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Weekend reading: Merryn says it’s time to sell your sacred final salary pension

Weekend reading: Merryn says it’s time to sell your sacred final salary pension post image

Good reads from around the Web.

Merryn Somerset-Webb might be the nearest thing we have to a punk writer on personal finance.

The FT columnist and editor of MoneyWeek has made a career out of provocative calls – not all of which turned out to be right, but most of which at least made you think.

This week she’s taken another sacred cow out back for a butchering, arguing it’s time to sell out of defined benefit pension schemes.

She writes in this weekend’s FT [Search result]:

Imagine you had invested in something back in 2009 and it had returned 25 per cent every year for the past seven years — a total return of about 480 per cent.

Then imagine that the value of that investment was 100 per cent linked to the bond market.

What would you do?

She’d sell it, she says, and she goes through the maths to show why.

Provocative stuff. I’m a humble blogger, not an FT columnist , and yet I’d be reticent about breaking this great taboo.

But Merryn is fearless – it’s time for her friend to cash in his defined benefit scheme for £300,000 she reckons:

Is his transfer value now so high that it is worth selling?

I think it is.

The first thing to say is that the price is very unlikely ever to be higher than 40 times the income.

Instinct tells you that’s a bubble price and, if the pace of the rise in the transfer value alone isn’t enough to scream “bubble trouble” at you, any proper analysis of the bond market has been telling you the same thing for a few years now.

What do you think? What’s Somerset-Webb missing?

(Do read the article before answering, as she goes through several scenarios. And clearly “you sell out, put it into shares, and then we turn into Japan” will be a counter-argument to almost any investment decision…)

Happy weekending. Don’t shop until you drop.

From the blogs

Making good use of the things that we find…

Passive investing

Active investing

Other articles

Product of the week: I’m not really sure about ethical Christmas gift ideas, such as those highlighted by The Guardian. Of course I’m not against helping others. But there are plenty of opportunities to do that all year without trying to chisel a smile out of your 11-year old nephew when he learns you’ve given a Peruvian a goat instead of getting him FIFA 17. Then again, Christmas gifts can be the worst landfill-bound plastic tat. Bah humbug. Goats all round.

Mainstream media money

Some links are Google search results – in PC/desktop view these enable you to click through to read the piece without being a paid subscriber of that site.1

Passive investing

  • John Kay: How to be your own investment manager [Search result]FT

Active investing

  • OPEC’s history shows oil cut deal just the beginning – Bloomberg
  • Ultimate stockpickers: Top 10 buys and sells – Morningstar
  • Fast-reforming India is an exciting place for investors – Telegraph
  • Everything changed in the month of November – Bloomberg
  • US dividends aren’t as overvalued as you think – Morningstar
  • A deep dive into the legendary Medallion Fund – Bloomberg

A word from a broker

Other stuff worth reading

  • How long will £100K last if you withdraw £4K a year? – Telegraph
  • Which online platform is the cheapest? [Search result]FT
  • Zopa puts retail investors on hold as borrowers dry up [Search result]FT
  • Brexit vote halves British demand for Spanish property – The Guardian
  • Should you buy a Christmas tree this weekend? – The Guardian
  • 89-year old gets job to avoid “dying of boredom” – The Guardian
  • Silicon Valley has an empathy vacuum – The New Yorker
  • Flying cars are closer than you think – The Verge

Book of the week: The Ways To Wealth has compiled a list of the best investing books of all-time by trawling the reading lists of top finance universities and Wall Street firms. Pretty cool, though there’s a US-bias and the links are American, too. So – spoilers – I’ll point you to the top three on Amazon UK: The Intelligent Investor, You Can Be A Stock Market Genius, and The Essays of Warren Buffett. I’ve read them all and they’re great, but they’re certainly for active investors. For passive investors we’re still flagging up Tim Hale’s Smarter Investing and Lars Kroijer’s Investing Demystified. (And yes, our book continues to be slow-baked down at Chateau Accumulator. It will be worth the wait!)

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  1. Note some articles can only be accessed through the search results if you’re using PC/desktop view (from mobile/tablet view they bring up the firewall/subscription page). To circumvent, switch your mobile browser to use the desktop view. On Chrome for Android: press the menu button followed by “Request Desktop Site”. []

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{ 72 comments… add one }
  • 51 L December 6, 2016, 2:35 pm

    @ SemiPassive – also agreed!

    My ‘small’ CS pension is a quarter of that…

  • 52 Hariseldon December 6, 2016, 3:42 pm

    For those who are happy to keep a DB pension at any cost, it is important to remember that the ‘value’ of any investment is dependent upon its price.

    When one hears people talking about its so good that no price is too high, then perhaps it’s worthwhile for them to step back and think about the premises they use to come to that viewpoint and be aware of “recency” bias.

    https://rpseawright.wordpress.com/2012/07/16/investors-10-most-common-behavioral-biases/

    Take an example of £5,000 per year, inflation linked but capped at 5%. Assuming the worst/best case scenario for inflation of 5+% pa, for a 65 year old and dying at 90 then £250,000 is the most you are going to get back, make it to a 100 years old its £479,000, so would £500,00 tempt you..a Million ?

    An assumption that you will get zero return on your cash is a tadge pessimistic and it’s at that point the alternatives become viable. £207,000 would take you to 87, anything over could be invested in equities, combined with the likelihood that inflation will not run at 5+% for every one of 20 odd years and that you will get some return on your cash pile then the chances are you are going to be quids in.

    There has to be a point where it is clearly better to have the cash and a point where keeping the pension is a no brainer and it’s worth then thinking about where the tipping point is.

  • 53 Mike December 6, 2016, 4:24 pm

    @Hariseldon – Granted, if someone offered me £1m for my CS Pension I’m likely to accrue(£10k) , I might re-consider 😉

    But expecting a CS pension allows me to be more aggressive in my investments (though I guess this could be factored in) but, crucially, allows diversification of income streams and allows me to sleep easier at night.

    At any cost? No. But at the transfer value I’m likely to be offered in the open market? Yes (though you can’t transfer out of CS pensions.)

  • 54 Hariseldon December 6, 2016, 5:49 pm

    @Mike That’s the question I was posing , where is the tipping point, it’s different for each individual case and I’m with MSW that the situation 5 years out could be very different to today and that people may regret inaction or least giving the matter deep thought.

    My only interaction with a professional advisor was interesting, much better than I had feared, quite balanced and sensible. ( To get to him I went through others, “No transfer is ever a good idea at any price” and “wink wink nudge nudge, £3,000 and I’ll write any report you like” )

  • 55 Vanguardfan December 6, 2016, 7:42 pm

    Yes, a basic omission by MSW is that public sector DB pensions cannot be cashed in. I agree with hariseldon that, rationally, there must always be a price at which it is financially worthwhile. I think though that DB pensions do have massive psychological benefits, particularly if you’ve been salaried all your working life, in terms of giving a clear income for budgeting/bounding spending. I’m with ermine in thinking that drawing down capital at a sustainable rate is a very tricky thing to get your head around, particularly if your funds are only just adequate.

  • 56 The Investor December 7, 2016, 12:49 am

    @all — Just a quick note to say thanks for all the excellent and often superbly detailed insights on this one, which was exactly what I was hoping for. This area is well out of my skillset (I might as well be writing about corralling a herd of unicorns, for all the real world experience I’ll ever have of cashing in a defined benefit pension scheme) but pleased the Monevator brain trust had something to add. That reasonable people can disagree about it, as evidenced here, shows it *is* a dilemma.

    @Gregory — The new John Kay books is the second edition of the old (ish) John Kay book, which I have indeed read. (In fact The Accumulator gave me my copy as a present! I think he hoped it’d slow me down… 😉 ) It’s worth the time, though not one of my favourites. (TA is a fan though).

    @mathmo — Cheers as ever for the recap. Re: The DCF article, well yes in some respects all he was saying is different versions of “a bigger number compounds more than a smaller number” but personally I often feel DCFs are better mined for insights than constructed for conclusions. So I was in-tune with that approach. 🙂

  • 57 The Investor December 7, 2016, 12:52 am

    @all — Forgot to add a link to this related guest article from the start of the year from a reader who found it wasn’t so easy in practice to transfer a final salary pension scheme into a money purchase scheme:

    http://monevator.com/transferring-a-final-salary-pension-into-a-money-purchase-scheme/

  • 58 dearieme December 7, 2016, 1:03 am

    “a basic omission by MSW is that public sector DB pensions cannot be cashed in”: funded ones can, can’t they? The biggest funded public sector scheme is LGPS.

  • 59 Brod December 7, 2016, 10:06 am

    @Hariseldon

    Before we totally disappear down our particular rabbit hole I think we basically agree.

    Yes, there is a tipping point but the point I was trying and failing to make is that in my case the benefits are non-quantifiable. Discount rates, interest rates, bond rates don’t quite capture what I value.

    I’ve a young family and the certainty a DB pension gives me allows a rather cavalier SIPP investment strategy – 100% equity, globally diversified, super low-cost. I have to make sure my wife is supported when I die and the (current!) SIPP inheritance rules are brilliant for that.

    But you’re right, individual circumstances are key. Hence I suppose why a consultation before people transfer out is a good idea. Assuming objective advice, of course.

  • 60 Mark Meldon December 7, 2016, 10:26 am

    As a final thought on the “hold” or “fold” DB transfer dilemma, I think that we are caught in a difficult situation. I mean that the FCA/Schemes/IFAs (well, a lot of my colleagues) look to “objective” analysis of the CETV on offer and this involves the independent production of a transfer value analysis report that “crunches the numbers”. There are severe delays in actually getting these reports done, by the way, at the moment.

    In my experience, the objective analysis, whilst very important, pretty much ignores the things that motivate most people to look into their pension provision with particular regard to DB Schemes; these are “subjectivities”. Here we are concerning ourselves with emotional responses to money issues and as to how they interact with our private life, aims and aspirations. You can’t really measure these and, alas, they can change from hour-to-hour, let alone from year to year.

    The current distortions that have arisen by the broad increase in CETVS over the last few years has perhaps blinded people to the merits or demerits of actually having a DB pension as they see what is often a very big number and get rather carried away. I really don’t want to see a repeat of the late 1990s pension transfer scandal, but I fear its going to happen.

  • 61 Brod December 7, 2016, 10:58 am

    @Mark Meldon

    Exactly what I was trying to say. Beautifully put.

    * sorry, posted under Mike for #53 & #59.

  • 62 WestCountryEscapee December 7, 2016, 4:55 pm

    @Ermine – I agree and had thought of the small DB pension from my wife’s contributions to the LGPS as an additional bond-like component of the overall pot.

    However, if the valuation is 25x or 30x I would be tempted to move it into her SIPP. She may not be able to guarantee a 3% or 4% withdrawal rate there but she still has a number of years to invest it in something like Vanguard LS80 and I don’t fully trust the government not to fiddle with the LGPS in the meantime…

    @WhoeverItWas – interesting that John Kay’s book suggested having a chunk of bonds to act as a damper on market fluctuations (which I do) but his recent writing in the FT is suggesting avoid bonds altogether…

  • 63 Mr optimistic December 7, 2016, 10:24 pm

    I presume no one is considering transferring out of an active DB scheme here, presuming it’s a 40 year accrual type, and we are talking about deferred pensions?

    In terms of time to get a CETV, the four I applied for all got back to me with numbers in less than two weeks.

    In an active DB scheme, not CA probably as don’t know, setting up a parallel avc under the same trustees is a good idea as you can take some or all of the tax free lump sum from the DB scheme out of the avc together with the 25% due from the account. So a DB scheme giving say £12k pa with an avc of £80k let’s you take out all the avc give or take tax free, without suffering the DB scheme commutation rate, typically 20:1.

    A small advantage of transferring a deferred DB scheme is that the tax free element will be increased, assuming the factor exceeds 20. However don’t let this tail wag the dog.

  • 64 Mr optimistic December 7, 2016, 10:41 pm

    TI #57. Hmm. I’ll run that strategy past our scheme Trustee tomorrow. The CETV all came with a lot of paper work to be filled in by the receiving scheme and the adviser ( not any old advisor, they have to have a particular ‘qualification/registration’ to advise on DB transfers). All paperwork must be back with the scheme within three months to guarantee the offer, which isn’t as long as it seems if you have to start from scratch, find an IFA, decide destination, get forms back etc.

    One last thing, DB schemes are not obligated to offer a CETV once you are within one year of the schemes retirement date for you. Can’t see why they wouldn’t, but….

  • 65 Vanguardfan December 8, 2016, 10:09 pm

    One point that makes this decision different, and not a simple matter of deciding the your price, is that you can never buy it back again, ever.

  • 66 PC December 9, 2016, 7:27 am

    @vangardfan you can always buy an annuity if that’s what you want? Not on the same terms because you are on the other side of the trade .. but I might consider it at some point with part of my SIPP.

  • 67 Mr optimistic December 9, 2016, 10:13 am

    @vanguardfan. It’s also one thing to muse over transferring a deferred DB scheme, quite another to transfer out of an active scheme. For the latter, your future benefit will increase with your salary which the scheme will no doubt consider to rise at more than inflation. It is only once the scheme is closed, or somehow your accruals stop and the benefit becomes deferred, that the inflation cap has any bearing. Leaving an active scheme also means you need to make alternative arrangements for your future savings. So if the employer offers a parallel DC scheme and matches contributions up to some level then ok that’s Plan B. If not then in leaving you are turning off the tap for the employer contribution.

    Lots of caveats about health, dependants, strength of employer etc however in terms of the valuation, the factor I have been offered for a deferred scheme where I am a continuing member of a DC scheme (x28 ish) with the employers continuing contributions, can’t be compared to being offered a factor of x40 to leave an active scheme many years away from retirement and get no further support from the employer. Well, in my opinion anyway.

    MSW has written previously about the value of DB schemes and to think long and hard before giving up the security of these. This recent article doesn’t give sufficient context to really judge the pros and cons. From the factor offered I suspect it was for leaving an active scheme but I’ll have to re-read it. As a subscriber to money week I am used to her opinions!

  • 68 Scott December 9, 2016, 12:08 pm

    @Mr optimistic – transfers from an active scheme may be considered where benefits have been eroded by the employer, e.g. I’m affected by a salary cap so my pension can now grow only with additional service but not salary increases. If we have high inflation, a deferred pension could in theory be worth more than an active pension. Whilst the company implemented an underpin to prevent the active pension being worth less than it would have been had I deferred, by remaining active I’m still paying contributions potentially for no gain. It’s another factor making transferring out more attractive.

  • 69 Michael December 9, 2016, 8:05 pm

    Fascinating stuff and very relevant to myself as this week I handed in my AW8 to request my NHS pension. In the end I decided to take a larger lump sum but not the maximum I could have which I was contemplating. Tax played a big part. Having exceeded IP16 and being a higher rate taxpayer I decided to take an extra £88K and lose £4.4K CPI linked annual pension after tax. The precise sums worked out at a 20.6 ratio. Not good but diversifies my finances.
    I really fear that the NHS scheme will not pay out in full for my likely life expectancy. Mostly because the scheme is funded fully by current members and with an aging workforce and a shrinking NHS at some point it will cease to be a positive contributer to the Treasury and become an expense to the taxpayer.
    I reckon I will discover if I made the best decision sometime between fifteen and twenty years from now.
    The diversification of potential income streams persuaded me to accept a poor commutation rate. Particularly as my reduced pension is still quite adequate for our comfortable but fairly frugal lifestyle and commutation does not reduce survivor benefits.
    Great topic, I really enjoy monevator.com.
    Michael.
    P.S. If you want a suggestion for a future topic I’d really love to hear your suggestions for producing the best globally diversified equity portfolio.

  • 70 Mr optimistic December 9, 2016, 9:00 pm

    @scott. True. I left one scheme for similar reasons, in 2001. Presume you are just gaining years so you can calculate how much an additional year is worth (if you have 20 years service will another year add 5% ?). Presumably the underpin is increasing with cpi/rpi. Despite what MSW says, I am not sure factors of 40 are that commonplace, best I got was 28. Flat GMP pensions offered 21ish.
    @michael, guess the IP16 might Trump everything. Looking at HL, £100k, single life rpi annuity buys you around £2k per annum today.

  • 71 Michael December 9, 2016, 9:59 pm

    @Mr Optimistic. Almost wish you hadn’t posted the HL figure. It makes me wince. However another way to put the issue is would you rather have £88.5K to invest now, or £4.4K a year for the remainder of your life? Assuming I get a return of 3% above CPI and live 25 years this works. Investment goal pass money to kids on death. Long to the grave. 25 may be optimistic, I’m in good health, various websites say 23, but family history is not brilliant. I ‘d have to live 29 years before the regular investment beats the lump sum. If I get the 4.5% in the Monevator.com compound interest tool I’ll not be kicking myself until I am 103 years old. So I am a bit upside down, accumulating in retirement.

  • 72 Mr optimistic December 10, 2016, 9:22 am

    @michael. I am in a similar position but without quite the terms you had. If you have sufficient income then the freedom that comes with tax free cash isn’t to be sneezed at.

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