuations, which might suit some people more than others.
- If you have high life expectancy, transferring looks less appealing.
- It’s handy to have a certain amount of secure pension.
- A company pension is pretty effortless to keep on top of.
All this means that the yellow “maybe” band can be pretty wide and different for different people.
Also there’s a balance to be struck between how much secure DB/annuity/state pensions you have, and how much DC/SIPP/Drawdown pensions. More on that below.
Annuities vs investment yields
Think ahead to age 75. Will you still be able to keep up with the ever-changing tax rules? Will you be able to manage investments like you do now? My latest plan is to have a good wedge of the capital intact, and then in my late 70’s I will decide whether
(1) to buy an annuity with about half of it, hopefully getting a return of over 7%, but of course the value dies with me & my wife. The remainder is then available to use for something other than my income.
(2) to set up a relatively maintenance-free stream of income so the capital can be inherited. If I can find a simple enough version of this I’ll probably go for it because it’s better for inheritance in the end.
I’ll also see what end-of-life care looks like costing!
Remember that you can purchase an annuity (PLA) from your current account and only a small part is subject to income tax. Annuities are not just for pension funds.
So when you do the maths for yourself, be realistic about the performance of investments and consider whether performance might drop when managing finances gets beyond you.
Secure vs variable pension
I’m happy with my balance of DB/annuities/state compared to SIPP/DC/Drawdown. My wife and I assume we will get 2 full state pensions, her current company DB pension, and my frozen DB pension. That gives a baseline of about £24,000 which is very close to the lowest budget that we’ve worked out for an OK retirement. The £44,000 budget we’ve worked out for the retirement we’d like to have is just about covered by adding the SIPP/DC. Adjusting my retirement date by 2 or 3 years (or working part time after retirement) should help manage that.