Timing is critical in the transfer market
When people leave service with an employer who runs a final salary pension scheme, their pension benefits usually remain in the scheme as deferred benefits until they reach retirement age. People don't have to leave their deferred pensions in their former employer's scheme though, as they have the right to transfer the cash equivalent of their pension rights into another pension scheme, such as their new employer's occupational pension scheme or a personal pension plan. Such cash equivalents are referred to by nearly everyone in the trade as transfer values, and pension scheme trustees are required to consult their pension scheme actuary for how much to offer individuals seeking to transfer rights. The trick is to give people their fair share, so those remaining in the scheme are not disadvantaged by people moving on, and those who go aren't shortchanged. It's difficult, but that's where actuaries come in.
I know that you know all of that, but I couldn't think of an easier way of starting an article on the proposed changes to the way transfer values of deferred final salary benefits are calculated. Because that's what's about to happen. The actuarial profession ensures all its members are up to speed on how to calculate transfer values by regularly issuing detailed guidance on the subject. This comes in the form of guidance notes, and the particular one that deals with pension transfer values is guidance note number 11, or GN11 for short.
GN11 was first issued in the mid-80s, with GN11 Version 1.0 becoming effective on December 1, 1985. It has developed, like software updates, and version 9.1 (actually the 13th upgrade) came into force in March last year. The actuarial profession has recently announced that it will consult with actuaries from now until July on further changes, so GN11 Version 10.0 can be issued later this year.
A new version is needed because of changes to pension scheme funding due to come into force in September 2005 to comply with the provisions of last year's Pensions Act. That is when the minimum funding requirement that we have had since the last Pensions Act will finally get knocked on the head and be replaced by something called scheme-specific funding. In practice, this will mean that pension transfer values made in the new post-Pensions Act environment will need to take account of such things as the funding level of pension schemes and the financial strength of employers. Things like the level of protection offered by the new pension protection fund will also need to be taken into account.
According to the consultation document, the idea is that a more prescriptive approach to the calculation is now being proposed. The new proposals aren't just a tweak on GN11 Version 9.1, but a fundamental change of approach to the calculation of transfer values. The suggestion is that the calculation will be based on bond yields, and that could lead to much higher transfer values being paid out for early leavers. But, as ever, there is a flip side. Although the proposed changes to GN11 should result in transfer values being increased in many cases, scheme trustees will still have to act in the best interests of all scheme members. Because of that, if a scheme is underfunded, trustees will be able to reduce the transfer values offered to take account of that. That, of course, is why people need to take the advice of a financial adviser if they are considering transferring their deferred benefits from a final salary scheme to an individual arrangement. Timing, as in many things in life, could be crucial.
This point about advice is very important. One feature of our pension environment after A-Day will be the emphasis placed on pensions being an individual's own assets, even where such pension assets form part of an occupational pension scheme. Indeed, all members of final salary schemes will soon find their annual pension statements include more information, including what will effectively be the cash value of their pension rights. This new approach will, I am sure, mean that people will become more acutely aware of what their various bits and pieces of pension are worth in the same way they already do with other investments. It is bound to fuel a boom in individual pension transfers, but people need to make sure they never get tempted to try something so difficult without getting proper advice.
First published in Retirement Planner, June 2005