Should your pension scheme really be offering reduced Transfer Values?
Transfer Values (TVs) have become an increasingly popular way for defined benefit (DB) pension scheme members to access their benefits flexibly (via a transfer to a defined contribution scheme). As well as the draw of flexibility, this has also been driven by low interest rates inflating the TVs payable. The FCA is also in the process of reviewing its guidance to financial advisers, moving away from the presumption that transfers from DB pensions schemes are not in the members’ interest. There is clear evidence that the number and value of TVs paid is on the increase.
The finances of the scheme and the company sponsor are likely to benefit from transfers-out and pension scheme risk is reduced. Well advised members should also be happy. So, if your pension scheme is currently offering reduced TVs, should it be, and, if not, how can TV reductions be removed?
Trustees can decide to reduce TVs when the scheme is underfunded. This mechanism is designed to protect the members that are left behind, avoiding the situation where the level of asset cover decreases even further, due to members transferring out.
When TVs are reduced it makes members less likely to transfer-out, not only as their TV is lower but also as this fact is clearly stated in the quote. This will put off many members as the reduced TV quote will normally be poor value as it “should” be higher (regardless of the amount offered and the calculation method used).
If the trustees have reasonable confidence that the scheme’s benefits will be provided in full, because they have confidence that the funding plan is valid, then they don’t have any reason to reduce TVs below their normal level.
TV reductions should be for those situations where the trustees are very worried about employer covenant, the length of the recovery plan, or both. In such cases, it is right that trustees worry about managing asset cover levels.
The company sponsor could agree to pay a top up into the scheme each time to allow a ‘full’ TV to be paid. This will require additional cash from the company sponsor. However from its point of view, if reductions to TVs are a strong deterrent and the transfer value is below the funding reserve for that member, then this is a more efficient method of funding the scheme than standard contributions. The funding deficit will go down by the top-up amount PLUS the funding gain on paying a TV.
We encourage all scheme sponsors to consider these options if their schemes are currently paying reduced TVs.