Pensions - Articles - Exploiting the transfer window: What QE implies for DB to DC


In new research, What QE means for transferring you pension, Fowler Drew demonstrate how central bank distortion of the normal workings of capital markets has created an exceptional but short-lived ‘transfer window’ for exchanging the safeguarded benefits of a DB pension for the uncertain outcomes of a controlled drawdown plan in a SIPP.

 In new research, What QE means for transferring you pension, Fowler Drew demonstrate how central bank distortion of the normal workings of capital markets has created an exceptional but short-lived ‘transfer window’ for exchanging the safeguarded benefits of a DB pension for the uncertain outcomes of a controlled drawdown plan in a SIPP. This window has the same causes as the widely-reported increase in accounting deficits in DB schemes. It is important information for anyone with deferred pension benefits to come from a funded, final-salary pension scheme.

 Founder Stuart Fowler says ‘Transferring your pension is likely to increase both levels of after-tax wealth (be it income enjoyed or residual capital) and aspects of flexibility and control that many retired people value. The chance of worst value always exists but we have never seen it as low. So much so that in conditions in which significant loss arises the entire framework of guaranteed or insured pension income will itself be under stress. Public markets provide no free lunches but Government intervention in public markets can have that effect. This comes close.

 ‘There is no guarantee that the terms of transfer will not improve further’ Fowler argues. ‘However, we believe we are at or close to a tipping point in the terms. When it tips, the terms can change very fast.’

 Fowler Drew’s transfer analysis relies on stochastic or probabilistic modelling of drawdown plans. Stochastic modelling, though rare in private wealth, is critical for the task of comparing the near-certain real income of a DB pension with the distribution of uncertain outcomes for sustainable real draw, such as from a SIPP. Because its model for stress-testing a transfer is the same model it uses for managing the drawdown portfolio, the impact on the probability distribution of life-styling effects, or derisking the asset allocation as time horizons shorten, is fully captured. So too are the impacts of changing market conditions.

 What Fowler Drew’s model reveals about current capital-market conditions is that the risk premium relative to the yield on index linked gilts (they most closely match the nature of the DB promise and can be selected to hedge it perfectly by date and amount) is as high as would normally be associated with a deep bear market. This was featured in a recent press release, the Break-even Year for equities. So while Cash Equivalent Transfer Values have been driven sky-high by falling bond yields, the range of uncertain returns of the risky assets in the drawdown portfolio is quite close to normal.

 This means it is unusually easy to justify even a risk-averse investor being better off by transferring. This is without bringing into account the benefit of other 'optionality' a scheme member may value, such as higher tax free cash, higher income for a surviving spouse, lightly-taxed death benefits in the event of early death and substituting all or some of this capital to support retirement spending by other capital that would otherwise be subject to IHT. This option value is normally necessary to offset the risk of lower gross income than the DB pension.

 Says transfer specialist David Anderson: ‘In the paper we show a simple current case with a transfer value that reflects the most recent fall in yields. With no higher than normal risk aversion, and constraining the drawdown plan to last until at least age 100, the client can expect only 8.5% of the probability distribution for sustainable real draw to lie below the level of the DB pension. This is after assuming costs associated with the drawdown plan of 1.25%. This is lower than most firms charge but is feasible with systematic processes like ours. And for larger clients, because we charge flat fees, the proportion of outcomes worse than the DB pension could drop to 2.1%.

 ‘When clients ask me what the worst case in the stress test looks like’, adds Anderson, ‘I explain that it is like Japan over the last two decades but occurring across most economies and markets. If it did happen, and the real rate of draw was never cut, even after the death of a spouse, the capital would last till age 93 with the higher costs or age 97 with the lower costs. Realistically, there is virtually no chance of loss to weigh against the upside. I never thought I would be telling clients that and I can’t see myself saying it for long.’ 

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