How the Gilt Yield has made a Final Salary Transfer an Option

Although the long-term economic effects of the Brexit vote look as opaque as the campaigns behind the referendum, one clear consequence of the vote was that gilt yields fell to historically low levels.

As investors clamoured for safe investments, demand shot up for gilts meaning prices went up, and yields fell. At one point yields fell below 1% for the first time.

This had an immediate effect on the annuity market. Standard Life, Legal & General, and Canada Life all announced they would cut their annuity rates in reaction to these falling yields, which are used by insurers to back up annuities.

However, while annuity rates fell, declining gilt yields proved positive for transfer values out of defined benefit (DB) schemes, which saw an upswing after the Brexit vote.

Pension provider Xafinity’s transfer value index was at £223,000 on 30 June 2016, its highest level in 2016 and 4% higher than any level in 2015 (this figure is based on a 64-year-old member with a £10,000 annual DB pension).

This increase in value was largely a reflection of tumbling gilt yields in the wake of Brexit. The rise of pension transfer values could mean an upturn in the number of people wanting to transfer out of DB schemes, something that may be considered strange given their traditionally gold-plated reputation. Although, there are concerns over an ageing population within the schemes and how viable they are in the long term to continue to pay benefits the members.

The pension freedoms, combined with this increase in values, has opened up the transfer option. There were some benefits for investors when it comes to transferring that extended beyond rates of guaranteed income. Having access to the cash was one of them without restrictions. Investors wanted to buy property, give money to children or go on holiday are some of the examples.

There has also been a decrease in the lifetime allowance (from a high of £1.8m to a low of £1m), and this has pushed more people into a potential future tax problem. Expats have the option to move their scheme overseas to a QROPS to avoid this potential charge.

Once someone has transferred out of the DB scheme, there a choice over the best way to use that cash. With annuity rates falling – also a consequence of low gilt yields – Investors need to understand that drawdown will be affected by low-interest rates and more market volatility expected post-Brexit.

The transfer process involves getting a quote from the transfer value analysis system to produce the critical yield and then checking what an annuity would be worth based on the client’s health. This critical yield will be now more attractive as a result of the gilts movement. Advice is especially crucial as every individual circumstance is going to be different a suitably qualified adviser is a must.

The DB pension holders are getting a unique set of circumstances to exit a DB scheme, but it does come with the normal dangers and warning signs.

Source: Citywire