Tideway DB Transfer Case Study 1
Accessing a larger tax free cash sum and continuing to work
By James Baxter, September 2019
Introduction
A key attraction of taking a DB transfer for some members is getting access to a tax-free cash sum, often significantly bigger than available from the scheme and several years early; then having the option not to take a pension but to carry on working.
Nigel did exactly that with advice and help from Tideway in 2017. So in September 2019, two and a half years on, it was good to recap why he took the transfer offer, what he did with the funds and how his and his family’s position are panning out. The details below are based on a real life situation for one of Tideway’s clients (Nigel is not his real name).
The key facts of the transfer decision
Nigel was 55 when he made the transfer and had been watching the value on offer for a couple of years having attended one of Tideway’s seminars. At the end of 2016 the value had risen significantly on previous years and Nigel accepted a transfer of £884,572 to an AJ Bell SIPP in lieu of a pension payable at age 60 equivalent to £24,500 per year with the usual annual price inflation increases.
He received an immediate cash sum of £221,143 in March 2017, four and half years ahead of his 60th birthday. Comparing this to his DB scheme, he could have received a maximum scheme cash sum forecasted to be £135,217 at age 60 and a reduced starting pension forecast to be £20,665 per year at age 60 after allowing for price increases and a reduction for the tax-free cash sum.
Having taken the cash sum, the remainder of his transfer value (after all initial fees), was invested in Tideway’s Stable Return 3 portfolio, which forecasts a return of inflation plus 2% p.a. after all fees.
Why we recommended the transfer
Here are the key reasons why we were happy to recommend the transfer:
- We could see Nigel was clearly prudent with money and had a sensible plan as to what to do with the funds post transfer.
- He was able to understand the transaction, be comfortable with the risks he was taking on and had a clear preference to have access to the much higher tax-free cash sum and income flexibility, even if this was potentially at the expense of long-term income security.
- He did not have excessive income needs in retirement and almost half would be covered by state pension income post age 67. He also has a small investment property which gave him some extra capital to fall back on if needed.
- He had a very generous offer. We calculated that with a forward scheme pension inflation assumption of 2.5% he would need a return net fees of just 2% per year on average to sustain equivalent income payments equivalent to the full pension to age 90 and only 3% per year to get to 100. These target returns would have been lower further if we considered the pension he would get after taking the maximum tax-free cash sum.
- The tax-free cash sum he could get two and a half years early allowed him to clear all his debts with some funds to spare.
- Clearing the debts would give him significant monthly savings on a repayment mortgage and loan repayments. Some of these monthly savings could be redirected into ISAs and new pension contributions. Nigel and his wife were also keen to make some gifts to their grown-up sons.
How has it worked out?
Nigel is clearly still very pleased with his decision to transfer. His investment portfolio has been, in his words, ‘up and down’ quite a bit, but as we speak sits at just over £733,000. He has made a return net of all ongoing fees of approximately 4.7% p.a. compound on the fund for two and a half years.
He is still working full time but considering going part time next year. He is still almost two years away from his 60th birthday when he could have first collected full scheme benefits without reduction.
He has paid off all his debts and made gifts to both sons, helping one on to the property ladder and one to retrain as a deep-sea diver for a complete career change.
Hard to measure, but clearly very important to Nigel, he feels both satisfaction from having created the opportunity to be debt free and help the boys, but also to feel financially secure with options that come with having a £733,000 invested SIPP fund.
His current thinking is that as and when he is ready to stop work, he will likely draw around £30,000 p.a. almost 50% more than the scheme pension with a view to lowering withdrawals as the state pensions start, effectively smoothing out his income and ensuring, if anything, higher income in the early years of retirement, accepting he will probably need less later on. Importantly, he has options and choices.
How we would assess his position
The extra £86,000 received in the cash sum, and getting the sum four and a half years early, is a huge benefit. If you put a 4% per year value of money on this cash sum, it’s a £125,000 gain on day 1. That’s equivalent to 6.75% years’ worth of the after-cash sum pension at the time of the transfer. Given the pension may be payable for around 25 years, that's a 27% upfront uplift on the pension.
Now with a fund of £733,000 versus a surrendered pension of £19,700 p.a. in today’s money, but still 2 years from payment, the family are in a great position and well on track to create a windfall fund that can be passed on.
The target returns to match this pension to 90 and 100 have dropped to just 1.4% p.a. on average net fees and 2.8% p.a. respectively and given a 2.5% scheme pension annual inflation assumption. In fact, CPI is running at a bit less than this right now at about 2% p.a.
If they were to draw income from the SIPP matched to the scheme pension surrender and the investment portfolio continues to deliver a 2% real return ahead of inflation after fees, then the chart below shows how the SIPP balance would develop over time. Bear in mind this is in today’s money.
Investment risks looking forward
Of course, to achieve positive real returns today after fees it's essential to take some investment risk.
With 20-year gilt yields only offering a 1% return the ‘risk free’ return would be no return at all; it would be negative after fees.
To manage the risks, we take several steps:
- The portfolio is invested via collective funds so that it gets invested in hundreds of individual securities and would not be damaged by the demise of any one company.
- We invest for income as well as growth, so that there is always some cash being created every year to cover withdrawals.
- We invest in a range of strategies including short dated bond funds which would be very resilient in any market correction, and these can be cashed in separately from the more volatile funds, so that our clients should never be forced sellers of investments at a loss in down markets. The more volatile investments can then be held for the long term to get the best returns.
Nigel’s Stable Return 3 portfolio
The portfolio creates natural income each year of 2.6% forecast to about £19,000 in the next 12 months after all costs. For now, this is being reinvested but as soon as Nigel wants to switch on his income this can be used to fund income withdrawals without selling any capital items. It's already getting close to the pension he surrendered and will likely exceed it if he keeps working for a couple more years.
Nigel's asset allocation
Nigel holds 10% of his portfolio in cash and short dated bond funds. So if, as he is thinking, he wants to draw say £30,000 up to age 67, he would have over £70,000 (£10,000 a year for 7 years) to supplement the natural yield of the portfolio again without having to sell any significant amounts of the more volatile investments in the event there is a market down turn in the next few years.
Further information
To find out more about Nigel’s experience please do contact one of our advisers on:
Tel: 020 3143 6100
Email: info@tidewayinvestment.co.uk
On our Pensions Advisory Service site:
Important considerations
- Defined benefit transfers are complex, risky and always irreversible transactions. They will not be suitable for many DB pension holders.
- The information here should not be construed as advice to transfer but rather an illustrative example as to what can be achieved in a transfer and under what circumstances a transfer can be considered suitable advice.
- Investment returns post transfer are not guaranteed, and your capital is at risk in a Stable Return 3 portfolio managed by Tideway.
- Past returns are no guide to future returns.
- There is a legal requirement to seek advice from a properly qualified adviser and appropriately authorised firm if a transfer value is greater than £30,000.