Huge Falls in Cash Equivalent Pension Transfer Values 2023
Published / Last Updated on 17/02/2023
We suggest that cash equivalent transfer values (CETV) of defined benefit pension schemes such as Final Salary or Career Average Salary schemes and other guaranteed/deferred annuity pension schemes may fall back to 2008 levels after hitting highs in 2020-2021 due to interest rate increases with the Bank of England base rate now at 4% when in 2020 during covid-19 lockdown (March 2020 to December 2021) it was 0.1% (a forty fold increase).
Why have Transfer Values Fallen?
The answer is simple, interest rates have increased or more accurately ‘government borrowing’ interest rates i.e., gilt yields have increased.
When a pension trustee guarantees your pension income for life, it quite literally lends money to the government, that borrows £billions every year, for a fixed or inflation linked rate of return. This means the pension scheme has a guaranteed income from the government to enable them to offer you your guaranteed pension income. When you die or when the Treasury Stock matures (usually 15, 20 or 30 years), the original loan is repaid by the government i.e., the pension scheme gets its capital back.
Think like a banker:
You need a guaranteed income/interest of £100 pa and your capital secure.
- Bank interest was say 1% pa.
- You deposit £10,000 in the bank and at 1% pa, you get £100 pa interest/income.
- If interest rates increased from 1% to 4% pa, how much do you need to deposit to get £100 pa? The answer = £2,500.
There has been a fall in how much it costs you/deposit to get £100 pa of £7,500.
It is the same for pensions.
Over the last few years, the Bank of England has increased Interest rates from 0.1% pa to 4% pa.
The indirect impact is that gilt yields/interest rates have increased.
This means that the cost to trustees to buy your pension has fallen.
This is why we suggest cash equivalent transfer values will fall even more so than they had.
Example 1: Defined Benefit CETV (Interest Rates 1% pa)
Worked and member of a DB pension scheme for 20 years. It is a 60th scheme. Your salary when you left at 60 was £30,000pa. Normal retirement age is 65.
P R A D – Calculating a CETV
P = Pension - Your pension is 20/60ths of your salary when you left 20/60 X £60,000 = £20,000 pa
R = Revaluation - Your pension is revalued to allow for inflation, from age 60 to retirement age 65. But usually capped E.g., at 2.5%pa.
- £20,000 pa X 2.5% pa compounded over 5 years = £22,628 pa (your revalued/projected pension at age 65)
A = Annuity cost - The estimated cost to buy an annuity with inflation protection and 50% spouses benefit = 2%
- £22,628 divided by 2% = £1,131,400.
- This was the real cost a few years ago for your pension scheme to buy your annuity pension income.
But you are only 60 and have 5 years to go, so the pension scheme trustees can make an assumption that your pension investments funds after transfer will grow e.g., at 4% pa (FCA assumption of mid-growth rate).
D = Discount (investment discount allowed from now to age 60)
- £1,131,400 divided by compound decrement of 4% pa over 5 years = £929,928.
The cash equivalent transfer value in the above example could be £929,928.
Example 2: Defined Benefit CETV (Interest Rates now 4% pa)
A = Annuity cost - The estimated cost to buy an annuity with inflation protection and 50% spouses benefit has increased from 2% to 4%
- £22,628 divided by 4% = £565,700.
- This is the real cost today for your pension scheme to buy your annuity pension income.
But you are only 60 and have 5 years to go, so the pension scheme trustees can make an assumption that your pension investments funds after transfer will grow e.g., at 4% pa (FCA assumption of mid-growth rate).
D = Discount (investment discount allowed from now to age 60)
- £565,700 divided by compound decrement of 4% pa over 5 years = £464,964.
The cash equivalent transfer value in the above example may have fallen from £929,928 a few years ago to £464,964 today but you will still be entitled to the same pension of £22,628 pa, it is just cheaper for the pension scheme when buying your pension income hence a much lower transfer value today.
