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5 March 2018 last updated

Final salary transfer values remain high even after strong rise in gilt yields

Final salary pension transfer values are stable at £232,000 even though gilt yields have increased this year with an expectation of a rise in interest rates due to higher inflation.

Data from the Xafinity Transfer Value Index shows the value of the benchmark fund has increased by about £1,000 over the month and is only £4,000 less than December.

The value of a final salary scheme is based partly on the 15-year gilt yields which have increased from 1.50% at the end of December to a high of 1.89% in February ending the month at 1.75%.

Future benefits to members of final salary (also called defined benefit) schemes assume an inflation rate of 2.5% per year whereas investment returns based on gilts is only 1.75% per year and this gap helps significantly to boost transfer values.

Inflation is rising and the Bank of England increased interest rates from 0.25% to 0.50% resulting in higher 15-year gilt yields. This still leaves schemes with a shortfall in funding and the opportunity to offer high transfer values.

final salary transfervalues remain high
  Transfer values of final salary schemes are stable despite strong rise in 15-year gilt yields
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Members transfer £50 billion in pensions

Over a two year period 210,000 members of final salary schemes have transferred out £50 billion to money purchase pensions turning many average professional salaries into millionaires.

The Xafinity Transfer Value Index tracks the transfer value that would be provided by a benchmark member aged 64 entitled to a pension of £10,000 each year starting at age 65 increasing each year with inflation, producing a fund of £232,000.

This is a multiple of about 23 times projected annual income although some scheme would offer 30 or 40 times and so the fund value offered to transfer out would be £300,000 or £400,000.

A projected income from a final salary scheme of £25,000 per year could potentially have a transfer value of £1 million.

Across all schemes the Xafinity Index average value increased from £210,000 in June 2016 reaching a high of £244,000 in October 2016.

There remains a £700 billion pension funding shortfall for final salary schemes. It is not possible for for companies to fund this overnight and some schemes are weaker than others. To reduce their liability to future member benefits, some schemes are willing to offer higher multiples.

Are final salary values expected to fall?

The 15-year gilt yields have a significant impact on final salary pension transfer values. Yields rise and fall due to market expectation of interest rate rise in the future.

UK inflation continuing to climb to a near six-year high of 3.1% in November 2017 following the fall in sterling after the Brexit vote. Any rise in the Bank of England base rates will send gilt yields higher slowing the rate of growth in transfer values and reducing it over time.

Sankar Mahalingham, Head of DB Growth, Xafinity said, the Bank of England Monetary Policy Committee (MPC) kept the Official Bank Rate at 0.5%, but also indicated that rates may need to go up more quickly and further than previously thought during 2018. 

The impact of this on longer-dated gilt yields was muted, and it is these that affect transfer values rather than the Official Bank Rate suggesting the comments from the Bank were broadly in line with market expectations.

While the market is anticipating gradual rises, any delay in actual rises would likely mean an increase in transfer values if the delay is expected to be prolonged.

News related stories:
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Pension annuities set to rise as ECB signal end to cheap money
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Related internet links:
Xafinity - Transfer values remain stable over February 2018
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