Why critical yields are not critical
When a person is thinking about transferring from a defined benefits scheme into a personal pension their adviser will produce a special report for them. It is called a TVAS (transfer value analysis report).
One of the, very many, figures in that report will be a “critical yield” percentage.
This is designed to show the rate of investment growth needed, if a transfer takes place into a personal pension plan, for that plan to produce the same pension benefits that are given up by transferring out of the defined benefits scheme.
The critical yield is calculated based on a lot of assumptions about the future. Many of those assumptions will of course not turn out to be true in the future; that’s the nature of assumptions I suppose.
The critical yield does though assume that the personal pension owner is going to use the pension plan monies to buy an annuity at retirement.
For very many people this will not happen. Instead the plan owner will use Flexible Access Drawdown to take their entitlement to the much loved tax free cash lump sum and drawdown monies from the fund for their future income needs.
Where this is the chosen route for taking benefits a critical yield isn’t much use to help inform of us of the suitability of a transfer. Instead we will need to test the sustainability of the drawdown fund and ask if it will last the client as long as the client lasts!
So critical yields can be replaced by sustainability calculations.Understanding the limitations of critical yields for defined benefit transfer advice. Click To Tweet
It is also possible to calculate a critical yield for someone who is keen to take early retirement benefits.
Again if they are going to retire early it is even more likely that they won’t be buying an annuity with their personal pension pot. Annuities whilst guaranteeing an income for life don’t look particularly attractive for younger pensioners.
Other things to take into account when transferring out of a defined benefits scheme include comparing the amount of available tax free cash lump sum. In many instances this is much higher for a personal pension than it is from the defined benefits scheme.
Death benefits also need to be considered.
For some the capital sum death benefits from a personal pension available to be passed on down the generations are a much better alternative than the spouse’s pension on death of the scheme member.
Personal circumstances determine suitability for transfers out of defined benefits scheme.
Transferring isn’t the right thing for everyone to do but it is important to establish that by taking advice. High levels of the cash equivalent transfer value of defined benefits is driving up demand for advice at the present time.
But the so-called critical yield is not the most important thing to consider when deciding what to do with your pension benefits.
Critical yields are no longer critical.