The Department for Work and Pensions (DWP) recently delayed new regulations governing the calculation of defined benefit pension scheme transfer values. These new rules will now come into force from October 2008, instead of the originally planned April 2008.
The debate over transfer value calculations has been around for over two years now. After protracted consultation, draft regulations eventually appeared in August of this year. These regulations were supposed to reflect the new scheme specific funding rules introduced by the 2004 Pensions Act, but in practice, they allow trustees significant freedom.
Under the new rules, trustees will be responsible for setting the assumptions used in calculating the transfer value. The draft legislation requires trustees to take the advice of an actuary, and it is likely that the sponsoring employer will pay that actuary. Crucially, the employer has a vested interest in keeping transfer values low because this means that their future contributions to the defined benefit scheme are lower. The rules also allow for the reduction of transfer values when the scheme is under-funded.
Legislation should be fair to all parties - to the pension scheme, the employer and to the ex-employee. The ex-employee should receive a value that fairly represents the benefits given up. The scheme should pay fair value, nothing more and nothing less.
Many advisers will be all too well aware of the derisory transfer values on offer in many cases. Current guidance allows actuaries a great deal of freedom in the assumptions they use in calculating transfer values.
In many cases, double-digit annual returns are needed in the receiving scheme to match the benefits being surrendered. Unless the scheme is also assuming double-digit returns on the assets it holds, then transfer values are being calculated unfairly.
The practice of offering poor value transfer values would appear to be a deliberate ploy on the part of some schemes and their sponsoring employers. Up until January this year, some schemes offered a cash inducement alongside the transfer value to encourage the ex-member to take the transfer value.
This practice may have made it appear to the leaver that they were getting a good deal, and of course, the attraction of cash in hand often allows the heart to overrule the head. However, in most of these cases, the combined transfer value and cash bung was still well below fair value.
The Revenue effectively killed off the payment of cash inducements in January 2007 when it announced that these would be subject to both income tax and national insurance.
Given the Revenue's stance, any inducement paid today is more likely to be an enhanced transfer value rather than a cash payment. While this makes comparison with the benefits given up easier, transfer advice still falls within the heavy-duty category. These are complex considerations. Independent financial advice will therefore be necessary - for both the individual leaver and the trustees.
Advisers engaged by employers and trustees should start by ensuring that communications to ex-members should be fair and not misleading. The Pensions Regulator (TPR) offers some pointers suggesting employees should be told about the nature of the benefits being given up, the risk of employer insolvency and the risks inherent in and guarantees offered by the defined benefit scheme.
The final transfer value regulations are now awaited with interest. We can only hope the DWP has built in the necessary changes to ensure that transfer values are fair, by linking assumptions to scheme specific funding. This would end the charade of inducements once and for all.
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