Pension freedoms were announced in 2014 and came into law on 5 April 2015. In the words of Chancellor George Osborne in his March 2014 budget:
“Pensioners will have complete freedom to draw down as much or as little of their pension pot as they want, anytime they want. No caps. No drawdown limits. Let me be clear. No one will have to buy an annuity.”
Ten years on, the timing of the announcement was perfect. Quantitative easing (QE) was in full swing in the aftermath of the Great Financial Crisis (GFC), which pushed up bond prices and pushed down bond yields. Annuity costs were soaring and offered very poor value for money. Extracted from one of our transfer reports in 2016 and clipped from Hargreaves Lansdown’s annuity website pages, the table below shows the starting income on offer for a £100,000 annuity purchase.
In 2016, a 60-year-old buying a level annuity at £4,004 per £100,000 would have to live to 85 just to get their money back! To receive in income the equivalent of the purchase price of the annuity.
For those with defined benefit (DB) pensions, the new freedoms were only available after a DB to defined contribution (DC) transfer. For a 55-year-old DB pension holder to take even £1,000 from their benefit meant exercising early retirement benefits and crystallising lower levels of tax-free cash, locking in lower income for life than could have been expected at normal retirement age.
By contrast, a transfer value typically at around 40 times the age 55 pension, and significantly higher than had ever been seen pre-GFC, looked extremely attractive to someone wanting to access some of their fund but not buy the annuity.
At the time, Tideway’s analysis highlighted two key points:
- Given the size of the transfer values offered, the higher tax free cash sum immediately available, and the historic track record of UK-managed pensions generating returns more than inflation, those who transferred out of a DB scheme would likely be able to receive higher lifetime benefits through retirement when compared to remaining in their DB scheme.
- There was a strong chance that, as we recovered from the GFC, QE would ultimately need to end and that generationally low bond yields would not last forever. If bond yields rose annuity prices would fall, and it would be cheaper to generate secure income in retirement with or without an annuity. Cash Equivalent Transfer Values (CETVs) for defined benefit pensions would also fall.
How did it work out?
Ten years on from pensions freedoms, we can already see that the period from 2012 to the end of 2021 was ‘The Golden Era for DB Transfers’. QE started to end in 2019 but was thrown back into action to keep us all afloat during Covid. The post-Covid supply chain issues and easy monetary policy – including QE – unleashed horrible inflation in 2022 and 2023, outstripping pension increases of most DB schemes, and brought QE to an abrupt end. As QE ended, bond prices fell and bond yields rose fast.
From 2016 to date, CETVs have collapsed by around 40%.
Since 2016, Annuity costs for escalating income have halved.
A decade on, the annuity purchasing power of DC pension pots has doubled.
To buy £30,000 of joint life escalating income in 2016, a 55-year-old would have needed £1,430,000 in their pension account. By 2025, an equivalent 55-year-old today would need just £700,000.
It’s been a rocky road, but managed pension funds have continued to beat inflation
It’s not been the easiest of decades to navigate, with Covid in 2020 and the big inflation and interest rate jump in 2022, which saw both bonds and equities fall. However, over time most sensibly invested pension funds will have kept pace with inflation.
IA 20-60% Equity Mixed Asset Sector returns(A) versus CPI (B) since 2015
Tideway’s portfolios have done better than the average, returning around 1% p.a. more than CPI since our model portfolios began in September 2016 (after allowing for our ongoing advice fee).
Individual outcomes
Each transferee’s circumstances and outcome will be slightly different, down to the exact timing of the transfer and their withdrawals to date. However, the rising tide of long-term investment returns combined with higher bond yields and falling annuity costs has lifted all boats.
Tideway client example: Mr M
Mr M transferred out of his Defined Benefit scheme in 2016, aged 55, in order to access benefits immediately.
He gave up an early retirement scheme lump sum of £123,000 and a starting pension of £18,400 p.a. The pension revalued by LPI to 2025 would now be worth £24,800 p.a.
On Tideway’s advice, Mr M accepted a transfer value of £1,175,000 and took an immediate lump sum of £294,000, which was £167,000 more than the sum offered by the scheme). He put the remaining £870,000, after our advice fee, into his drawdown account. Tideway’s calculations showed that even if his investments only kept pace with the LPI inflation of the scheme pension (rather than outperforming, inflation as expected) this sum would match the surrendered scheme pension income for 47 years, or until he was 102.
A financial gain calculation from this transaction for Mr M today would look something like this.
- His actual fund value today, nine years on, is £844,000
- The cost of an annuity to match the scheme pension today is £530,000 – this is £314,000 less than his actual fund value
- Extra tax-free cash value in 2016 revalued to today is £167,000 +3% p.a., which is worth £217,000 in 2025
- Extra income drawn so far (first nine years) compared to scheme pension is £78,000 gross
The gain for Mr M today, net of tax, is:
- the surplus pension fund after buying a matched annuity
- plus the extra income drawn to date
- minus 20% tax
- plus the value today of the extra tax-free cash in 2016
To only pay 20% tax on his pension fund, Mr M will need to draw down those profits over time.
Assuming 20% income tax on all pension income, then this is:
- Gain = (A-B+D) x 0.8+C = £530,000 (45% of the CETV)
This is a staggering net of tax gain to have made in just nine years. It was achieved simply by seeking an alternative to the scheme’s early retirement options, accepting the transfer value, taking financial advice, and following a plan by investing and drawing sensibly.
It’s equivalent to about 26 years of extra pension, half of which Mr M has enjoyed already, and half is still to come.
By continuing to invest his fund rather than buying an annuity, we expect these gains to continue to grow.
What about the next decade?
We are focused on two key issues for the next 10 years:
1. Investment Risk
Having made such great gains to date, the last thing we want to do is lose them. Two quick ways to do that would be to take too much investment risk or to buy an annuity and fail to live beyond average life expectancy. On the latter front, there is not much persuasion to be done.
On the former risk, we see the US stock market as the biggest issue.
The S&P 500 is up a massive 600% since 2009. Even taking off inflation from 2009 to date, it’s the equivalent of a 9% p.a. compound return over inflation. Long term history tells us that equities typically grow at 5-6% above inflation. Additionally, equities in the US currently look highly valued, with an extended price to earnings ratio. Not as high as we had in 1999, but nonetheless high. Whilst it could keep going up, it could also take a nasty fall.
The events since the start of 2025, with a 20% fall in US equity values in just a few weeks, illustrates the danger of such a highly valued market.
Having too much exposure to US equities in 2025 could be one way to risk losing some of the gains made in the last decade.
There is more to read on this subject here.
2. Inheritance Tax
Last year Rachel Reeves, the new Labour Chancellor, announced plans to bring unused pension pots into the inheritance tax net. Relatively modestly well-off families worth more than £1m, including their pension funds, are going to be drawn into paying the 40% tax.
In our example, client Mr M and his wife have a home worth c£500,000 and additional savings of £200,000. To be safe and avoid IHT, Mr and Mrs M should be looking to get their assets below £1m real value (after inflation) in their 80s. That will mean getting the pension pot to at least half in real value.
Assuming 6% growth on his fund and inflation at 3%, to half the value of the pot Mr M will need to withdraw just over £50,000 p.a., escalating by 3% per year, or £73,000 p.a. if he takes a level pension and lets inflation reduce the fund and his income over time, which is not crazy. Most people expect to spend more between 65 and 75 than between 75 and 85.
In any event, Mr M should be able to enjoy at least 40% more income for the next 20 years than if he bought an annuity today. In all, and over the next 20 years, this should see Mr M and his family’s gains from the transfer increase to over £800,000 after tax.
The good news is that all that extra income does not all have to be spent. Some can be gifted to Mr and Mrs M’s children, and some can be set aside in ISAs to look after them beyond age 80 and for issues like health care.
More good news is that it’s not too hard for us to make that 6% p.a. growth anymore over the medium to long term. With more normalised bond yields now exceeding 6%, we even do it without investing in equities at all.
I have written more on this subject here.
Tideway's DB transfer legacy
In all, Tideway advised on around 2,000 transfer transactions, moving around £1bn from DB pension schemes to DC schemes during the Golden Era.
At the time we estimated we did a little under 1% of all UK transfers by volume, a little over 1% by value, suggesting total transfers in that period of around £100billion. It may seem like a lot, but those that took advice were probably only about 10% of those eligible to transfer; according to a government report, private sector UK defined benefit pension schemes still held around £1.4trillion of assets in 2022.
In aggregate, and based on Mr M’s figures, it suggests our advice to members to transfer may have caused around £500m of financial gains for those members and their families.
We also know those members helped the economy, spending on home improvements ahead of retirement and taking well-earned holidays. Equally, we know that those members are already, and will continue to, let their pension wealth flow down to the next generation. At Tideway we are very proud of that.
Always be sceptical of backwards looking consensus opinions when it comes to financial advice
So why, after pensions freedoms came in, did only 10% of members take a transfer? The exceptionally high transfer offers lasted another five years, so people had plenty of time to think about it. Surely the maths wasn’t that hard?
A key perception in 2015 was that taking a DB to DC transfer was considered by many, including the UK financial services regulator, the FCA, as a high-risk transaction and generally the wrong thing to do.
Since their introduction in the 1980s right up to 2008 DB transfers, inflation had been slowly coming down and life expectancy and been slowly increasing. As bond yields fell and annuity prices increased, the lifetime income purchasing power of a DC pension fund generally fell.
Up until 2008, DB transfers had faced almost permanent headwinds, which meant transferees had to take relatively high investment risks with their transfer funds to get bigger benefits than the scheme would have provided, unless of course they were in poor health. If members thought they were badly advised to transfer – and many were, mostly by company-appointed advisers where companies were looking to lower their DB pension liabilities – then they were less well-off, and compensation was due.
In 2015, many pension commentators, advisers and, it seems, the FCA, could only look backwards at history and take a consensus view that transfers were generally bad. Additionally, there was a somewhat ‘nanny state’ view that people could not be trusted with their own money; they would make bad investment choices and buy a Ferrari!
There seemed an inability or unwillingness to do the maths that Tideway did and look at the bigger picture and the impact of QE. Many of our clients may not have realised QE was the source of their windfall, but they did recognise a windfall once they got their transfer offer and did some basic maths!
Our experience has also been that they have generally been incredibly sensible with their money, acting on our advice to invest it sensibly, and not a Ferrari in sight!
In conclusion
The Golden Era for DB pension transfers, and the lack of participation in what one financial adviser whom I respect called “the closest thing to a free lunch the markets will ever offer”, highlights the real importance of not basing financial advice wholly on backward looking consensus opinion.
This brings into question the value of advice given by artificial intelligence, something we are seeing increase at a scary pace. By very definition, such advice will always be backward-looking and consensus-based – one might argue calling it intelligent is an oxymoron.
More on that soon.
