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