Will Your Transfer Value Fall The Impact of Rate Increases

Published / Last Updated on 20/10/2017

Calculate Pension Transfer ValueWill Your Transfer Value Fall? The Impact of Rate Increases.

A defined benefit pension scheme is a salary related company pension usually based upon the number of years’ service as a multiple of your salary (usually your final salary or a career average salary).  Legal protection is also in place to revalue this pension before your take it and also when it is being paid to you.

For most defined benefit pension schemes, you also have the option of transferring this pension to either another defined benefit scheme or more usually an investment linked, money purchase pension scheme to take advantage of self-investment or death benefits or flexible retirement options.  Over the last two years, we have seen significantly higher cash equivalent transfer values encouraging more and more to consider transfer.

So why are we looking at the impact of interest rate increases on defined benefit schemes?

Firstly, you need to understand, in basic terms, how a transfer value is calculated:  E.g. you are 50 and the normal retirement age is 60.

  • Pension income:  Your accrued pension income to date. E.g. £10,000 pa.
  • Revaluation rate:  The rate at which this revalued before your retire e.g. 3% pa.
  • Annuity rate:  The cost to buy the pension income e.g. inflation protection, 50% spouses annuity.  Annuity rates are linked to interest rates and gilt yields.   e.g. At age 60, e.g. 3% Annuity Rate.
  • Discount:  The assumed investment return between now and retirement.  This is then a discount to the annuity cost e.g. 5% pa.

Using the above figures the Cash Equivalent Transfer Value (CETV) would be:

  • Pension income:  £10,000 pa.
  • Revaluation rate:  3% pa.  10 years to retirement, so projected income at age 60 = £13,439 pa
  • Annuity rate:  3%.  To get a pension of £13,439 pa at a return of 3%, it would cost the pension scheme a staggering £447,966 at age 60.
  • Discount:  5% pa (investment return), this is the assumed return on the transfer value over 10 years, so the projected cost of £447,996 is discounted back assuming 5% pa growth for 10 years.   
  • Result:  £275,012 Cash Equivalent Transfer Value today.

Now let us assume, interest rates goes up just 0.25% pa and gilt yields 0.25% pa.  Let us then assume overall Annuity rates rise by 0.5% pa to 3.5% pa.

  • Pension income:  £10,000 pa.
  • Revaluation rate:  3% pa.  10 years to retirement, so projected income at age 60 = £13,439 pa
  • Annuity rate:  3.5%.  To get a pension of £13,439 pa at a return of 3.5%, it would now cost the pension scheme £383,971.
  • Discount:  5% pa (investment return), this is the assumed return on the transfer value over 10 years, so the projected cost of £383,971 is discounted back assuming 5% pa growth for 10 years.   
  • Result:  £235,724 Cash Equivalent Transfer Value today.

With annuity rate increase assumptions, affected by interest rates and gilt yields, the transfer value has fallen by nearly £40,000 overnight.

This is the impact of rate increases on defined benefit schemes and future cash equivalent values.

Increased rates are good news for beleaguered company schemes as pressure on funding reduces but bad news if you want to transfer out of such a scheme as you may get a lower value.

 


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