Defined benefit members are being left £2-3bn out of pocket every year as trustees and advisers fail to update the terms offered on tax-free lump sums at retirement.
Actuaries warn that cash commutation factors have not been revised in line with market conditions, such as rising longevity, low interest rates and low inflation.
Buck Consultants senior corporate consulting actuary Colin Richardson said across the board factors are being understated by 20-30% and put the loss for members at a “conservative” £2-3bn per annum.
He said: “It is possible that many advisory firms have not stood up and raised this issue because it may raise some inconvenient matters for advisers and clients. This has helped keep the issue away from the spotlight.”
In occupational DB schemes, members can choose to take up to 25% of their pension as a tax-free lump sum at retirement – with estimates that almost 90% of members take this option.
The member’s future income is then reduced by a formula – for instance a factor of 10-to-1 would reduce a pension by £1 for every £10 of lump sum.
Richardson said many schemes have moved to factors that are 12 or 13-to-1 in recent years but a market value factor would be nearer 20-to-1.
He added: “With enhanced transfer value exercises there are lots of FSA rules and regulations so a member can only transfer after independent advice.
“If you did a test on it in the same way as people now have to take advice to do a pension increase exchange, a financial test, in almost every case the adviser would have to say – don’t do it. If your life span is anything approaching an average life expectancy, you’d be better off not taking the cash.”
Richardson said this was an area where trustees may not be acting in the best interest of members by failing to update the factors.
LCP partner and scheme actuary Richard Murphy said commutation factors vary considerably from scheme to scheme.
He said: “Historically the factors were relatively low but most trustees as a matter of good practice will update their factors and members have this option to take cash: the question is how close to market value you move to?
“Pensions are now as expensive as they’ve ever been. If people are cashing in their pension today do trustees give that sort of value or something that’s more like what they’re hoping to deliver for long-term funding?”
Murphy added: “And that’s a difficult decision for trustees but we have seen them consistently improve over the last decade but the question would be: have trustees gone far enough?”
Pitmans Trustees managing director Richard Butcher argued some schemes’ commutation factors are hard-coded into rules and can be set by the actuary or employer as well as trustees.
Butcher said: “Is there a big scandal here that some trustees deliberately keep the rate very very low and some advisers allow them to do that because we know that the vast majority of people will take cash in an uninformed way? I don’t think it’s a big conspiracy but I think there is probably an element of that.
“I think the responsibility for that is shared by the trustees and their advisers – the trustees can only act on advice.”
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