What is the transfer value of a pension?

Reviewing your immediate and long-term finances can be a positive step to building healthy money habits. If you are considering transferring your pension as part of this process, you may be looking for further guidance on what a cash equivalent transfer value (CETV) is. This will be relevant if you have a defined benefit (DB) pension, which is also known as a final salary pension.

If you're not sure about what type of pension you have, you can learn more about what a defined benefit pension is.

First, let’s make sure we have the basics to build confidence. Here are 5 points to get you started:

1.  Pension transfer value

• This general term refers to the amount of money that is available to transfer from one pension provider to another.
• Pension transfer values are applicable to defined benefit pensions and defined contribution pension schemes.

2.  Cash equivalent transfer value (CETV)

• This term specifically refers to the transfer value calculated for defined benefit pension schemes only.
• CETV is intended to provide a cash equivalent value of the benefits you would receive from your defined benefit pension.

3.  Lump sun

• Although the transfer value is shown as a lump sum, that does not mean you will receive that value in cash. Instead, the amount can be transferred to another pension scheme of your choice, where the funds will be invested based on the rules of your new pension scheme. 
• It's worth noting that there are many variables that will determine a CETV.

4.  No guarantees

• As with any investment, there is risk. There are no guarantees that transferring your pension scheme value will generate greater returns for you in the future.
• With a defined benefit pension, you are largely safeguarded from changes in the stock market. However, if you move to a defined contribution scheme, these same safeguards will not apply and your pension may be affected by shifts in the stock more greatly.

5.  Stirring the pot

• For a defined contribution scheme, figuring out the transfer value is typically based on how much the current funds you’ve built up are worth. But for a defined benefit scheme, it’s not simply taking a wooden spoon to your pension pot and seeing what’s in there to figure out its value (more on this below).

6.  Pension fund value versus transfer value - these terms refer to different calculations.

• Pension fund value: how much your defined contribution pension is worth, which includes all of the investments in your pension plan.
• Transfer value: as mentioned above, this is how much your current pension provider will give your new pension provider for transferring out of your current scheme.

For this type of pension, figuring out the transfer value will generally mean calculating the fund's current value. In some instances bonuses may be added or penalties deducted.

Your pot in a defined contribution pension will hold what you've paid (be that you or your employer) over time plus invested returns. Some schemes, however, include a bonus in addition to the fund value. Since this bonus isn't guaranteed and may be held back if market conditions aren't looking great, it's important to check the transfer value rather than only looking at the fund value.

This is a bit trickier than figuring out the transfer value for a defined contribution (DC) pension because of the nature of how DB funds work. And while the calculations may be more complicated and can change dramatically between years and decades, one of the main features affecting DB pension calculations is: time.

With these pensions, the process includes a more complex review of long-term financial promises instead of simply adding up how much you’ve paid in and the invested returns. This means, the transfer value will estimate how much the guaranteed income for life you’re entitled to on retirement is worth right now. ^{Footnote [1]}In this case, you’d think actuaries (the people with the big, glistening maths brains who crack numbers like walnuts in a nutcracker), would need a crystal ball. Instead, they use a defined benefit pension transfer calculator that crunches the numbers on your age, expected retirement date and life expectancy.

If you are considering transferring from your DB pension, explore our article on what you need to know about defined benefit transfers.

But it's important to understand that, for the vast majority, transferring a defined benefit pension may not be in your best interest. Transferring out of a DB pension means that: 

• you’re trading a guaranteed income for a pension pot that could potentially run out.
• your pension pot will be invested and could go up or down depending on what happens in the stock market.
• you'll be in charge of managing your pension from now on.
• you'll probably have to pay for advice on the transfer.

What factors impact CETV for defined benefit pensions?

While formulas for calculating CETVs look as complicated as they read (don't worry, we won't scare you), actuaries look at a few factors which could include:  ^{Footnote [1]}

1. The benefits: this is how much your current pension benefits are worth, including both how much you have (accrued benefits) and how much you may have (projected benefits).
2. The valuation: figuring out the present value of future pension benefits, often based on market conditions and the specific pension scheme's rules.
3. Assumptions: different assumptions about future events, like mortality rates, retirement age, salary increases, and inflation.
4. Investment returns: the amount of money the pension fund is likely to earn from its investments.
5. Market conditions: this is all about interest rates and economic realities that influence the value of pension benefits.
6. Regulations: making sure that all CETVs meet the legal and regulatory frameworks around pension transfers.
7. Expenses: any administrative fees or costs related to processing the transfer.
8. Scheme-specific issues: these are unique features of the pension scheme, including any guarantees or options that may affect the value.