Pension values destroyed by Bank of England interest rate hikes

Martin Lewis shares tips for boosting state pension

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Pension transfer values have been hammered by rising interest rates and gilt yields, and the crash is set to intensify after the Bank of England hiked interest rates yet again on Thursday.

Some schemes are suddenly worth hundreds of thousands of pounds less in a matter of weeks, and the trend will worsen with more interest rate hikes in the pipeline.

Members of final salary “defined benefit” workplace pension schemes are being urged to think twice before moving their money as transfer values have plunged by a third this year, with more to come.

The average pension transfer value stood at £270,000 at the end of 2021, but had crashed to an “unprecedented low” of £181,000 by the end of September, according to XPS Pension Group’s transfer value index. 

Transfer values are likely to fall even further after the Bank of England hiked interest rates again on Thursday.

Defined benefit pension transfers have always been controversial, and City regulator the Financial Conduct Authority has placed curbs on advisers involved in this area, due to the fat commissions involved.

These schemes are often called “gold-plated” because they offer a predictable, rising income in retirement, based on years of service.

They are expensive to run and most companies have replaced them with cheaper “defined contribution” plans, where the amount workers get at retirement depends on stock market performance.

Around 3.73million employees still belong to fully-open final salary schemes, down from 4.1million a year ago, according to the Pension Protection Fund. Once “closed” schemes are included, the total rises to 16.7million Britons.

Many employers offer lump-sum payments to former employees to quit their scheme, as it takes the financial liability off their balance sheet. But wealth manager RBC Brewin Dolphin has warned that members transferring out now get much less, due to today’s rising interest rates and gilt yields.

Savers are typically given a fixed amount to transfer out based on the amount of income they can realistically generate from low-risk assets such as cash, gilts or annuities. 

Someone with a defined benefit pension paying £30,000 a year might be offered a lump sum of £1million if base rates are at 3 percent.

But if rates rise to 4 percent, they may only offer £750,000 to recreate the same benefits.

Daniel Hough, financial planner at RBC Brewin Dolphin, said one of its clients was offered a lump sum of £1.3million three weeks ago but has since had it cut to just £850,000.

That’s a staggering £450,000 less. More companies may now take advantage of today’s “perfect storm” to make “seemingly generous offers” to get former employees off their books. 

Hough warned: “Accepting a large lump sum payment may seem tempting, but may prove a poor long-term decision.”

One big attraction of defined benefit schemes is that the income should continue as long as you live, with inflation protection, too.

But once you take a lump sum, the responsibility of managing that money is entirely down to you.

“It is good to have options, but it can also be a daunting prospect,” Hough added.

Short-term gilt yields rocketed in the wake of former Chancellor Kwasi Kwarteng’s disastrous mini-budget, but have since settled. However, yields on 20 and 30-year bonds are still rising, and these are the ones to use to calculate defined benefit transfer rates.

Andrew Tully, technical director at Canada Life, said transfer values vary according to the scheme, so it is always worth asking for an up-to-date valuation.

“Despite the attraction of taking out cash lump sum, in most cases people are better off remaining in their defined benefit scheme.

”Yet a transfer can make sense for some, particularly those in ill-health or with debts they cannot clear from income, Tully added.

There is one consolation for those offered a lower transfer value, he said. “If you use the money to buy a lifetime annuity, you will get up to 50 percent income more than a year ago, due to rising gilt yields and interest rates. This could help maintain your income overall.”

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