WHAT IS THE ‘CASH EQUIVALENT TRANSFER VALUE’ (CETV) AND HOW IS IT CALCULATED?
The cash equivalent transfer value is the expected cost to purchase the same benefits as a specified defined benefit pension scheme.
A final salary (DB) scheme member can transfer their pension away from one scheme into another pension. The cash equivalent transfer value is the expected amount that would be received by the receiving scheme on transfer.
There are four main steps involved in calculating the CETV:
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- Calculating the preserved pension of the deferred member.
- Revaluing the preserved pension to the normal retirement date using the statutory minimum rate of revaluation.
- Dividing the revalued pension by the prevailing annuity rate shows the estimated cost of the benefits at the normal retirement age for the member.
- Discounting that back by an appropriate discount rate (usually prevailing equity rates if there are more than 10 years until the normal retirement date, and the 5-year gilt rate if there are less than 10 years until the normal retirement date).
CETV Example
Here is an example:
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- If the preserved pension is £12,000 per annum
- If the minimum rate for revaluation is 5% for each tranche of the scheme and there are 6 years until retirement. £12,000 x (1.05)^6 = £16,081.15
- If the prevailing annuity rate is 1% then the revalued pension may cost as much as the following at retirement assuming annuity rates are the same at the normal retirement date. £16,081.15 / 0.01 = £1,608,114.77
- Discounting this figure back to the present day could cost based on a 5-year gilt rate of 0.5%. £1,608,114.77 / (1+0.005)^6 = £1,560,704.46
The main reason for large transfer values being common is due to low gilt rates as shown in step 4. Incorrectly, many individuals believe their cash equivalent values will increase over time, however, this may not be the case. A small change in the gilt rate will have a big impact on the CETV.
Bearing this in mind, even small changes in annuity rates, revaluation rates, and estimated discount rates can also make an impact.
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