How are pension transfer values calculated?

There are many reasons for transferring your pension from one provider to another. These include lower costs, wider investment options, or simply bringing all of your pensions under one umbrella.

It is essential to look at how pension transfer values are calculated, how the type of pension you have affects these calculations, and what options are available to you once you have the pension value. 

What is a pension transfer value?

Should you decide to transfer your pension to a different scheme or provider, the pension transfer value is the amount of money that your existing pension provider would pay to your new provider.

Getting an accurate pension transfer value is not always easy, as it will be calculated based on different factors, including the type of scheme you're currently invested in.

Defined contribution transfer values

For a defined contributions plan, the fund value is simply the value of the pot's investments at any given point, whereas the transfer value is the value that would be transferred in case you had been to finish a pension switch to some other scheme.

In most cases, these two values will be equal. However, if you request a transfer value quotation, please note that it is not guaranteed and will be an estimate that may be subject to change in line with investment performance up until the date your funds are transferred.

Another important fact is that, depending on your pension plan, your transfer value may take into account exit charges and any market value reduction (MVR), which will reduce the transfer value compared to the fund value.

However, some schemes offer final bonuses (terminal bonuses), which increase the transfer value. It is important to seek financial advice to fully understand the transfer value of your plan, particularly if it does not align with your fund value.

Defined benefit transfer values

The term cash equivalent transfer value (CETV) typically refers to final salary pension schemes (defined benefits). With this type of scheme, your pension on retirement is based on your salary and time in employment and is a bit more complex.

You will not accumulate a substantial amount of money. Instead, you make regular contributions to ensure a steady income for life when you retire.

As a result, your transfer value cannot accurately reflect the fund's value at any given point.

Instead, a value, known as the cash equivalent transfer value, has to be calculated and is the amount that your current provider would need to pay into your new scheme to generate the equivalent income on retirement that you would receive from the original scheme.

However, this is not a guarantee because, with a defined benefits pension, you are protected from fluctuations in the stock market. Still, once you transfer out into a defined contribution scheme and start investing, you expose your pension fund to risk.

How are CETV values calculated?

If you have a defined contributions pension, you can ask for your pension transfer value from your provider at any time, or you can look at a recent pension statement.

The pension transfer value will be calculated based on the value of the fund at the point of transfer.

If you have a defined benefits pension, calculating your CETV is a complex process that involves several factors. However, a very crude calculation would be as follows:

Final salary / 60 x years employed x 20 = CETV

If you had a £30,000 salary and were employed for 20 years, you would have a capital erosion tax value (CETV) of around £200,000.

In addition to considering how much you and your employer contribute and how long you have been contributing, it's also based on some personal and social factors.

Rules concerning CETVs:

• Once you request your CETV, your provider must provide it within three months, and it will only be valid for a specified period.
• If your CETV is £30,000 or more, and you are thinking of transferring the pension, then it is compulsory to take financial advice. You will also require a specialist financial advisor who is suitably qualified to offer advice on final salary pension schemes, as the majority of advisors are not competent to provide guidance.

 

These include:

• Your age and your scheme's retirement age
• Your relationship status
• How much your provider would like you to transfer out of the scheme.
• Life expectancy
• The pension transfer value index
• The cost of living

 

It is worth keeping an eye on the pension transfer value index, as it tracks the current value of pension transfers.

Higher figures mean you will be offered a larger amount, so if the figure drops, so may your CETV. Many schemes have faced shortfalls in recent years, so they have been encouraging members to transfer out by offering huge cash equivalent transfer values (CETVs). 

Should I transfer my defined contributions pension?

Many employers are now transitioning to defined contribution schemes because defined benefit schemes can be costly for employers to administer and manage.

You cannot be transferred out of a defined benefits pension without consent. Although an employer, you may close it to new contributions and transition to a defined contribution scheme going forward.

However, if this does happen, you retain the benefits you have built up in the original scheme. 

Advantages of transferring out of a final salary scheme:

• Get access to your pension from the age of 55
• You can make use of pension freedom, so you get a more flexible income
• Your transferred pension forms part of your estate tax-free to your family
• CETV values can be incredibly high, giving you more money to spend now

 

Downsides to transferring out of a final salary scheme:

• You will be giving up a guaranteed income for the rest of your life.
• Your money will become exposed to the stock market so that it can fall as well as rise in value
• You could run out of money

 

Get expert advice

Taking all of this into account, it's essential to seek financial advice before making any decisions, as a transfer is final and cannot be reversed.

Therefore, any decision should be based on a careful and expert assessment of all your circumstances. 

Let Regulated Advice match you with a financial advisor for expert advice.