Advisers are receiving an increasing number of requests from clients looking to transfer their pension from final salary schemes to personal pensions.
This is a complicated area of advice and new rules which add additional factors to the equation do not help. One such factor is the Lifetime Allowance (LTA).
Gilt yields and annuity rates have been falling over the past few years and this trend has accelerated over the past year as a result of economic pressures and the Brexit vote.
So because you now need more money to buy a particular level of guaranteed pension, transfer values have been rising by around 12%, according to some reports.1
Added to the attractions of pension freedom under defined contribution (DC) arrangements, it is not surprising that transfer requests have increased.
The way in which benefits are tested against the Lifetime Allowance is different for defined benefit (DB) and DC arrangements. The same factors that have led to increased transfer values also mean that the DB test (20 times the accrued pension at the relevant date) currently produces lower Lifetime Allowance valuation figures than the DC test (the value of the fund).
This means that if a transfer goes ahead, some clients could end up with a lifetime allowance issue that they wouldn’t have had if they’d remained in their DB scheme.
The problem isn’t helped by the fact that if the client tries to use individual protection (IP) to mitigate the situation, it will be based on a lower value. This is because the value for IP 2016 for defined benefit pensions is the value of the pension as at 5 April 2016 and for IP 14 is the value as at 5 April 2014.
Read about individual protection in more detail.
Take the case of Max. He’s aged 59 and has an accrued pension in his defined benefit scheme of £40,000. He’s thinking of transferring to a personal pension to take advantage of the new pension freedoms and has been quoted a transfer value of £1.2m. A few months ago, he’d been quoted a value of £1m.
If Max goes ahead with the transfer, the immediate value of his transferred pension will be £200,000 over the current lifetime allowance of £1m.
However, assuming the accrued value of his pension at 5 April 2016 was also £40,000, this would mean the valuation for IP 16 is only £800,000. This means that IP16 is not available.
So as well as the usual merits or otherwise of transferring from a DB environment, an adviser needs to take into account the impact the transfer will have on the client’s lifetime allowance situation. The transfer may still be in the client’s best interests of course but it’s one more issue that the advice needs to take into account.
Senior Product Insight & Technical Support Analyst