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The transfer value calculation
 
The transfer value from a final salary scheme, is technically called a Cash Equivalent Transfer Value (CETV). It has no relationship to the values quoted for the Lifetime Allowance, an amount quoted in retirement quotes. 
 
The CETV is a value that is supposed to represent the value of the benefits given up. Below is a worked example. 
 
Mr Smith, age 60 has just been made redundant. He was a member of a final salary scheme, and is due to retirement at age 65. This was a final salary scheme.  This was a 1/60 scheme. He was in it for 30 years, and his "final salary" £40,000. 
 
So his promised pension (at age 65) is 30/60 of £40,000. This therefore is 1/2 of £40,000, which amounts to £20,000. Se he has a deferred pension of £20,000.  Between age 60, and 65 it will increase, usually by or around inflation (it might be more); it is not frozen! 
 
So, he has a promised future income of £20,000. He also has a right to get a transfer value (CETV). This is calculated by the scheme actuary. This is the basis of the calculation. 

Estimate how this pension will increase up until age 65. The actuary assumes this will be 2.5% per year
 
£20,000 increased by 2.5% per year over five years would increase this to £22,628
 
Estimate how much it would cost to secure this level of income. This means they have to guess what the cost would be. This scheme is inflation proofed, and has a joint 50% spouses pension. Suppose the actuary assumes that if the rate of conversion was 3% i.e. he would need £100 of fund value to secure every £3 of it.  This means that at age 65, the hypothetical fund needed would be £754,272.
 
The actuary then has one more step, he has to "discount" this value.  This means he has to calculate how much would need to be invested today to grow into £754,272.  He therefore uses a discount rate. This is an estimate of a rate of growth. Suppose the discount rate is 6%.  He calculates that if £563,635 was invested, and it grew by 6% per year it would grow into £754,272.
 
Therefore the Cash Equivalent Transfer Value is £563,635. So, in this example he can give up a promised income of £20,000 at age 65 and have a value to take away of £563,635. 
 
The transfer value should be closer to the actual value of the benefits the closer to retirement you are (the discount (reduction) rate is the larger than the assumed inflation rate). 
 
However, these assumptions are not the same from scheme to scheme.  Suppose the assumption for inflation was 2%, the conversion rate 3.5%,  and the discount rates was 7%, then the CETV would be lower.

The income at age 65 would be assumed to be £22,081
The fund needed to secure it £630,885 (at age 65)
The amount needed to be invested today £449,812
 
So, by having less generous assumptions, it can significantly change the transfer value, and impact on the decision to transfer. 
 
Free CETV 
In our view everyone should ask for a CETV from a pension scheme to see what the value is, and you're entitled to a free one every year. We advise everyone who is looking to take benefits from a final salary scheme to get the CETV, and assess what the scheme can offer, and what can be arranged with with the transfer.

Click here to find out more about assessing the CETV (Transfer value).

If you have a final salary scheme and want to discuss this in more detail, then please contact us online or on 0800 011 2713 for an informal chat.
 
 

If you can't find the information you're looking for on the website, or you want to know more or have a question, or just want to chat through some details about your pension then please feel free to contact us, without obligation. Either contact us online or call 0800 011 2713.

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