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
- 10,000 hours or ten minutes to be a great investor? – Charlie Bilello
- Slow down to go faster – Bason Asset Management
- Mental scar tissue – The Irrelevant Investor
- 80% of fund management biz is redundant – Centre for Policy Studies
- Gina Miller on the recent FCA report [Video] – Evidence-based Investor
Active investing
- Why investors and management don’t see eye to eye – Oddball Stocks
- The M&A lesson even shrewd managers miss – The Value Perspective
- Rising rates can be good for high-yield credit – A/B Context
- Terminal values and discounted cash flows – Musings on Markets
- When I was a boy – The Aleph Blog
Other articles
- Animal spirits can’t be modeled – The Reformed Broker
- Five types of retirement – Money Boss
- Great minds disagree about the value premium – Alpha Architect
- Sleeping and napping through bubbles – Investing Caffeine
- An accidental tourist in the world of matched betting – S.L.I.S.
- Monevator reader’s Facebook group for frugal Londoners – Facebook
- Networking sucks because people don’t give a shit – Jon Westenberg
- Every business is a lifestyle business – Bryce Roberts
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
- Oil prices – and inflation – are headed higher – TD Direct
- Greene King: Hangover looming – Hargreaves Lansdown
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!)
Like these links? Subscribe to get them every week!
- 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”. [↩]
Comments on this entry are closed.
I think she’s wrong.
Everything is bubble priced, so even if you sell out of your DB pension where are you supposed to invest the proceeds?
US bonds are tanking, which to me is an indication that people expect inflation, and a lot of it. And that isn’t exactly outlandish since the developed world is being squeezed by a mountain of debt, and the easiest way to get rid of it is to inflate it away (enter Trump, that slithering psychopath). Most DB pensions are indexed for inflation (whether or not that indexing is sufficient to protect purchasing power is a debate for another day). So here’s one scenario: say we have high inflation for a prolonged period of time, which presumably erodes the value of the investments that fund the DB scheme, which has been investing in a mix of inflation-linked and non-inflation linked bonds. Then, if this erosion is significant enough and the employer finds itself unable to fund the scheme due to whatever reasons (insolvency?), presumably you’d be facing the risk of default. But I say so what, many of those schemes are not fully funded anyway (some by a long shot), so you’re relying on the longevity of your employer whatever the outcome with the bond market, and in that case Merryn’s bond bubble is a red herring. It’s slightly trickier if your employer has funded the scheme and then offloaded it to some spinoff of an insurance company (seen a few deals like that in the past). Presumably then the default risk increases, but it’s no different from a risk you’re taking with an annuity… then it all depends on how dodgy is the outfit that’s taken on the DB scheme from your employer. And so we’re back to where we’re started. You sell out of what you think is a dodgy DB scheme and do what with the proceeds? If anyone has a crystal ball, I suggest you lend it to The Investor and he’ll make you rich. I’ll charge a small commission for facilitation 😉
Well one thing Ms S-W doesn’t mention is the legal requirement to obtain an opinion from a regulated Financial Advisor before transferring, at a cost of up to 3% of the transfer value.
How many financial advisors are likely to be as bullish as Ms S-W in recommending a transfer, low bond yields notwithstanding, given the risk of a misselling claim if it goes wrong?
And how many people, having received a safe recommendation from their financial advisor at great cost telling them to do nothing, will then feel confident enough to ignore that advice and go ahead with the transfer anyway?
Then there is the tax angle to consider (there’s always a tax angle) in the form of lifetime allowances etc., and the possibility that this isn’t the end of the great bond bull market. The FT ran a piece this week (Google “Wall Street breaks from groupthink on Treasuries”) that covered the wide dispersion in forecasts for 10-year yields at the end of next year, ranging from 1.35% to 3.3% (currently at 2.3%). If it turns out to be anything like 1.35%, a transfer out now, even at 40x income, may look rather foolish.
I think MSW is right. I did the same for much the same reasons a bit too early in terms of the bond market, a couple of years back, before the regulations tightened up, so I was able to move the proceeds straight into my SIPP without any hassle.
The other reason very important to me was that a SIPP is inheritable. A pension does have additional benefits but it dies with you.
She’s wrong IMO 😉 There’s a better way to play this, using the principles of what she says.
I have a FSP. I consider it as the entire bond part of my portfolio to the tune of about 16*the annual income, and my DC savings are/will be entirely in an ISA by the time I draw it at 60 (the NRA for that scheme). Because the FSP represents the bond part, my DC pension savings are 100% in stocks. I won’t have quite matched the capitalisation of the DB pension, but the stocks/bond mix will be within the ballpark for my age.
I’d say that’s the right way to use a FSP if you have one – to shift the balance of the rest of your retirement savings massively into equities. I can take that sort of risk because if the stock market goes titsup and I eat a 75% drawdown early on I can totally stop drawing an income from the ISA and live off the FS pension.
The ISA performs the complementary role. If inflation spikes, my FSP loses value, permanently if the inflation > the cap. It’s the job of the ISA to try and hold value against that. There are of course some scenarios where that’s not enough, I can’t insure against the end of the world, and I’m too old to stockpile guns and ammo – I don’t want to live in that sort of world.
And then there’s the issue hosimpson raises. What the hell do you invest in now with valuations so high?
My better half has a small FS pension worth about £11k/annum right now from a prior job. It’s RPI linked with no cap, but given I tend toward the idea that we need CPI+2% just maintain our standard of living, I was interested to see if we’d get a decent bid for it. I was hoping for a CETV of £150-200k but just got <£70k. With RPI at 3%, this implies capitalization at 4% and discount factor of 10%!
My feeling here is that unless you are offered a decent multiple, then it's probably still worth keeping FS pensions. If global asset returns are low for the next 20 years, it will be worth it's weight in gold. If not then the FS pension value will be eroded but you won't care because the rest of the portfolio will be doing just fine. In that sense I agree with @ermine that a FS pension is essentially a decent inflation-linked hedge against the rest of the portfolio. The only issue would be if the FS pension has a low CPI cap on it (say 2.5%-3%) and you were still a long way from retirement.
Did You read John Kay’s new book https://www.amazon.co.uk/Long-Short-investment-normally-intelligent/dp/1781256756/ref=sr_1_1?ie=UTF8&qid=1480767236&sr=8-1&keywords=john+kay? Any opinion?
I think the pension article has some structural issues. The obvious one is that of course do you need a lot more money to get the same retirement income at age 65 if you are 7 years older.
Plus one would need to understand what kind of implicit guarantee the current plan has. Despite the increase in value, it could still be better than other stuff.
I’m with @ermine’s analysis. The purpose of the exercise is to give me a flow of income to make the choices I want and live the lifestyle I want. Like many readers of this fine blog, I am not angling for a rock-star or premier league footballer lifestyle, but something a little more modest that suits me well enough.
So I have a baseline of income from DB pensions, and savings/investments to cover lumpy and fun stuff. I am not trying to build an empire or leave a massive legacy. That’s nice rather than necessary.
So since I can see a number of ways in which her strategy could go wrong (and be much more complex), why would I want to do that?
The knowledge of a steady income under most, but not all, scenarios is worth a great deal to me. Theoretically I might be better off taking the cash and doing my own thing, but that to me is to drift away from the core purpose of the exercise, the steady flow of necessary cash.
I can see the temptation to do a Merryn particularly if someone had a good DB pension building up and a deferred one sitting around. It might be tempting to split the risks and transfer out of the latter if the terms were good.
Surely the pension freedom introduced to allow DB transfers is part of a wide range of choice , it may be for you it may be not , you do your homework and makes your choice.
Interesting. I am in a similar but different position. In March I take my NHS pension. I plan to commute as much as I can to take the maximum tax free PCLS, 25%. Commutation rate is 12:1 but take tax into account and it is more like 20:1. So I would jump at 40:1.
The NHS scheme I am in is a defined benefit scheme but of course is not directly related to the bond market and is CPI linked rather than RPI.
I simply don’t trust the government in respect of public sector pensions for the long term and so want to move as much as makes sense tax wise.
As for a Japan scenario I will be going 100% equities with a global market portfolio made up of Vanguard funds. Depending on cash flow I may spend dividend income or reinvest but intend to go long to the grave.
Reached FI point some years back, retiring early, 60, because of the management culture that we now have in the NHS.
Age is obviously very relevant. Were I fifty and faced with such a choice I might be thinking differently.
Yes. Bonds are dangerous at the current time. So “Stocks for the Long Run”:)https://www.advisorperspectives.com/articles/2016/11/28/jeremy-siegel-why-long-term-investors-should-own-stocks-bonds-are-dangerous
Leaving aside whether it is actually possible to get a 40x income transfer value from your pension (many of the FT comments disagree), this is an extremely easy decision to make. Even if the UK does a Japan I think you’d struggle to be worse off if you took the money and put it in a globally diverse portfolio. Even in that doomsday scenario, inflation would be zero so you’d be starting with 40 years of income when life expectancy is 20, and your bonds/gold would offset the devaluation in equities. I just wish I had a final salary pension!
We now live in the post-truth age
Nothing Gina Miller, Merryn Somerset-Webb, Vladmir Putin or Donald Trump says should be taken literally
I do think though that the idea that “developed markets” have low political risk needs to be reassessed
Perhaps I should explain that the reason inheritance is so important to me is that both my kids have had to give up work with ME/CFS, we have no way of knowing how long that will last, and so I want to help them when I’m no longer around. A final salary pension is of no help at all to them.
I can’t help feel the right thing to do on this is to break it down into manageable chunks.
The 40 times defined benefit is a very good transfer value. I would take it (in the example provided) and put it into a SIPP now – that doesn’t require too much thought, just a lot of hassle to actually execute with the 3% in fees from a financial advisor to give you the piece of paper to allow you to do it.
I’d be thinking something along the lines of:
1) Transfer into SIPP right now.
2) Cash holdings for 6 months (to give me time to work out what I need)
3) Lifestyle projection (risk, return required, when to take benefits, staging income withdrawal etc).
4) Portfolio allocation.
5) Invest £300K proceeds.
6 months in cash is not going to make much difference, the big prize on offer is the 40 times defined benefit – and that is very much a time limited offer.
SIPPs are fantastic, not only in terms of investment choice, but also because it is ring fenced for you personally (with the right one), you can decide when and how to take benefits – thus mitigating significant tax problems with being forced to take a defined benefit pension – and you absolutely can live in the expectation that your descendents get a significant legacy, which they will need, since they won’t get higher rate relief on pensions. Living costs – especially housing costs – are looking like they will be materially higher for that generation. OK, not everyone needs to leave a legacy, but it is a significant factor for many.
Just like pension transfers which are often valid for 3 months, you can often reserve a new mortgage (with the rate and amount) for a small fee and have as long as 6 months to complete.
Both of these scenarios allows for a lock into the interest rate environment (bonds for pensions, swaps for mortgages) – at your option, without an obligation – on a backward looking basis, for virtually no cost. This is a massive, massive benefit in a volatile interest rate environment.
I suspect what may have to happen is a tightening up on transfer value windows for defined benefit pensions. At 3 months, it opens up all sorts of arbitrages on options. Anyone sitting on a transfer value from say late August / early September is likely to be something like 15%-20% higher than a valuation requested today.
@ michael “I simply don’t trust the government in respect of public sector pensions for the long term and so want to move as much as makes sense tax wise.”
I too am in the public sector and am kicking myself I wasn’t brave/quick enough to transfer out my pension into a SIPP before George Osborne stopped us being allowed to do so. I simply do not trust the government to provide me an index linked pension of any meaningful value throughout the whole length of my retirement. However, I’ve missed that boat so will just have to wait and see. In the meantime I’m saving saving saving to build that safety net.
@JonWB: having transferred it to a SIPP provider, I’d be tempted then to split it with a second, and maybe even a third, provider. Just in case.
I sold my FS scheme about a year ago at nearly 45x annual pension. This amounted to about 30x my contributions but what sold it for me was that I could take the cash and, at the values prevailing then, immediately buy an index linked annuity yielding 30% more than the FS scheme.
A few other things should influence a decision as to whether one should cash a pension in – martial status, dependants, other assets and state of health being four of the most important.
Largely due to the information I have read on this site I invested this pot in a very simple DIY 40/60 bonds/equity portfolio – VWRL and short dated bonds and its being doing fine. I think I can manage on a withdrawal rate of 2.5% pretty easily so while I may come unstuck that made it, in my mind anyway, a reasonably good bet. That’s about what the FS would have paid but I get, I hope, to keep the capital, or rather my heirs do.
Remarkably, though, had I remained in the scheme and cashed out a year later the transfer value would have been up another 40% or so – the rise of index linked gilts I guess. So on that basis I think Merryn is probaby spot on in her timing.
@ JonWB – just a lot of hassle to actually execute with the 3% in fees from a financial advisor to give you the piece of paper to allow you to do it.
A bit of hassle yes, mostly listening to IFA’s drivel and fending off their overtures to manage the pot. I was charged 1% of cetv.
@ PC
re post 13
Have your children considered if they might have an eligibility for Personal Independence Payment – https://www.citizensadvice.org.uk/benefits/sick-or-disabled-people-and-carers/pip/before-claiming/check-you-are-eligible/
I have seen ermines suggestion about thinking of the FSP as the bond part of the portfolio before. I think it is an interesting slant, and I may shift more into equities.
I did recently ask my provider for a transfer value quote and am not getting 40 x pension, but more like 28. And I am pretty confident the employer will be around for some time. So I won’t be following Merryn’s advice quite yet. If I did get 40x I would have lifetime allowance issues, which would eat away at the value. I also really like the idea of a base line income which I don’t take investment risk on…
A commutation rate of 12:1 is scandalous. Do not take it. I haven’t read the article but for the last year I have been considering the same thing. I am lucky in that I have a number of db schemes, having never got round to consolidating them. Until George O this was a mistake: now it looks like genius. This site has a good article about ensuring your essential income and only then considering investments which are a risk. The db scheme I am looking to convert is linked to inflation. If that was that I wouldn’t consider swopping it for a DC scheme. However, the inflation link is capped at 5%. This undermines the oft quoted apparent benefit that a db scheme, or a similarly capped annuity, hedges against longevity risk. If I live a long time, what are the odds of there not being a bad inflationary episode in say 30 years, from which there is no recovery. Think sudden market decline which is instantly crystallized and for which there is no chance of recovery.
“Networking sucks because people don’t give a shit” – I get so bored at other peoples drivel and I’m sure die at mine, let’s all agree none of us will change the world and get on with it ffs!
Well, that’s one approach. Glad it’s yours not mine.
MSW is right.
A couple of years back I took a small FS at about 33x, my age was them 55, 5 years before it was due to start paying out at 60.
Cost was £750 about .75%, no brainier.
Given that I was invested globally I have seen a 25% up lift from the recent currency movements and that’s a factor that I had stuck with the pension and present exchange rates persist I would have taken a real world pay cut.
Its interesting that people see bonds at 1 or 2% yield attractive but stocks at p/e ‘s around 20 and dividends around 2% or 3%+ as unattractive….
Great links this week – thanks TI – and so glad you led with MSW. I was fascinated to read her article, but surprised that you didn’t go down the obvious FI route: How much does one need, so how can one get it with as little risk as possible? If the DB pension was providing the person with more money then they needed, why up the risk? One reason might be looking at the state of the fund itself (ie if funded by a non-governmental body): a DB BHS pension isn’t as safe as you might have thought it was. But her argument is that the long term bond rate is used to do the valuation (is that true?) and that this price is distorted away from the true expectation of nominal interest rates (possibly by the massive money-printing exercise and regulatory special nature of government bonds?).
The immediate next question, is whether that other provider of old age wealth isn’t just the same thing — time to flog the property? Less obvious that the performance has mirrored the spectacular pumping up in bond growth … or will track its decline. And it is probably inflation-linked through rents.
Some great links this week as well. Love the pieces on networking (although mainly for understanding why the author is wrong) and the lifestyle of the entrepreneur. Great to see the Telegraph rolling out the SWR thinking again — although in a barely comprehensible article, I felt. And the technical DCF article was a little wishy-washy to be useful. Yes — that’s how numbers work when you multiply them like that – but each example is so varied that it’s virtually impossible to draw general conclusions. The only refuge is to build the model and stress-test the inputs.
I find the Zopa decision very interesting indeed. I don’t understand why they aren’t pulling the pricing lever harder if they have a supply imbalance. Since taking the market into their own hands (investors no longer buy individual loan parts, but invest in a basket) they have opened themselves upto this risk. It’s to their credit that they’ve avoided it (and serious defaults) so far. Becoming a bank is an obvious next step. The difference between them and Santander 123 is narrowing daily — or it would if Santander 123 hadn’t just halved their rates.
This yield-chasing is going to end in tears.
A number of my colleagues are leaving our DB scheme after the trustees made some pretty generous CETV offers.
I’ve swung back and forth, listened to what the guys on MSE pensions had to say, then dithered some more.
At my age (mid-40s) there seemed to be too much of a potential downside risk to justify giving up all the benefits the scheme gives.
However, i’ve promised myself I will review it if bond yields stay very low AND there has been a 20%+ drop in equities AND the CETV has reached the figure I have in my head.
I guess the upshot is that I will be in a great position if I stay in the scheme so I really need everything to align before I transfer out.
”Did You read John Kay’s new book https://www.amazon.co.uk/Long-Short-investment-normally-intelligent/dp/1781256756/ref=sr_1_1?ie=UTF8&qid=1480767236&sr=8-1&keywords=john+kay? Any opinion?”
This is a second edition of the book the first edition is excellent. In the list of links above there is an exert from it in the FT.
I have just started it and it is not very different from the previous edition so far . One thing that stands out is his target return is now 8% nominal rather than 10%
@ Uncertain – thanks.
Mike, is your DB scheme active or deferred? If active can’t see why anyone would leave. If deferred what automatic inflation protection do you get? If it’s say up to 5%, where are you going to get 5% risk free anytime soon ? To transfer, assuming more than £30k you will need to budget in advice (£2k if managed) plus the SIPP charges you will immediately start to pay.
Hi TI,
Its an interesting one – as others above have said I think it would really come down to what the offer on the table is, it would have to be significant to make thinking selling out is worth it, but although its a good steady income there is always the risk of the fund going bust so unlike Ermine above, I wouldnt want to rely on it as the sole steady income – the same reason I would be worried if my entire pension was with one company!
Given where bond yields are at the minute it would have to be a heck of an offer to compensate.
FIREin’ London
I’ve heard this stuff many times and never been convinced it’s a good ides. In Canada you may be heavily taxed on windfall profits from commuting your DB pension since in many cases not all of it can go into a tax deferred scheme. The tax department determines the allowed contribution based on an actuarial calculation.
Hindsight is 20/20 but my wife and I have collected our DB pensions for close to 12 years now. Both pensions are well managed, costs are low and the companies behind them are solid. My wife gets full indexation; mine is partial.
These pensions combined with some state security provide a solid basis to cover our needs and we have money saved besides them to leave in our estate. We don’t have the hassle and worry of managing our pensions ourselves.
The person making the recommendation has mentioned that she doesn’t have a DB pension herself. I would take her advice on that basis.
Mr Optimistic,
The scheme is active and increases for those in receipt are full CPI. There are also pretty generous enhanced payouts if you die in service or within the first 10 years of retirement.
I think perhaps there has been an element of temptation when the numbers for CETV are taken in isolation without properly assessing the against all the benefits of staying in – assuming typical life expectancy.
Not having to worry about investment performance has a pretty high value to me as well – I don’t want to be worrying about it.
That said, if I can enter the market post a sizeable drop and everything else looks good then i’m open minded.
I’d be tempted if my scheme was in deficit, because if these schemes start failing I don’t believe the state is going to bail out the richer pensioners who have lots of other assets, as I hope to. But as my scheme is one of the few that’s in surplus I think I’ll keep the diversity of that income stream in my portfolio. Nobody can predict the future!
@Alice Holt re: PIP one of them applied got zero points and gave up. Not optimistic on them getting anything at all based on our current experience with that or ESA assessments.
Would love a 40x transfer value. My DB scheme offered low 20’s – aged early fortys with NRA 60, and active member for the time being.
In deferral, the first three quarters of accrued pension grows in line with RPI uncapped, remaining quarter grows by CPI capped 2.5%.
There has been constant tinkering over the past few years with contribution rates, accrual rates, inflation measures, etc. People may view these schemes as ‘guatanteed’ income, but I have to ask myself, is it likely the scheme will still exist in, say, 50 years time? Might I be safer to take a transfer and invest it.
Mike, I am looking at maybe transferring one if several deferred schemes. I am only two years away from state retirement age. The factor they offered was 28 using the pension they would offer in two years time. You will be protected in the scheme by the pension protection arrangements, to a large degree. Presumably the company has a matched contribution arrangement? Can’t say I would be tempted, at all. Some recipient schemes will accept a transfer if if the financial advisor said no, but you have to wonder about those.
Its worth bearing in mind the payout to a spouse in the event of one’s demise, mine was 50% in DB scheme but transferred out its 100%. In my case with a spouse quite a lot younger, this is an extra benefit.
What are all your thoughts on the Italy referendum? It’s a little hard to understand. Do you guys want Italy to leave the EU or no?
I’m buying municipal tax free bonds now that interest rates are up in the US.
Sam
Financial Samurai
Italy changes their govt every year, so this is not a significant result unlike the Austria result. It maybe significant, but it is not unusual.
Hmmm…as a practitioner “licenced” to undertake DB to DC transfers, I’d say “it all depends” on what the Scheme member (deferred) wishes to achieve when looking at the transfer option. There are many “traps” for the unwary, such as the “ill health” 2-year trap under Section 3(1) of the IHT Act 1984 (http://www.hmrc.gov.uk/manuals/ihtmanual/IHTM17072.htm), the transience of subjective responses to investment risk, the loss of “mortality cross subsidy” on transfer to drawdown compared to annuities (and, thus, DB Schemes), the undoubted attractions of “inheritability” of DC Schemes, etc., etc.
As an IFA, I must make sure that potential transfer clients go into this complex area with their eyes wide open and, to be honest, it can be quite difficult to fully understand the complexity of the series of decision making processes that you need to go through. However, there are times when the transfer is quite the right thing to do, but I must be sure that the client understands the transference of risk and costs (noting that my professional indemnity excess on DB transfer business is £15,000) plus the fact that drawdown is expensive and must be closely looked at for many years, likely decades. Do you want to be in drawdown aged 95?
Oftentimes, clients end up with a “base” income in retirement from state pension and DB Schemes they have and also have a “dip-into” DC pot under flexi-access drawdown, possibly the best of both worlds.
As I said, it all depends!
I transferred a deferred pension 2 years ago. I was forced to get independent financial advice first. The “advice” totalled about 60 pages and was complete waffle. They analysed the risks of moving, recommended some naff scheme & nowhere did they mention the risks of keeping it in the DB scheme (in the inflation indexing is capped).
I did my own analysis on one sheet of paper split in 2. Then moved the money to my SIPP.
To her great credit, the article by Merryn is the first time I have seen any journalist mention the risks of capped inflation indexing. Pensions can lose value rapidly under periods of high inflation.
@ermine –
I had recently reached the same conclusion (that my tiny DB pension was basically a hearty bond slug to be weighed against my current DC pensions). It had the effect of making me realise that, rather than being a cavalier 100% in equities as I had thought, it was more like 50/50, far too conservative for someone in their young 30s.
Financial Samurai
–“What are all your thoughts on the Italy referendum? It’s a little hard to understand. Do you guys want Italy to leave the EU or no?” —
Nothing to do with leaving the EU. Their parliament didn’t have a majority result on whether to change the laws on their Senate, so it went to a referendum. They simply wanted to simplify the whole process to try and overturn the stagnant decision-making procedure in Italy, so that they can take decisions on their economy without being outvoted due to corrupt senators from the south. I work in Italy and everybody I know wanted the result to be YES. But, like Brexit, the result depended on trashy discussions on trashy TV shows. As a colleague said today: ‘What a year. Brexit, Trump and no change in Italy!’
@steve21020 – Nothing to do with leaving the EU
Nothing and everything wasn’t it?. Renzi was a fool to link his staying to a yes vote because in doing so he extended the vote far beyond in its initial premise and effectively made it a plebiscite on his leadership. When ones does that people will vote with their frustrations, of which the EU was one, I suspect.
Mark M, yes that general approach was what I was thinking about. I worry about a relatively early demise and regretting leaving it all in db schemes ! However if my pension was basically a single db scheme I wouldn’t think about transferring unless I was single with no dependants. Even a 5% cap is worth a lot currently. Against this, I wonder if the capped annuities being sold aren’t the basis for a future ‘mis-selling’ scandal. If a burst of high inflation leaves thousands stranded in their deep old age will they go quietly ?
If you think about it, a DB pension is very similar to an annuity in that it provides a guaranteed income stream for your life and, most commonly, a spouse or partner, too. Sales of annuities have plummeted in the last few years and many previous providers such as LV= and Prudential have exited the market, leaving a mere half dozen or so competing for business. “Flexi-Access Drawdown” has usurped the annuity, often for very good reasons, but one has to remember that transferring from a DB Scheme into FAD means a very significant transference of risk and costs to the individual. I have been around long enough to remember the so-called “Pension Review” of 20 -odd years ago when millions was paid in redress for poor transfer advice. That’s the real reason for the layers of regulatory requirements you will find when looking at DB to DC transfers today.
However, I think that today’s situation is very distorted by the seemingly stratospheric DB transfer values on offer. Sometimes the figures are very compelling on a purely objective view. I looked at a case recently where a chap was 10 years from Scheme retirement age and was looking forward to a DB pension of around £40,000 per annum indexed. The transfer value on offer was in excess of £1m. Setting aside matters like the Lifetime Allowance for the moment, the numbers looked good on a transfer value analysis report. He took the transfer, not because of the numbers, event though we agreed that they were attractive, but for very personal and subjective reasons concerning his expectations of life span, the issue of control and the opportunity for early retirement, amongst other things.
Other recent cases have been “hold” rather than “fold” as, in most cases, the transfer value on offer from the DB Scheme had been “actuarially adjusted” to reflect the Scheme funding situation – sometimes very significantly.
My hunch is that FAD will lose some of its lustre when, if, the markets take a big tumble, which they will one day and that annuities will slowly become more attractive for some DC pension holders, perhaps when rates climb from the current 4.2% or so for a joint life annuity at age 65 to around 5%; we shall see.
@zxspectrum48k, I like your use of the word “small” there. 11k pa linked to RPI may not be a huge income but you’d still need something like a £400k pot to buy an annuity that paid the same depending on retirement age. Not all that far short of half the LTA and about 10 times the average personal pension pot.
Britain has a massive wake up call coming as the government pushes the state retirement age up to 70 and beyond.
@Semi-Passive – I agree!
So compelling are the FS pensions (or Average Salary as they are now in the Civil Service, which is much more equitable) that I took Civil Service job just for one (and the flexibility they offer.) I regard it as buying me an index linked annuity each year. Like Ermine, no bonds in my SIPP.
I’ve divided my retirement provision into three pots – state pension, Civil Service pension and SIPP. All have different risk profiles and benefits/drawbacks.
The State pension and CS pension will form the foundation of my retirement spending from 67 and the SIPP the extras – emergency funds – or frolics! 🙂 – and an inheritance. I’m relatively relaxed about the prospect of the state pension as I believe there will be enough of us to maintain a decent provision (though the triple-lock is excessive and divisive and I hope/expect Hammond to ditch it soon) and the CS pension is a contractual benefit, so they have different risks associated with them.
I’m 50, and as my wife is 15 years younger than me and we have a 3 y.o. and a 5 y.o., the (current!) ability to pass on the SIPP is another bonus. Though I’ll be taking my 25% lump sum and stashing it in ISAs asap, thank you very much! (A fourth retirement pot and a diversification move to reduce the political risks.) You can’t obliterate Risk, all you can do is make sensible, risk-based mitigations. And I hope I’ve done that.
Sadly, with a 3y.o. and a 5y.o., FIRE is a little unlikely (unless the oil price doubles soon. But I think we’ve seen a technological step change there.)
But best laid plans and all that…
@ SemiPassive – also agreed!
My ‘small’ CS pension is a quarter of that…
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.
@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.)
@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” )
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.
@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. 🙂
@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/
“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.
@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.
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.
@Mark Meldon
Exactly what I was trying to say. Beautifully put.
* sorry, posted under Mike for #53 & #59.
@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…
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.
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….
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.
@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.
@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!
@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.
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.
@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.
@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.
@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.