For anyone considering leaving a company pension scheme and transferring a lump sum to another policy, the key is to aim for a time when interest rates are low.
Despite the furore surrounding the mis-selling of personal pension policies it would be a mistake to believe that all pension transfers are wrong. The problem is how to work out when a transfer is the better option.
Since 1st January 1986 anyone leaving a company pension scheme has a right to preserved pension benefits, or, in accordance with prior legislation, a lump sum which can be transferred to another scheme.
If your occupational pension is a 'defined contribution' scheme, otherwise known as 'money purchase', and you have no personal reasons for wanting to transfer the money, the decision is reasonably straightforward.
The considerations are typically two-fold. First, are the investment managers currently managing the fund as well as any you could find by switching? Secondly, are there any penalties imposed by the existing fund managers for moving the money, and what are the comparable level of charges? In other words, with a money purchase arrangement it is usually a simple evaluation of the relative merits of investment managers.
However, most large companies have what are known as 'defined benefit' schemes where the pension paid at retirement is linked to salary and the number of years of employment. The first and most obvious consideration here is whether the company, and possibly the pension scheme, will still be in existence at the date of retirement. Many of the complaints handled by the Occupational Pensions Advisory Service involve companies which have been taken over, merged or gone into liquidation. Records also get lost. In the worst possible case, the pension fund is in deficit or, as with Maxwell, has been raided to prop up an ailing company.
Assuming your ex-employer passes this test, it still doesn't make the next stages of decision-making any easier. The arguments on whether to take a transfer value from a 'final salary' scheme are highly complex with many unknown and unquantifiable factors to take into account.
In a defined benefit scheme the employer effectively underwrites the pension. If at retirement age there is insufficient money in the fund to pay the promised benefits, the employer must top up the fund. This is rarely necessary, however, as pension funds generally carry out an actuarial survey every three to five years and funding levels are adjusted to achieve the necessary balance between assets and liabilities. Once you have transferred out of the scheme no such under-writing guarantees exist.
You must also establish whether the transfer sum offered by the former employer can buy better benefits elsewhere - not something you are likely to be able to work out yourself. This, however, is only part of the consideration. 'You have to look at the company's policy on uprating the benefits of deferred pensioners - both during the deferral period and after retirement,' explains Michael Otway of stockbrokers Carr Sheppards. 'With a few company pension schemes there is a guaranteed uprating, but in most cases it is discretionary, so you have to look at what has happened in the past and what is likely to happen in the future. You also need to work out whether the transfer value offered and the implied investment return assumed by the fund managers to secure your benefits is realistic, and whether it can be bettered by taking the transfer.' Timing is also crucial. Because the transfer sum reflects the cost of providing benefits at a future date, certain investment assumptions are made by the scheme's actuary. One of the criticisms of the 1988 legislation which gave pension scheme members the right to take a lump sum transfer was that it did not set down the formula for calculating this amount. As a result, different actuaries take different views on investment returns over the period (and therefore the lump sum needed today to provide these deferred benefits at retirement) and two employees with identical service in identical schemes may well find that they are each offered different transfer values. If you are a high-flyer or key executive, you may well be in a position to obtain favourable treatment on your pension - either from a prospective employer as an incentive to move, or from your current employer as an encouragement to stay or take early retirement.
In addition, if the pension fund trustees want to get rid of the nuisance of administering many thousands of deferred pensions for past employees, they may offer a more attractive transfer sum to encourage deferred pensioners to leave. A few pension schemes might take into account discretionary increases in benefits - most do not.
What the actuary is doing when he arrives at the lump sum is working out in today's money what it will cost to provide the promised benefits at the date you retire. To do this he has to make assumptions about what average investment returns will be over the period based on the expected average return from long-dated gilts. Clearly, if retirement is 20 years or more away, a lot of guesswork goes into the calculations.
Generally speaking, however, a simple rule applies: the transfer value will soar when interest rates are low and drop sharply when interest rates are high. Mark Ainscough of Fraser Smith gives the example of a 45-year-old man retiring at 65 with a pension entitlement of £10,000 per annum. When interest rates are 5%, the employer might reasonably offer a lump sum of £44,100; if rates are 8%, that amount could plummet to just £19,900. The key, therefore, for anyone considering leaving a company scheme is to time the transfer to a period when interest rates are at a historically low level. In such circumstances the result will be an unusually high lump sum, which should outperform the benefits from the former employer's scheme. If you are confident, however, that you can pick that moment, then you're unlikely to trust anyone else with your money anyway - let alone your previous employer.