By James Baxter, December 2019
It is just over five years since Pensions Freedoms were announced in the 2014 budget. This new freedom allowed the public to re-evaluate how they could access their pensions and, as a consequence, interest in DB transfers grew. So, now is a good time to reflect on those five years, assess how clients who transferred have fared and review the outlook for transfers today.
For Tideway Clients, the Outcome Has Been Overwhelmingly Positive
Tideway has taken great care over the years to recommend DB transfers to clients where the transfer funds can meet their objectives in retirement and where they have an appetite and ability to take some investment risk.
Despite Brexit, Trump, Neil Woodford and trade wars, investment markets have been pretty good to us. The vast majority of transfers completed in the last 5 years required only modest real returns above inflation after all fees to make clients economically better off over time, and that is being delivered by Tideway’s portfolios and other wealth managers we have worked with.
The chart below shows the performance of our most popular Stable Return 2 mixed-asset Horizon portfolio since its creation in September 2016:
Performance of our Stable Return 2 mixed-asset Horizon portfolio since its creation in September 2016
As can be seen, the portfolio has returned just over 18% for a little over three years. Allowing for Tideway’s adviser and custody fee, clients have therefore made around 15% over that period and a little more than 2% each year ahead of inflation which has been averaging at around 2% p.a.
The chart shows the importance of having a long-term view to investing as clients who invested in the first half of 2018 found themselves at around a 5% loss by the end of the year. However, these losses have now been fully recovered and all clients have made a profit.
On top of these returns, we have also had many clients taking full advantage of pensions freedoms.
An increasingly popular “freedom” is the ability to take a tax-free cash sum and then no further income whilst continuing to work. By having an ongoing relationship with our clients, we know these cash sums are being put to good use paying down mortgages, helping family members on to the property ladder or reinvesting in ISAs for tax-free capital gains.
No Ferraris or Lamborghinis have been bought to our knowledge, but definitely a few motorbikes and campervans!
Many of our clients have circumstances which mean that they are clearly never going to touch the capital in the pension funds as they have other sources of income. Or, they are simply happy taking the natural income from their portfolios which meets their needs.
As an example, our current Stable Return 2 mixed-asset Horizon portfolio is yielding just over 3% p.a. after all fees. So, a £600,000 pension drawdown account can pay out £18,000 per year of pension income without touching capital. Combined with two state pensions and some savings income, this can take a couple’s income in retirement towards £3,000 per month after tax.
These case studies are based on real Tideway clients for whom a transfer was in their best interests and they are by no means unique. However, it is important to note that these examples are not representative of all of our clients.
The aim of the case studies is to highlight the significant impact that a DB transfer from a scheme making a generous offer, followed by a well-managed investment plan, can have. Both clients have an ongoing relationship with us and have been using one of Tideway’s Horizon model portfolios. In both cases, their names have been changed.
Bob wanted to retire from shift working at the age of 55 and gave up a defined benefits scheme at that point in 2016 which, had he not transferred it away, would have provided a cash lump sum of £142,000 plus a starting pension of £21,300 linked to inflation.
Having established that a transfer away was a suitable option for him, he was able to take an increased cash lump sum of £301,000. He took no income for a year and then started an income of £36,000 p.a., recently increased to £42,000 p.a. but still within the basic rate tax band.
Bob’s drawdown fund at the start of December 2019 is worth £923,000 and could generate £28,000 per year without capital encashments based on the natural portfolio yield after fees on our Stable Return 2 Horizon portfolio. As Bob is drawing more than the natural yield of the portfolio, it is essential to ensure he does not put his longer-term income needs at risk. To this end, he will regularly review his position with his Tideway Wealth manager to look at sustainable withdrawal levels for the future. Tideway also keeps a buffer of lower volatility investments (cash and short-dated bonds) that can be cashed in to fund the shortfall between his withdrawals and the portfolio income, leaving more volatile investments for the longer term. In this way, it is possible to avoid selling investments at a loss in any market downturn just to fund withdrawals.
Vicky wanted to retire at 55 at the same time as her husband, who was due to receive a defined pension from the fire service. In 2018, Vicky took a DB transfer and gave up a cash sum of £63,000 and starting pension of £9,400 p.a. from her defined benefit pension scheme that would have commenced in January 2019.
As a result of our advice to transfer, Vicky received a tax-free cash sum of £127,000 on her 55th birthday and, so far, has not taken any income. Her drawdown fund is worth £400,000 at the start of December 2019 and could generate £12,000 p.a. of income without touching capital based on the natural portfolio yield after fees on our Stable Return 2 Horizon portfolio.
In both cases, I have focused on the natural portfolio income available now from the current drawdown scheme and after fees, as this is a good indicator of indefinitely sustainable withdrawals. In both these cases, this natural yield income is in excess of the defined benefit pensions given up, despite the clients in both cases receiving double the tax-free cash sum. A feature of a pension outside of a defined benefit scheme, where investors limit withdrawals to the natural yield income, is that the capital in the drawdown account is effectively a “windfall” for the family of the DB member after they die. The “windfall” can become a large family legacy, albeit with some tax to pay versus the certainty of no transferrable value from a defined benefit pension to the next generation.
The strategy and management of our portfolios mean that the income they produce should increase from year to year and, whilst capital values are more volatile, the bond coupons and share dividends that create the portfolio income are much more stable and reliable.
It is possible to draw more than the natural yield income but, in this case, capital will likely be depleted over time so at some point the account could be run dry. We can help clients manage this capital depletion where they want higher income in the early years of retirement but not to exhaust the fund too quickly as to completely run out in later life.
Transfer Values Further Uplifted, but Potentially Falling Back
Having dipped to new lows in 2016 after the Brexit referendum results, the 20-year UK gilt yield, a key driver when calculating the cash equivalent transfer value of a DB scheme, stabilised at around 1.75% before falling significantly in the first half of this year to as low as 0.8% at one point.
UK 20-Year Gilt Yields Over the Last 3 Years. Source: Market Watch
This has resulted in the highest transfer offers we have ever seen appearing in the last few months. Whilst transfer offers of 35 times an age 60 pension have not been uncommon, we have now seen a few 40 times plus offers.
As part of a wider consideration of a client’s needs and objectives, the size of an offer matters for the following reasons:
Defined Benefit Transfers have received an increasing amount of mainstream and mostly negative publicity. The British Steel debacle and subsequent FCA activity have attracted much more press attention than positive case studies of members enhancing their lives and retirement prospects through DB transfers.
Some of this negativity is clearly justified. Some unfortunate clients have been scammed of their pension funds, transferred into unsuitable investments, or persuaded to transfer by fee-hungry advisers where they would have been better off staying in their DB scheme.
This has caused the FCA to visit many firms and they have said they are prepared to visit all firms active in DB transfer advice until standards improve. This must be welcomed and we commend them in their efforts to do this. Some firms, including one or two high profile firms, where you would have thought standards would be better, have been forced to withdraw from advising on DB transfers following the FCA visits.
DB transfer advice is complicated and requires significant attention to detail. Those who transfer most often require significantly different investment solutions post-transfer to younger investors still accumulating their pension accounts. The UK advice market as a whole was ill-equipped for the increase in demand seen from 2015 onwards and a small number of unscrupulous advisers have taken advantage of the increased demand for transfer advice.
However, we hope those still with DB scheme benefits (a leading UK actuary tells us there is still £700bn worth of you!) will keep an open mind around the transfer option and at least give it some time and research as a viable alternative before locking into an irreversible annuitized income from your scheme.
At Tideway, we find it hard to reconcile the very negative picture painted of DB transfers with the very positive outcomes that our clients achieve both immediately and in terms of planning their future income needs. Given the size of transfer offers as we move into 2020, we can see the potential for huge economic gain for clients where the transfer clearly meets their objectives and where they have an appetite and financial position to take some investment risk in retirement.
DB transfers are complex, irreversible and often very high value transactions that should be considered carefully and not undertaken lightly or without properly qualified advice. Those with transfers above £30,000 in value must take advice from a properly qualified and authorised adviser and firm.
Undertaking a DB transfer will put your capital and the income it can produce at risk to investment markets. If you would prefer to receive guaranteed lifetime income, unless you have exceptional health issues it will usually be better to stay in your DB scheme, with your benefits backed by a fund, your old employer and the pensions protection fund.
Please remember that past performance is not a good guide to the future performance of an investment and value of investments and the income they produce can fall as well as rise. Your capital can be at risk and you might not get back all of your initial invested money.
Tideway Investment Partners is authorised and regulated by the Financial Conduct Authority.