The Pension freedoms (April 2015) delivered potential benefits to those with Defined Contribution pensions. They did not, however, apply to Defined Benefit (final salary) pensions. This led some final salary pension holders to consider if it would be best to transfer out of a final salary pension to a Defined Contribution scheme. In this post, we consider both the potential benefits and risks of a final salary pension transfer.
First, It is important to summarize the benefits of a final salary pension. They include:
- A guaranteed sum (assuming the sponsoring employer survives) paid monthly in retirement, for life. That sum is linked to the pension holder’s salary and years service (not annuity rates).
- The monthly pension income is index-linked meaning it increases each year to cover at least some of the impact of inflation.
- A death in service payment is payable if the pension holder dies before reaching pensionable age.
- Once retired, the rules vary but often pension payments continue (at least in part) to a spouse after the pension holder’s death.
- A full pension is generally payable if early retirement is necessary due to ill health.
- No decisions are required on the best pension arrangement at retirement.
- A reduced pension may be available for early retirement. This is usually allowed at age 55 but some schemes have a protected retirement age of 50.
Given the above advantages, it may appear that transferring out of a final salary pension scheme would be financial madness. The regulatory starting point remains a transfer is unsuitable until proven otherwise. However, for some, a transfer is an option at least worth consideration.
For some individuals, there may be advantages in a final salary pension transfer including:
- Transfer values relative to future pension entitlements are higher now than ever before.
- Transferring the value of a final salary pension scheme to a DC scheme enables you to bequeath any remaining pension fund to children after you die. Beneficiaries pay no tax when inheriting the benefits if you die before age 75 and pay tax at their marginal rate of income tax when withdrawing benefits if you are over 75 at the date of death.
- A transfer offers you flexibility over how much you draw from your fund and when. A final salary pension does not offer this flexibility.
- Your final salary pension scheme usually continues to pay an income to a surviving spouse when you die. However, the payment is reduced (if it is payable at all) and controlled by the terms of the scheme. Making a transfer gives you more control.
- Transferring out of a final salary pension scheme and drawing benefits from a personal pension arrangement can also be more tax efficient in certain circumstances.
There are also some major pension transfer risks to consider, they are:
- Once you’ve made your final salary pension transfer, there’s no going back.
- A final salary pension offers a guaranteed pension for life. A transfer to a defined contribution type scheme does not offer this guarantee.
- The transfer value offered by your employer may be low and placing it in alternative investments may not (after inflation) deliver a higher (or equivalent) return to what you may expect if you stayed in the scheme.
- Any investment (including pension investment) is a risk. It is important to consider carefully if you are better off where you are.
- If you do transfer, your investment will require ongoing management. you will need to actively manage your fund or pay someone to do so. As you get older managing a fund may be more of a problem for you.
If you are attracted to a secure lifetime income, with very limited risks and with no effort then it may be best to stay with the Final Salary Pension Scheme. Transfer from a final salary pension is not the best option for most.
It is vitally important to consider all options available and take professional advice from a suitably qualified (and experienced) financial adviser.
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This blog is intended to provide a general review of certain topics and its purpose is to inform but NOT to recommend or support any specific investment or course of action.