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The right pension

The ability to transfer between registered pension schemes has been a feature of the UK pension regime since the 1980s, allowing members to move their pension savings for a variety of reasons. But it has become increasingly important since the advent of DC 'pension freedom' in 2015.

However, defined benefit (DB) pension schemes offer valuable guarantees and the Regulator's view is that transferring away is unlikely to be beneficial for the majority of scheme members.

But for some, typically wealthier, individuals who aren't reliant on the guaranteed income for life provided by a DB pension, the DC 'pension freedoms' could provide a route to a more flexible retirement and increased death benefit options that better meet their needs.

Income drawdown under DC schemes can give the member greater flexibility and tax efficiency in how they take their pension savings. And the changes in how death benefits are taxed and who can benefit mean that the option of inherited drawdown gives the ability to pass pension wealth down through the generations - or even to friends - very tax-efficiently outside the estate.

DB schemes are unlikely to provide the ability to vary retirement income and pension death benefits are limited to a taxable income for dependants only. An individual with no spouse/civil partner and only adult children could find that all their DB pension rights are extinguished on death.

However, moving from the security of DB to access DC flexibility normally brings a significant increase in risk for the individual - so it's not a decision to be taken lightly. It also comes at the cost of limiting future funding, as accessing income flexibly under a DC scheme invokes the 'money purchase annual allowance' (MPAA), which restricts DC contributions to no more than £4,000 a year (with no carry forward).

Being in the right pension for the member's needs is crucial. Advice is paramount to achieving the right outcome. And where the DB benefits have a transfer value of more than £30,000 advice is mandatory.

The right to a DB transfer value

Members of occupational DB pension schemes have a statutory right to a transfer value, known as a cash equivalent transfer value (CETV), as long as:

• they've stopped accruing DB benefits within the scheme (even if they are still an active member on a DC basis); and
• are not within one year of the scheme's normal retirement age.

The member can request a guaranteed transfer value once every 12 months. The trustees of the scheme can grant more frequent requests if they wish and even provide a CETV when a member doesn't have a statutory right to one.

Timeline of a DB transfer

• Request for a transfer value - If the value of the member's DB rights (or any other safeguarded benefits) is over £30,000, the member must obtain financial advice before they can proceed with a transfer. Where this advice requirement applies, the DB trustees must tell the member within one month of receiving the request for a transfer value statement
• Guarantee date - The guarantee date, on which the CETV is calculated, must be within three months of the original request. This is the date which sets the start of the guarantee period (or 'acceptance window')
• Statement of entitlement - The trustees must provide the member with their guaranteed CETV 'statement of entitlement' within 10 days of the guarantee date. This means that the trustees have a maximum of three months and 10 days to calculate and provide the member with the CETV.
• Acceptance deadline - The member has three months from the guarantee date to confirm they want to proceed with the transfer - which means they may have little more than two and a half months to act by the time they receive their guaranteed CETV statement. They also have to confirm details of the receiving scheme and complete the paperwork required by the DB scheme within this deadline.
• Proof of advice - Where the advice requirement applies, the member has to provide the trustees with written confirmation from the authorised adviser that advice has been given in relation to the transfer, within three months of receiving their statement of entitlement. They don't need to say what the advice was - just provide evidence that appropriate advice has been obtained.
• Transfer completion deadline - Assuming everything is in order, the trustees must transfer the benefits within six months of the guarantee date.

Public sector schemes

Even though a member may have a statutory transfer right, unfunded public sector pension schemes (for example, the NHS Pension Scheme) cannot transfer benefits to a DC scheme capable of providing flexible benefits, such as income drawdown.

But transfers are allowed to DC schemes that don't provide flexible benefits. This allows members to transfer to buy conventional annuities, which could help those who are unlikely to get good value for money from their DB promise - for example, those in poor health or single people who have no need for a survivor's pension on their death.

Funded public schemes (for example, the Universities Superannuation Scheme) will allow transfers to DC schemes that offer income flexibility.

Pension scams prevention

Regulations were introduced on 30 November 2021 to help protect members from pension scammers. The new rules allow pension trustees and scheme managers to refuse transfers where there's a suspicion of scam activity. When processing transfers, they’re encouraged to pass through several steps of due diligence, which includes flagging potential problem transfers as either ‘amber’ or ‘red’ flags.

• If the transferring scheme raises a red flag, the transfer can be stopped
• If an amber flag is raised, the member will have to take specific scam guidance from the Money and Pensions Service (MaPS) before the transfer can go ahead

The following types of scheme are deemed to be ‘safe destinations’ and are effectively exempt from these new rules:

• public sector schemes
• authorised master trusts schemes
• authorised collective DC schemes

Safeguarded benefits and the advice requirement

'Safeguarded benefits' are certain pension benefits that provide security or valuable guarantees that can be lost if the member transfers or converts to get flexible benefits. Defined benefits fall into this category.

To make sure individuals are fully aware of what they could be giving up, they must get 'appropriate independent advice' from an FCA authorised adviser before they can proceed with a transfer - unless the value of the safeguarded benefits is £30,000 or less.

Some schemes have different categories of benefit, some of which are safeguarded benefits and others which aren't - e.g. an occupational scheme with both defined benefits and defined contribution funds. With such schemes it may be possible to transfer the non-safeguarded (DC) benefits without having to get financial advice - regardless of the value of the DB rights.

Confirmation that advice has been given
Before safeguarded benefits worth more than £30,000 can be transferred or converted, the individual must confirm to the trustees or scheme administrator of the transferring DB scheme that they've received 'appropriate independent advice' on the transaction.

This must be in the form of a written statement from the adviser confirming:

• advice has been given on the proposed transaction
• they have the appropriate permissions to carry out the transaction
• their firm's FCA reference number for the purposes of being authorised to carry out such transactions
• the member or beneficiary's name plus the name of the scheme which holds the safeguarded benefits to which the advice applies

The adviser must provide this statement, regardless of whether they recommended a transfer or advised against it. Remember, the statement just confirms that the member has received advice on the matter from a suitably qualified and authorised professional - not what that advice was. Giving the statement doesn't imply the adviser endorses the member's course of action.

This adviser's statement must be given to the trustees or scheme administrator within three months of the individual receiving their CETV statement of entitlement.

Calculation of transfer values

The pension scheme trustees are responsible for deciding how transfer values should be calculated, based on guidance from the scheme actuary - particularly around appropriate assumptions about the future course of events affecting the scheme and the member's benefits.

There are five broad steps in the calculation:

1. Calculate the accrued pension
2. Revalue to normal pension age (to establish the expected pension at normal pension age (NPA))
3. Multiply by something akin to an 'annuity rate' (to establish the cash value/reserve needed at NPA to provide the expected pension income)
4. Apply a mortality factor (to reflect the chance of surviving to NPA to receive the pension)
5. Discount back to the current date (to establish the current cash equivalent transfer value)

In other words, the CETV is the estimated amount that would need to be invested now, based on assumed investment returns on the DB scheme assets between now and NPA, to deliver the estimated reserve needed at NPA to provide the expected DB pension income.

Although this broad approach to calculating DB transfer values is fairly standard, trustees have discretion over the assumptions used (to reflect the particular circumstances of their scheme) - so different schemes could offer very different transfer values for the same amount of DB pension.

Assumptions
The main assumptions made in DB transfer value calculations tie in with steps 2 to 5 above:

• Inflation - to revalue the accrued DB pension to the scheme's NPA and estimate how much it will increase by each year once in payment
• Gilt yields - to estimate the cash value of the accrued DB pension at NPA, something akin to annuity rates are used. Annuity rates are primarily based on 15 year gilt yields
• Mortality - to reflect the chance of surviving to NPA and to estimate how long the pension will be paid. Mortality assumptions may be influenced by the industry in which the employer operates and/or by geographical location
• Investment returns - to establish an appropriate discount rate for calculating the current transfer value, by estimating returns on the scheme assets between now and NPA.

There's a choice of two methods available for calculating transfer values:

• The best estimate of the expected cost of providing the member's benefits (as above) and
• An alternative, where the trustees want to pay a transfer value above the minimum amount

Further guidance on DB transfer values is available on the Pensions Regulator's website.

Reduced transfer value
It's possible, in certain circumstances, for the trustees of DB schemes to offer reduced transfer values less than the 'initial cash equivalent' under the best estimate method.

The funding situation of the scheme is one of the situations that allow a reduction. But cash equivalents may only be reduced for this reason after obtaining an insufficiency report. This is an assessment by the actuary of the funding of the scheme using the transfer value assumptions. Any reductions to transfer values taking scheme funding into account must not be more than the maximum reduction identified in the insufficiency report. And, if a transfer value is reduced on grounds of underfunding, the trustees must tell the member the extent of the reduction applied and when they expect to be able to pay a full transfer value.

Although trustees have the power to reduce cash equivalents to allow for low funding levels, there's no obligation for them to do so. The decision may hinge on the trustees' view of the strength of the employer covenant and the length of the scheme's funding recovery plan.

What factors have the biggest impact on DB transfer values?

There are many factors which impact on DB transfer values, but the bulk of the increases in values over recent years have been driven by:

1. lower gilt yields
2. lower investment return expectations
3. improved life expectancy

Falls in gilt yields have had by far the greatest impact. And it's likely that changes in gilt yields will continue to have the single biggest impact on DB transfer values going forward.

Alied to this, as schemes have matured and/or closed, scheme trustees have typically been taking less investment risk, reducing equity exposure in favour of gilts and fixed interest stocks – creating further upward pressure on transfer values as expected returns from their investments have reduced.

Gilt yields can, of course, change as economic conditions change: the current low yields may not last forever.

Increasing life expectancy, on the other hand, appears more permanent. Scheme trustees now expect to pay pensions for longer than they have in the past, which is reflected in higher transfer values.

Finally, employers may be motivated to encourage transfers where a scheme deficit is dragging down net asset values on their balance sheet. This is because transfer values are normally smaller than the 'book value' of the benefits sitting on the employer's balance sheet, so transfers can be a very efficient way of reducing this debt.

Partial transfers

A binary 'all or nothing' transfer option doesn't always support the best member outcomes. While most people with a DB pension will be best advised to stick with it, a partial transfer could be the solution for those caught between needing some of the security of their DB promise and some of the income flexibility and estate planning opportunities offered by modern DC pensions.

Many schemes don't give the option of a partial DB transfer - there's currently no statutory right to a partial transfer of DB rights - but the number of schemes now offering them is on the rise. The barriers holding some DB schemes back from introducing a partial transfer option are the perceived complexity and cost. Legal fees to amend the scheme documents, actuarial fees to develop a transfer basis and the costs of implementing the necessary administrative processes can all be off-putting. But these are all achievable and the payback for all concerned could be worth it.

• Member - For members who want some guaranteed income, but not as much as their full DB entitlement, a partial transfer may be the best fit for their needs. It can provide the guaranteed income they need, plus flexibility with the balance of their accumulated DB wealth.
• Employer - Growing numbers of employers have realised that allowing partial transfers helps get DB liabilities off their balance sheet efficiently. If they stick with an 'all or nothing' stance, more liabilities may stay on their books.
• Trustees - Every transfer paid normally improves their scheme's actuarial funding position – leaving remaining members more secure. It's rare for a transfer value to be higher than the actuarial 'technical provisions' they have to reserve for to back the DB promise. -

Partial transfers are, however, possible - to a certain extent - for members of mixed benefit schemes. A change introduced by the Pension Schemes Act 2015 means they have a statutory right to transfer their DC rights and leave the DB pension behind (or vice versa).

When advising on a potential DB to DC transfer, advisers should always ask whether a partial transfer is available - so their advice can reflect all the options on the table.

Transfers in ill health – the IHT risk

When advising on DB transfers, it's important to appreciate that transfers in ill-health can have adverse IHT implications.

Most pensions are normally outside the member's estate for IHT purposes, because the trustees/administrators usually have discretion over who will receive any death benefits. But this IHT protection can be lost if pensions are transferred while the member is in poor health and dies within two years of the transfer.

On the face of it, a pension transfer where discretion exists both before and after the transfer, would appear to be neutral for IHT as both pensions are free of IHT. But HMRC take a different view.

Their view is that the member could have chosen to transfer to a pension that allows death benefits to be paid to their estate - however unlikely that may be. As a consequence, there's a loss to the estate when the transfer is made.

• In most circumstances, the value of the death benefit is negligible - because most transfers are done when the individual is in good health and expected to survive to take their retirement benefits
• But if someone is in ill-health at the time of transfer, the loss to the estate could have a value. The good news is that it will usually be less than the value of the pension transferred - and in some cases, a lot less

Being aware of these issues is important as it could influence a client's decision to transfer. But it doesn't necessarily mean a transfer shouldn't go ahead if the client is in poor health. A transfer may still deliver a better outcome for the member and/or their loved ones, despite a potential IHT charge.

Our guide 'Pensions and IHT' and our article 'What does the Staveley case mean for pension transfers in ill-health' give more information.

Transitional protection – how pension transfers can invalidate it

Pension transfers can result in certain transitional protections being lost. In particular, certain DB transfers can result in the loss of:

• Enhanced protection
• Fixed protection 2012, 2014 or 2016
• Protected tax free cash of more than 25%
• Protected low pension age.

But there are some options to plan around this.

Enhanced or fixed protection – the 'permitted transfer' rules
Enhanced or fixed protection is normally maintained following a pension transfer. But only if the transfer is a 'permitted transfer'.

A DB to DC transfer is only a permitted transfer if the transfer value represents the actuarial value of the benefits being transferred. No enhancements can be included. This means accepting an enhanced transfer value normally results in enhanced or fixed protection being lost.

Permitted transfers can include partial transfers. Similarly, a permitted transfer can be split between two or more receiving DC schemes.

Enhanced protection – the 'appropriate limit' rules
Even if a DB to DC transfer is a 'permitted transfer', enhanced protection will be lost if the transfer value paid is more than the 'appropriate limit'.

These rules go back to 2006, when accepting a limit on the size of DB pension that could be provided was the trade-off for securing complete protection against LTA tax using enhanced protection. This limit, known as the 'appropriate limit', also applies if DB rights are transferred to a DC arrangement.

Broadly speaking, the 'appropriate limit' is 20 times the pension built up at 5 April 2006, increased up to the 'relevant' (transfer) date by the higher of:

• 5% a year for the period from 6 April 2006 until the relevant event date
• the percentage increase in RPI from April 2006 until the month that the relevant event date falls in, or
• recalculated using the post-commencement earnings limit rules.

See our 'DB transfers and the appropriate limit' practical guide for full details on calculating the appropriate limit.

If the DB transfer value paid is within the appropriate limit, enhanced protection will be maintained - allowing the new DC fund to grow unrestricted by the lifetime allowance (providing enhanced protection is still in force when the funds are crystallised).

Partial transfers within the appropriate limit
If a DB transfer value is above the appropriate limit, a partial transfer (if the scheme offers it) up to the appropriate limit could be made - leaving the residual benefits within the DB scheme. This could allow DC flexibility for some benefits, while maintaining enhanced protection.

The residual DB rights would still be tested against the available appropriate limit when eventually drawn from the DB scheme (or transferred to a DC scheme). If enhanced protection is lost at this point, the member would have to rely on their remaining standard lifetime allowance (or any other protected amount they have) - but it wouldn't have a retrospective effect on any previous benefit crystallisation events.

Protected cash & low NRDs
There's an additional complication when transferring benefits which have:

• an entitlement to more than 25% tax free cash under 'scheme-specific tax free lump sum' protection; or
• a protected low pension age.

Unless the transfers are part of a 'block transfer', the protection will be lost.

• A DB to DC transfer is a 'block transfer' if two (or more) members of a DB scheme transfer to the same receiving scheme at the same time. The transfer must represent the members' total rights under the transferring scheme (including any DC rights) and can't be split across more than one receiving scheme.
• If any member involved in a block transfer has been a member of the receiving scheme for more than a year when the transfer is made, their transitional protection will be lost (unless membership predates 6 April 2006 and the scheme only held funds originating from contracted-out rebates before the transfer). The block transfer will, however, still be effective for the other member(s).

Of course, losing the protection may not be much of a concern if the level of tax free cash is only marginally greater than 25%, or if benefits are unlikely to be taken before the normal minimum pension age (55) - or perhaps if the benefits of transferring outweigh the protection. But it's best to maintain these options if possible.

Care is needed if consolidating pensions where more than one of the schemes has protected tax free cash – this can result in a lower overall tax free cash entitlement. More information on this is available in our 'Practical guide to pension consolidation'.

Our guides 'Scheme specific tax free cash' and 'Pension age' give more information on these protections.