Over the past eighteen months there has been a dramatic increase in those considering a final salary pension transfer to gain access to the potential benefits of the pension freedoms (2015). In that time we have received many questions on the issues surrounding a transfer. We have, therefore, compiled a list of common questions, complete with our answers below.
What Is A Pension Transfer?
A pension transfer is made from a final salary (defined benefit) pension scheme to a defined contribution (money purchase) type scheme.
Final salary schemes are workplace based schemes with pension payments, as the name implies, linked to final salary. Defined contribution type schemes may be workplace (where an employer may make a contribution to the pension fund) or personal. Contributions made and investment returns combine to build the value of the fund. A set pension payment at retirement is not guaranteed.
The pension freedoms (2015) delivered a number of potential benefits (see below) but only to those in defined contribution schemes. A transfer entails trading a final salary pension for a cash value. This cash value is then invested into a defined contribution type scheme allowing the pension holder to access the potential benefits of the pension freedoms.
Since 2015 market forces have combined to increase cash transfer values on a number of final salary schemes to an all time high.
Can I Transfer My Pension?
Teachers, NHS employees, Civil Servants, those in the Police and Fire Service and in the Armed Forces are not eligible to transfer out of their final salary pension scheme. This is because these schemes are unfunded (there is no investment pot to draw from) and are paid out of general taxation. There is one exception: if you intend to retire abroad you are entitled to transfer your benefits to a Qualifying Recognised Overseas Pension Fund (QROPS).
In most other cases, it is possible to transfer from a final salary (defined benefit) pension scheme although some schemes have specific rules and regulations which can make the process more challenging and time consuming.
What Are The Pension Transfer Benefits?
A final salary pension delivers a set monthly pension for life. In most cases the payment is index linked to cover at least some of the impact of inflation. Many final salary schemes also offer an ongoing pension to the pension holders spouse on the pension holders death and various other benefits. However, when the pension holder (and their spouse) is deceased the pension dies with them.
A transfer offers the flexibility to take whatever amount the pension holder may decide when they want. It potentially offers tax advantages and (crucially) it offers the opportunity to pass on whatever pension fund remains to beneficiaries (free of inheritance tax) on the pension holders (and their spouses) death.
For various reasons, pension transfer values are at an all time high making a transfer particularly attractive for some individuals. High transfer values may also potentially increase the tax-free sum over that available from the final salary scheme. It is important to note, a pension transfer is not the right approach for everyone and there are risks.
What Are The Pension Transfer Risks?
With final salary pension transfers at a high point the benefits of a final salary pension transfer are at least worth consideration but it is important to fully evaluate the risks, the main ones are:
- Once you’ve made your final salary pension transfer, there’s no going back.
- Placing your transfered fund in a portfolio of investments may not (after inflation) deliver an equivalent (ideally higher) return to what you may have expected if you stayed with your final salary scheme.
- Any investment (including pension investment) is a risk. The value of investments may fall. It is important to consider the potential impact (both long and short term) on retirement if investments do not perform as planned.
- If you do transfer we recommend that your investment is regularly reviewed. 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.
If you are attracted to a secure lifetime income, with very limited risks and with minimal effort then it may be best to stay with the Final Salary Pension Scheme.
How Safe Are Final Salary Pension Schemes?
In short, very safe. The risk of a final salary pension scheme failing to pay pension benefits is very low as the majority (not all) are backed by the Pension Protection Fund (PPF) lifeboat. That said if a scheme does fall into the PPF and you are yet to retire you should expect a cut in pension benefits.
The Pension Protection Fund (PPF) was set up by the Government to protect the benefits of members. If you are a member of a defined benefit or cash balance scheme and your employer goes out of business leaving the scheme without enough money to pay benefits due, the PPF may pay you compensation.
The British Steel Pension situation may be exceptional (and ongoing) but it does raise the prospect of so called ‘zombie schemes’ without a sponsoring employer. A report from the Pensions Institute in early 2016 suggested up to 1,000 defined benefit pension schemes (final salary schemes) were at ‘serious’ risk of falling into the Pension Protection Fund (PPF).
If a scheme does fall into the PPF existing pensioners can expect benefits to be paid in full while those still to retire can expect 90% of their benefits at retirement. However, for those still to retire it is important to be aware of rules on index linking of future payments and a salary cap.
What’s changed to make a final salary pension transfer more attractive?
There are two main reasons:
- The pension reforms of 2015 delivered potential benefits to those with defined contribution (money purchase) type pension schemes. Those benefits were not available to those in final salary pension (defined benefit) schemes. To access the potential benefits of the 2015 pension reforms it is necessary to transfer from a defined benefit to a defined contribution scheme.
- Several economic factors have combined to push transfer values (the cash value offered in return for giving up final salary pension scheme benefits) on many final salary pension schemes to an all time high. How long the current high will continue is open for debate.
Are any final salary pension schemes excluded from pension transfer?
Yes, so called unfunded schemes are excluded. With unfunded schemes there is no pension pot used to pay members in retirement, payments are funded by general UK taxation. Teachers pensions, NHS pensions, armed forces pensions, the police and fire service pensions are all unfunded schemes and pension transfers are not allowed.
What is a final salary pension transfer value
The pension transfer value is a key factor to review when considering if it is best to stay with a final salary pension scheme or transfer out.
The transfer value (known as the Cash Equivalent Transfer Value – CETV) of a final salary pension is the cash sum offered in exchange for a final salary pension entitlement. The pension transfer value calculation is complex. It is based on establishing (at the date of calculation) what cash lump sum will be required to buy an equivalent pension in the marketplace to the one offered by the final salary pension scheme. That sum is then discounted according to how far the pension scheme member is from retirement.
Why is a pension transfer value only valid for 3 months
The method used to calculate a transfer value varies from scheme to scheme but they all take account of a number of factors including potential future interest rates, potential future growth rates on a number of investments and probable future interest rates. Factors such as mortality rates and potential demographic changes are also considered. As transfer values are calculated on a set date and all of the above factors may (and often do) change over time the transfer valid can only remain valid for a reasonable, set period of time before it is necessary to re-calculate. The standard validity of a pension transfer value is therefore 3 months.
Is There A Pension Transfer Cooling Off Period?
Generally no, once you take any action on your pension there is no going back. Many Financial Advisers will hold the application for 14 days before actioning to give the client time to reconsider but there are no guarantees.
Do I Need To Be 55 Years Old To Action A Transfer?
No, but you do need to be at least 55 years old to take any benefits from that pension (including any lump sums). The only exceptions are if retirement is forced due to ill health (where each scheme will have their own rules) or if you have a protected retirement date that is earlier than 55 years. It is, however, vitally important to take appropriate advice as in most cases it will be best to remain with the final salary scheme until at least 55 years old.
Are Final Salary Pension Plans Taxable?
Any pension payments you receive (including the state pension) are treated as income and taxed accordingly. The standard tax bands and allowances (if any) apply hence any income above the personal allowance (£11,500 in tax year 2017-18) is taxed. Should you have any other income, perhaps from part time work, your pension income is added in and the appropriate tax band is applied. Pension payments are usually made after tax is deducted.
If a final salary pension transfer is actioned upto 25% of the fund value may be taken tax free. The balance is transferred into a suitable defined contribution scheme and taxed as outlined above when any income is taken from the fund.
Can I Take A Final Salary Pension Early?
Yes, it is possible to take a final salary pension early but no benefits from that pension may be taken until the pension holder is at least 55 years old. If early retirement is a possibility then the pension administrators should be requested to provide an early retirement quotation and a pension transfer value.
If early retirement is allowed (most schemes allow early retirement but not all) it generally reduces annual pension payments significantly compared to those available at normal retirement age.
The other option is a pension transfer to a defined contribution pension scheme but it is vitally important to take advice and consider both the benefits and risks. A transfer can be actioned if the pension holder is under 55 years old but no benefits can be taken until reaching the 55 years milestone.
Can I Make A Final Salary Pension Transfer Without Advice?
If the pension fund value is less than £30,000 then the rules state you may make a transfer without advice but you need to consider, given the complexity of a transfer, if this is the best approach.
It is important to note pension transfers are at the scheme administrators discretion. Some administrators will refuse to action a non advised transfer even if the fund value is less than £30,000.
If an individual believes they have performed all the required analysis, are happy to transfer and simply requests a Financial Adviser to provide a transfer recommendation as a sign off exercise to comply with the legislation it is highly unlikely any professional adviser will comply. The Financial Adviser will be held accountable for their recommendation and therefore will insist on performing their own fact find and analysis and charge accordingly.
How Do I Transfer From A Final Salary To Defined Contribution Pension
First, before starting a transfer review (and potentially a transfer) it is important to understand the transfer process is time consuming and, to transfer, will involve a cost.
The key steps are:
- Request a defined benefit transfer value and early retirement quote.
- Know your timeline – A transfer quote has an expiry date and there are restrictions on when you may (and may not) transfer.
- Find an appropriately qualified and experienced financial adviser.
- Undertake a pension transfer review meeting (this is a legal requirement if the fund value is £30,000 or more).
- Establish the costs of transfer and ongoing investment advice.
- Take time to consider ALL your options, the advice you were given, the benefits and risks.
- Beware of SCAMS.
From starting the advice process to transferring the pension fund into the recommended defined contribution scheme can take up to 12 months.
The benefits of a final salary pension should not be given up without careful consideration. The Financial Conduct Authority (FCA) position remains in most cases a transfer will not be suitable. There are a wide range of issues to consider and it is important to take appropriate pension advice.
Where should I transfer my pension to?
The transfer must be made to a HMRC approved defined contribution type scheme. There are a number of options available including Self Invested Personal Pensions (SIPP’s).
It is vitally important to carefully check any potential receiving scheme (the pension fund into which the transferred fund will be invested) its benefits, risks and fees. Be wary of SCAMS, any high pressure sales tactics, offers of any unusually high returns or unusual investments.
If the transfer value is £30,000 or more it is a legal requirement to seek advice from a suitably qualified financial adviser. Should you decide a transfer is the right way forward the adviser will recommend a suitable receiving scheme.
Can a company close or change a final salary pension scheme
Many employers have already closed their final salary pension scheme to new entrants.
The Pension Regulator (effectively the Government) regulates occupational schemes including both Final Salary and Defined Contribution type schemes. In principle, an employer cannot simply walk away from their pension payment responsibilities. They can, however, attempt to vary the benefits payable.
A variation of benefits is unusual for a number of reasons. The Regulator will robustly enforce any applicable rules and regulations and pension holders will often strongly resist any change.
If an employer is no longer able to financially support a pension scheme in deficit and becomes insolvent the scheme may fall into the Pension Protection Fund. This is a lifeboat that ensures pension benefits are paid although a 10% reduction in benefits does apply for those who are still to retire.
My IFA will not deliver final salary pension transfer advice
If you have an existing relationship with an IFA or are looking to arrange the first meeting there are many reasons they may not deliver final salary pension transfer advice.
Specific Financial Conduct Authority (FCA) permissions are required before an adviser can offer final salary pension transfer advice. The adviser must be qualified to a level acceptable to the FCA. If an adviser does not have these permissions they will generally not take on the work but beware (see below).
If an adviser does have the permissions they may still refuse to deliver final salary pension transfer advice. They may have taken a business decision that the costs, effort (and risk) associated with pension transfers do not make the business commercially viable. Or the adviser may decide they are only prepared to accept work on particular transfers that meet certain conditions.
It is important to note some advisers who do not have permissions to transact final salary pension transfer business may take on the work. They may sub contract the technical work to an IFA who specialises in transfers and has the relevant permissions. In this case, the fees may well be higher (two IFA costs to pay) and there tends to be a higher risk of mistakes.
There is also an increasing number of SCAMMERS in the marketplace. When choosing an adviser it is important to check their credentials carefully and to ensure they are listed on the FCA register.
I need a final salary pension transfer sign off
There is a legal requirement to take independent financial advice if a pension transfer value is £30,000 or more. To avoid advice costs some may seek to take a DIY route and complete the work required (as best they can) themselves. They may then seek out a Financial Adviser to simply sign off the relevant paperwork (for a nominal fee) to allow the transfer to proceed.
It is highly unlikely any regulated IFA would offer this service. The IFA would be liable for any transfer documentation they may sign and would not take on that liability without performing their own analysis. That analysis would, of course, be charged at whatever their full charging rate may be.
What are the pension transfer timescales
An average timescale to complete the final salary pension transfer process from first engagement with an adviser to the point the transfer is complete is roughly five to six months. However, it can take up to 12 months.
The IFA must complete a thorough review, source information make calculations, check and re-check recommendations and write reports. The regulatory demands (quite rightly so) on advisers are significant and it takes time and effort to ensure compliance. Several adviser/client meetings are usually required and you, as the client, must take the time to ensure you are entirely happy with everything discussed and your best way forward.
The pension scheme must make appropriate checks and calculate entitlements. They may have limited resources and/or a high level of demand and this can take time. The adviser may need to ask questions or seek clarification and again this can take time.
Should I take a lump sum from a final salary pension?
The answer to the pension lump sum dilemma depends entirely on personal circumstances. Taking a lump sum obviously reduces the pension fund available when you do retire. In all cases, an individual must be at least 55 years old to take a tax free sum and the maximum tax free lump sum is 25% of the total pension fund value.
You do not necessarily need to transfer a pension to secure a lump sum from a pension. Many final salary pension schemes allow a pension holder to take a lump sum once they reach 55 years old. Check with the individual scheme to establish if a lump sum is available and the terms and conditions.
If it is established a pension transfer is the right way forward given your individual circumstances then a lump sum can be taken at the point of transfer.
We will return to this post regularly to add more common final salary pension transfer questions and answers. In the meantime, if there is a question you would like answered that is not covered above please complete the contact box below and one of our advisers will email a response. Or, if you prefer, leave a telephone number and we will call you back.
The purpose of the FAQ section (above) is to provide technical and generic guidance and should not be interpreted as a personal recommendation or advice. All statements concerning the tax treatment of products and their benefits are based upon our understanding of current tax law and HMRC practices both of which are subject to change in the future. Levels and bases of reliefs from taxation are also subject to change, and are dependent on your individual circumstances’ and ‘the value of your investment can go up and down and you may not get back the full amount invested.