DIY investor: Cashing in on defined benefit

"The aspect of DIY investing that is most important to me becomes clear: the ability to choose which risks I take"
February 16, 2017

The logic of being a DIY investor is clear: I want to make my own decisions, I have a reasonable sense of my own ability to tolerate risk and I always prefer to put money into investments I have thought through for myself, rather than pay someone else to do the thinking for me.

Well, almost always. Recently, I’ve seen a series of stories about people who have chosen to cash in final salary pensions that provide a guaranteed, inflation-linked income for the rest of their life (and often their spouse’s life as well), in return for a lump sum that they can transfer into a personal pension and draw on as they like. My former colleague Martin Wolf, the Financial Times’s Chief Economics Commentator, announced in January that he had done so, largely because of the sum on offer in exchange for giving up his life-long guaranteed income was so large.

The attraction of cashing in so-called Defined Benefit pensions has increased as interest rates have fallen. This is because pension schemes calculate the amount of money required to pay final-salary pensions by looking at the income they will receive from high-quality bonds. The lower the yields on these bonds, the more money the pension scheme will need to invest in them to generate the income they need to pay the pension. As bond yields fall the so-called “transfer value” of these final salary pensions therefore goes up, increasing the sums that must be paid to those who opt out.

But even though these transfer values have become extremely high and I continue to believe it’s in my interests to take my own investment decisions, I’m not tempted. It’s undoubtedly true that taking a transfer can make a lot of sense in certain circumstances. For example, if you are close to retirement and in poor health, having access to a large amount of cash could well be a better option than a guaranteed income that you might not need for very long. Equally, if you don’t have dependents who could benefit from your pension rights after your death, it could make sense to withdraw your money.

But neither of those conditions applies in my case. Instead, I would have to decide what to do with a sum of money that would have to sustain me and my wife for the rest of our days. How would I invest it with the same confidence about the outcome as I would have if it were sitting in a final salary pension scheme? I find that question simply too daunting to answer.

Investing is difficult. The outcomes depend on luck as well as skill. And once you give up a final salary pension promise there is no going back. Reading about those who have taken that step, the aspect of DIY investing that is most important to me becomes clear: the ability to choose which risks I take. A great deal of my family’s financial security already depends on my decisions; increasing their exposure is not a risk I’m comfortable with. And in admitting that, I’ve found the outer limits of my appetite for DIY investment.