01 Nov How Has Brexit Affected Your Pension?
The long-term effects of Brexit remain significantly opaque, but one clear outcome of the referendum is that gilt yields have fallen to historic lows. If you have a UK final salary pension scheme, this could be important to you because it has also brought Cash Equivalent Transfer Values (CETV) to all-time highs.
cash equivalent transfer values are currently 80% higher than they were in 2012 and 25% higher than one year ago
A final salary pension scheme provides the member with an income for life, which usually rises with inflation each year. In certain cases, they also provide a surviving spouse or civil partner with an income – typically between a half and two-thirds of the original amount. They are a very secure pension plan, but that does not mean there are not circumstances where it is beneficial to transfer your pension into a cash equivalent lump sum. The fall in gilt yields has resulted in these transfer values reaching record levels.
How Do Gilt Yields Affect Your Pension?
After the Brexit vote, there was a high demand from investors for the safety provided by gilts. As with all economics, higher demand equals higher prices. As the prices of gilts rise their yields fall and currently, yields are at all-time lows. This fall also propelled a decline in AA-rated corporate bond yields, which track 15 to 20-year gilt yields.
When corporate and government bond yields are low, it is more expensive for final salary schemes to meet the liabilities to their members, because providing a stable return becomes more difficult. Lower yields also increase transfer values, which are a calculation of how much of today’s money it will cost the scheme to meet the future requirements of their members.
According to Punter Southall, an actuarial consultancy, CETV’s are currently 80% higher than they were in 2012 and 25% higher than one year ago. As the chart below shows, even over the past few months there has been a sharp uptick in transfer values:
Change in transfer value (£) for a male aged 45, with a retirement age of 65 and an initial pension of £10,000 per annum
Pension schemes are not obliged to inform members about these kinds of developments, meaning only the financially savvy and well advised are aware that their position has improved.
A final salary pension lasts for the life of the member and any dependents that they have. The employers who own these schemes must shoulder the risk of providing these incomes. The combination of higher life expectancies, low interest and poor market returns, has meant that many pensions now run in deficit. This shortfall means there is not enough money in the pension scheme to meet the long-term requirements of its members. These deficiencies are of particular concern to those who are still working and might see their benefits altered to reduce the deficit.
The collapse in gilt yields following Brexit has had a dramatic effect on the deficits in final salary schemes. Following Brexit, the total deficit of final salary schemes soared by £90bn from £294bn in May to £384bn in July, an increase of 83%.
Most members are completely unaware of the current ‘health’ of their final salary scheme. As part of the process of obtaining a CETV, it is possible to look into the underlying pension plan, including its current level of deficit. In many cases, this analysis will provide the member with a much clearer picture of the health of their retirement plan.
The Benefits of Leaving A Final Salary Scheme
It is important to carefully consider any decision to leave the relative safety of a final salary scheme. There are a lot of factors to weigh up, and everyone has a unique set of circumstances to examine. Below are some important factors for people to consider:
Taking your pension out of a final salary scheme ultimately gives you more control over your money. While it is in the retirement plan, you have no say in how the administrators invest or manage your money. Moving your pension puts this control back into your hands and allows you to structure your retirement assets based on your individual needs. If your scheme is running a high deficit, then transferring your money out of the plan could improve the safety of your retirement nest egg.
As noted at the beginning of this article, most final salary schemes will provide some benefit to the surviving spouse or civil partner. But very few offer anything for children, making the transfer of wealth to your kids impossible. The money in your pension is your hard earned pounds. If you and your wife are no longer around these funds would go back into the scheme to pay the benefits of other members. The problem is more significant for those that do not have a spouse or financial dependents.
Many expatriates around the world find themselves in more beneficial tax regimes while they live and work abroad. In Asia, many countries do not tax foreign incomes, which creates an opportunity for those retiring overseas.
With a UK pension scheme you are taxed at source in the UK at standard rates of income tax. However, by transferring your pension to a Qualified Recognised Overseas Pension Scheme (QROPS), you could dramatically reduce the tax you pay on your retirement income while you are abroad.
Final salary schemes will typically link their member’s benefits to inflation, which means that they increase each year by a set amount – usually between 2-3%. While this return is guaranteed, it is not very high, and it could be possible to achieve better growth once you transfer your money out of the scheme.
Since its inception in 1983, the FTSE100 UK stock market index has returned an average annual return of 6.08%, a return that is over double the average rate of inflation. Using the FTSE100 is a very simple comparison, but it highlights the fact that you could achieve investment returns which would equal or better your final salary scheme.
Free Pension Audit
If you have a final salary or defined contribution pension scheme and would like to know how Brexit has affected your retirement plans, then contact us for a free pension audit.
We will help you get an up to date Cash Equivalent Transfer Value (CETV) and valuation so that you can understand your options. As part of this process, we will also obtain an actuarial opinion on the health of your pension scheme.