Transfers: Not just if, but when? – John Broome Saunders

Anyone planning to transfer DB benefits to DC needs to consider carefully the timing of their switch, says Broadstone actuarial director John Broome Saunders

From April, the following question will inevitably be posed across the industry: “Should I transfer my DB benefits to DC?” If the answer is yes, the next question will be potentially even more complex: “When should I do so?”

If the rules do not change, DB scheme members will continue to have the option to transfer until at least 12 months before normal retirement age. So there is no immediate rush for the average deferred member to transfer.

Hopefully, transferred funds will grow, but that will depend on the strategy adopted. Of course, transfer values also ‘grow’ over time because they are discounted values. The rate at which a transfer value can be expected to grow depends on the discount rate used to calculate it in the first place. The discount rate should be linked to the DB scheme’s actual investment strategy – so transfer values from schemes with higher-risk, higher-return strategies should grow more quickly than those from lower-return strategies.

A common approach is to calculate transfer values with reference to discount rates that are linked to yields on Government bonds. Such yields change on a daily basis and even small changes can lead to large changes to transfer values. As yields rise, transfer value discount rates will also rise – leading to smaller transfer values. So if you think yields will rise, transferring soon may be best.

Transfer values may change for other reasons. Trustees are responsible for determining how they are calculated and such methodologies change from time to time. Transfer values should reflect the anticipated cost to the scheme of providing benefits – so if trustees start thinking that scheme members are likely to live longer, transfer values may increase.

Importantly, transfer values are linked to the expected investment returns from scheme assets – which means that if the trustees change investment strategy, transfer values themselves may change. But most transfer value calculations implicitly already allow for future changes to strategy.  Typically, they will allow for a move from higher-returning assets to lower-risk, lower-returning assets at the expected point of retirement. So if you think a scheme is likely to move into lower-risk investments more quickly than anticipated by the current transfer value basis, you are probably best to defer transfer until later.

If a scheme is in deficit, trustees can reduce transfer values – although there is no compulsion for them to do this. The reduction in the transfer value is meant to ensure that, in the unlikely event that all members decided to transfer, the scheme would not run out of money.

With the growing attractions of DB-to-DC transfers, the volume of actual transfers could increase, and thus trustees may be more inclined to reduce transfer values. Alternatively, trustees may feel sufficiently confident about the sponsor’s ability to pay off the deficit that they do not need to worry about the impact of the deficit on transfer values. So if transfer values are currently greatly reduced, you may be better off sitting tight, hoping that an improved funding position will mean that the reduction is removed. Conversely, if full transfer values are on offer, and yet the scheme has a big deficit that you think is likely to remain for some time, you may want to transfer sooner.

As long as benefits remain in a DB scheme, the security of those benefits depends on the ongoing solvency of the sponsor. If that solvency is in doubt, transferring sooner rather than later could be the best option. 

Some sponsors may be keen to ‘encourage’ members to transfer out of their scheme – because such transfers invariably reduce the overall pension risk that sponsors are exposed to and may help to reduce costs. Such encouragement could be in the form of an enhancement to regular transfer values. So if such an offer could be on the horizon, it may be worth waiting to see whether such an offer materialises. Usually sponsors will offer free independent financial advice as part of this sort of exercise, which could also be beneficial since, from April, a member who wants to transfer from a DB scheme will need – by law – to take professional advice if benefits are worth more than £30,000.

One final and significant area of uncertainty relates to future rule changes. Currently, members have a legal right to transfer, but that could change – indeed, during 2014, the Government talked seriously about banning DB-to-DC transfers altogether. That did not happen, but it is conceivable that a future government may look at this again.