The unprecedented economic disruption caused by the Coronavirus has led many individuals to consider taking the irrevocable step of trading their future retirement security to ease a cash crunch today.
Since “pension freedoms” were unleashed in 2015, more than £80bn has flowed out of traditional final salary-style pension schemes. More than 500,000 people have opted to trade a secure income stream from a defined benefit pension in the future for a lump sum.
In recent years, this has been driven by movements in the bond markets used to calculate the transfer value of a pension. Individuals have been able to access eye-watering lump sums of as much as 30 or 40 times the value of their expected annual pension.
Market volatility has not dulled the desire to cash in — although regulators are currently making it much harder to do so by allowing schemes to suspend transfer activity in an effort to stabilise the pension system.
Regardless, advisers say the key drivers for those looking to unlock their pensions during the current pandemic are the wish to pass on sizeable pension pots to family members, plus growing fears of corporate collapse as companies with large pension deficits struggle to navigate the crisis.
In volatile market conditions, why do people still want to transfer final salary-style pensions?
The difficulty of generating a secure income in retirement has been compounded by the current crisis, with equity markets plunging and companies taking the axe to dividend payments. However, some retirement savers would still prefer to take a cash lump sum over the regular income for life that a final salary-style pension could generate.
“Just as there has been evidence of an increase in people wishing to update their wills, those who have experienced poorer health may already have been considering a transfer with the aim of securing greater benefits for their family,” says Christine Ross, client director with Handelsbanken Wealth Management.
She says that while defined benefit schemes will provide a pension for a surviving spouse this will be at a reduced level — generally half or, in more generous schemes, two-thirds of the member’s pension.
“A transfer will provide a ‘pot’ of money which can be drawn upon by the member in their lifetime but also remains fully available for the surviving spouse to draw from,” she adds.
There could also be tax benefits for those who transfer to a defined contributions (DC) pension. Under the current rules, if you die before your 75th birthday, money in your pension below your lifetime allowance can be passed free of tax to your beneficiaries. After 75, they will pay income tax at their highest marginal rate on money subsequently drawn down.
“The tax treatment of pensions has definitely been a factor in the rising number of transfers over the years, although there can be no guarantee this quirk in the system will continue. As a result, people should go into this process with their eyes wide open,” says Michael Martin, private client manager at Seven Investment Management.
What happens to my pension if my employer goes bust?Just as the current crisis is causing people to focus on their own mortality, plenty are fearful about the longevity of company pension schemes where they have built up the bulk of their retirement benefits. Advisers recognise this as a key driver of current transfer inquiries.
“There will be members of DB schemes who are worried about their employer failing and consequently the impact this will have on their pension benefits,” Ms Ross adds.
Members of DB schemes whose employers become insolvent are covered by the Pension Protection Fund, the industry “lifeboat” scheme.
Those already drawing on their pensions will continue to receive their full pensions, albeit with lower annual increases.
However, those yet to reach normal pension age for their scheme will receive 90 per cent of the pension they were expecting — and the PPF caps annual payouts at £41,461 at age 65.
As the cap is applied before compensation is reduced to 90 per cent, the actual amount a “capped member” who retired at 65 would receive is £37,315, the PPF says.
Experts say those expecting pensions income above this threshold may want to consider a transfer if they are concerned about their employer failing.
“An individual having spent many years at a firm and expecting a pension, for example in excess of £50,000, will take a sharp reduction in what they were expecting to receive,” says Ms Ross.
“It is these members who will be carefully considering their options. Whilst transfer values must reflect the benefits being given up, it may be that the offer made would still not realistically allow a member to achieve the same benefits that would be guaranteed by the PPF.”
However, members looking to pursue a transfer will find that the regulator’s emergency measures present a significant stumbling block.
What emergency measures have been introduced by the regulator?
Due to the extraordinary economic circumstances at the end of March, the Pensions Regulator gave trustees of about 5,500 pension schemes — covering more than 6m active and deferred members — the right to suspend transfers and requests for transfer quotes for up to three months.
The regulator has made clear that trustees can suspend all transfer activity, so this will affect those who have a transfer in progress and are waiting for it to be paid, as well as requests from members to take their pension early.
Ordinarily, members considering their retirement options could request a quote known as a cash equivalent transfer value (CETV) up to 12 months before they reach the scheme’s retirement age.
In normal circumstances, pension schemes should issue transfer quotes within three months and then honour any payment request within six months.
However, the regulator has given schemes breathing space to review their CETV terms and to assess the administrative impact of any increase in demand for CETV quotes, with resources under strain from lockdown.
The cash value offered for a pension depends on market conditions at time and the funding position of the scheme.
The regulator’s chief concern is that volatility in financial markets and weakened funding levels that many schemes have experienced means transfer quotes issued on current terms may be too generous.
“Trustees need to ensure the scheme’s funding position isn’t prejudiced by overpaying transfer values, which could weaken the funding position for remaining members,” says Charles Cowling, chief actuary with Mercer, the professional services firm.
“This is something that trustees are looking at very closely at the moment.”
There are also serious concerns about fraud, which has rocketed since the onset of the pandemic.
“Savers might increasingly look to transfer their pension, prompted by the instability of their employer or the financial markets,” the Pensions Regulator warns in guidance for trustees on its website.
“This means they could be increasingly targeted by scammers attempting to lure them to ‘safe havens’. If a saver asks about transferring their pension, urge them to exercise extreme caution.”
Will all schemes halt transfers?
It is early days, but experts do not believe there will be a wholesale block by schemes on transfer activity for the next three months. It seems more likely that transfers will be halted for the worst-funded schemes, which have not fared well in the market downturn.
“Schemes with the highest exposure to equities will have seen the greatest hit on their funding levels,” says Alistair Russell-Smith, partner with Hymans Robertson, the professional services firm.
“Schemes that have held up tend to be the ones with high levels of hedging against interest rates falls and inflation and have a lower exposure to equities and credit. These are less likely to review their transfer terms,” he says.
Members denied a transfer request can challenge the reasons for the suspension by complaining to the scheme’s trustees. If you are not happy with their explanation, you can take your issue to the Pension Ombudsman, a free and independent service which settles disputes between schemes and members
However, the ombudsman has confirmed it will take the Regulator’s Covid-19 guidance into account if it receives complaints about delays caused by these specific circumstances.
How have market movements affected transfer valuations?
Market volatility may have widened pension deficits, but transfer values are still at near-record highs — mainly because of ultra-low interest rates, which influence how CETVs are calculated.
Mark Barlow, partner at XPS Pensions Group, a consultancy, says it is very difficult to say whether transfer values would rise or fall over the next six to 12 months, as this would depend heavily on how financial markets, particularly government bond yields, reacted to the progression of the Coronavirus crisis.
“March saw the highest volatility that we have seen in transfer values as government bond yields fluctuated significantly as the outbreak took hold in the UK,” says Mr Barlow.
“Whilst the future remains uncertain, it is likely that we will continue to see high levels of volatility in transfer values over the coming months.”
Damian Bailey, an actuarial consultant at Lane Clark & Peacock, says that if the economic downturn caused interest rates to be low for even longer, and if monetary loosening raised inflationary expectations, transfer values could be expected to remain high.
“But there is a risk that huge government borrowing could put upward pressure on interest rates, and this could lead transfer values to be scaled back,” he adds.
Could transfer values offered by pension schemes be reduced?
Currently, transfers deals offered by scheme must be at “full value”. However, it is possible for trustees to offer less if the scheme is not fully funded and paying full value could put the security of remaining members at risk.
For example, if the scheme actuary says a company pension scheme is only 80 per cent funded, transfer values may be cut by 20 per cent to reflect this.
Schemes that are fully funded on a “best estimate” basis cannot reduce transfer values without this action being signed off by the scheme actuary.
With all the uncertainty, does it still make sense to seek a transfer?
The regulatory starting position is that most people are better off keeping a DB pension and not transferring it to a personal pension arrangement, which is more flexible and attractive for passing on the fund to heirs, but loads full investment risk on to the individual.
Certainly, many of the half a million people who transferred out in the past five years will have seen large hits to their investment portfolios.
However, advisers say that over 55s who fear being made redundant or coming under severe financial pressures in the months and years ahead may well be more motivated to pursue a transfer.
“Whilst it may be tempting to consider a transfer because of concerns about an employer, it is potentially just adding risk on top of risk,” says David Hearne, director and chartered financial planner with Satis Financial Management.
“You could be trading a short-term risk with your employer for a lifetime of risk managing a new defined contribution pension instead. It would be sensible to look for other sources of funding before you had to call on your pension plan.”
Ms Ross of Handelsbanken Wealth Management agrees.
“The idea of a transfer may seem attractive as this would create a ‘pot’ of capital, some of which could be withdrawn as a tax-free sum and allowing income to be drawn for as long as needed and turned off if a new job is found,” she says.
“However, future income — and how long that can be sustained — will be wholly dependent on how the fund is invested and how it performs, which will be the responsibility of the individual.”
Mr Hearne adds: “For a small group of people, who are over 55, and may be at risk of losing a home or business without being able to take some benefits from a pension, it may still be worth seeking advice on a transfer.”
What alternative options are there to a transfer?
Taking early retirement from a defined benefit scheme is an alternative option that could be considered by those aged 55 or over experiencing hardship as a result of Covid-19, and could be particularly attractive because of the ability to take a tax-free cash lump sum.
However, it will mean accepting a lower income for life, which could prove more costly over the long-term.
A DB pension is usually reduced for each year it is taken early. For example, 3 per cent per annum for someone retiring 5 years early would result in an overall reduction of 15 per cent, but this allows for the fact the pension would be paid for five years longer.
Barnett Waddingham, the actuarial services firm, calculates for individuals not taking a tax-free cash lump sum and retiring at 55, it would take 20 years before the benefit of having the income early might outweigh the potential for future loss.
“It is therefore important that individuals considering this option in light of the current situation take independent financial advice before making a decision, so that they fully understand the implications of doing so,” says Simon Taylor, a partner with Barnett Waddingham.
“An independent financial adviser will also be able to help them consider whether transferring to a DC arrangement in order to access their pension more flexibly would be more worthwhile.”
Another option could be to ask if the scheme will consider a partial transfer.
“If so, part of the scheme benefits could be transferred to a personal pension arrangement, allowing income to be drawn for as long as required, and then switched off if new employment is found,” adds Ms Ross.
“Meanwhile, the individual would retain an entitlement to future guaranteed benefits within the DB scheme.”
Will I be able to find a financial adviser during the lockdown period?
Under current rules, if you are looking to transfer a DB pension valued at more than £30,000, you are legally required to obtain advice from a regulated pension transfer specialist before the switch can take place.
Just like other workplaces, IFAs have been sent home during the lockdown, so this has restricted face-to-face meetings but most will still do business with you remotely.
In spite of this, finding an advisory firm that is prepared to take on pensions transfer work has become more difficult as increasing numbers of firms step away from DB advice as they cannot get the insurance needed to operate.
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“It is increasingly difficult to find an adviser willing to provide transfer advice,” says Keith Richards, chief executive of the Personal Finance Society, which represents advisers. “Large numbers have withdrawn from the market due to [lack of ] access to insurance cover, creating issues for those still needing advice.”
In addition, advisers will be on alert for clients looking to transfer but who are considered “financially vulnerable”. Mr Richards says vulnerability is understood to be when people are susceptible to making financial decisions which they do not fully understand, and which may bear long-term consequences.
“There are already serious concerns about some people accessing their pension pots to meet short-term objectives stemming from Covid-19, which could have a profound impact on people’s wellbeing later in life and even the risk of a retirement in poverty instead of comfort and security,” he says.
“Advisers will recognise that the benchmark for assessing whether an individual is vulnerable or not is how well-equipped a client is to make a decision.”
Advisers say that losing your job will not increase the chances of a transfer being recommended.
“I can think of few circumstances where Covid-19 and its financial impact would make transferring more likely to be suitable,” says David Penney, director and a chartered financial planner with Penney, Rudder and Winter, an advisory firm.
“If there is an alternative to transferring, and by remaining in the scheme they can achieve their objectives, then our advice process would be the same whether they are in a vulnerable position or not.”