Final salary transfer values – Have we reached the peak?

A 40 times multiple! That figure was simply unthinkable a decade ago. However, in the past two or three years, defined benefit/final salary pension schemes have been offering eye-watering cash equivalent transfer values (CETVs) to members in exchange for their lifetime pension benefits.

This blog will explain what CETVs are, who is eligible to receive them, why there has been such a significant leap in transfer values and finally, if the inflationary environment will bring an end to the record breaking transfer values.

CETVs

A cash equivalent transfer value or CETV for short, is a monetary amount which is offered to a member of a UK final salary pension scheme in exchange for their lifetime benefit.

Members of UK final salary pension schemes are entitled to a lifetime income in retirement which is based on; the members final salary during employment, their years of service and the scheme’s accrual rate.

The member will receive this ongoing income when they reach the schemes retirement age until death.

UK legislation provides final salary members with the option to exchange their lifetime benefit for a one-time cash lump sum, this is known as a cash equivalent transfer value.

CETVs hit record highs

In recent years, CETVs have hit record highs. There are several reasons which are contributing to this including rising life expectancies, however, arguably the most significant factor is the drop in interest rates, which are linked to UK gilt yields.

In order for UK pension schemes to meet their obligations to their members, they need to invest and grow their pension fund using a cautious investment strategy. Historically, this has involved investing in UK gilts (UK Government bonds), often the fund would invest 50-60% of the fund in UK gilts. The return which is achieved from UK gilts is based on interest rates. Ergo, the higher interest rates are, the better the return.

UK interest rates have been in long term decline. Between 1971 and 2021, UK interest rates have averaged at 7.24%. For pension funds, this level of return was usually sufficient to allow them to meet their liabilities. However, UK interest rates have slumped to lows of 0.10% in March 2020. For schemes, this means that growing their fund and meeting their liabilities has become significantly more difficult.

As a result of this environment, UK final salary schemes have increased transfer values, as meeting their long term liabilities has become more challenging. As such, schemes are offering more attractive CETVs, as the liability has grown in value.

Historically transfer values were often around 15-20 times multiples. That is the promised annual pension amount times 15-20 as a one off lump sum.

In recent years, these figures have jumped significantly. We are now often seeing 35-45 times multiples.

For example: if a members final salary income is £25,000 this would equate to a £875,000 – £1,125,000 cash equivalent transfer value (35-45 multiples).

Have we reached the peak in transfer values?

Transfer values have steadily being rising due to a long term decline in interest rates. However, there is now an increasing belief that interest rates rise.

Andrew Bailey, the Governor of the Bank of England, has warned “inflationary pressures building in the UK has made a rise in interest rates next year more likely”.

Against a backdrop of rising fuel prices and the prospect of higher transport costs pushing up the price of food in the run-up to Christmas, the Bank of England’s governor said there were signs that inflation could be sustained and the central bank’s monetary policy committee (MPC) may need to increase borrowing costs in 2022 (Phillip Inman, The Guardian 2021).

Click here to read an in depth analysis on why interest rates impact pension schemes.

A prolonged rise in interest rates triggered by inflation, has the potential to put downward pressure on transfer values. Speaking with any degree of certainty on this is speculative. However, by observing the wider economic environment, it is certainly possible to make an educated guess.

What can final salary members do to better understand their options?

If you’ve worked in the UK and you’re a member of an employee sponsored pension scheme, you may wish to take advantage of deVere Group’s complimentary pension review service.

A deVere Group UK pension adviser can educate you on your entitlement by requesting a full report from your scheme. This will allow you to understand what you’re entitled to, what age you can access your benefits, what death benefits your loved ones are entitled to and what options are available to you moving forward.

Click on the link below to request a complimentary UK pension review.

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