The benefits of membership of a final salary pension scheme (or defined benefit pension scheme) have long been recognised, so why would anyone consider transferring out of such a scheme? In this post we discuss why a final salary pension transfer may be an attractive option in some circumstances, the potential risks involved and why professional advice to aid the decision making process is so important.
Everything changed with the Chancellor’s budget of 2014, (effective April 2015). Significant changes were made to pension rules and the tax position on inheritance which, at that time made, a final salary pension transfer worth considering for some individuals. Since early 2015 changing economic conditions have combined to drive transfer values to an all-time high.
Both the pros and cons of leaving an existing final salary pension scheme must be considered in detail before making a decision. Mistakes can be costly so the UK government have rightly put controls in place. Individuals must take appropriate financial advice from a qualified Financial Adviser before making a decision to transfer a final salary pension transfer (or not) if their pension fund value exceeds £30,000.
THE BENEFITS OF A FINAL SALARY PENSION
Approximately 11 Million people are members of final salary schemes in the UK. Final salary or defined benefit (DB) pension schemes provide a guaranteed income for life. Often the income is index linked to provide at least some protection from inflation, the income you receive is based based on either:
- How much you’re paid (your salary) at the point you finally retire (or sometimes your highest salary in the last few years of employment).
- An average of your salary across your career.
Unlike a personal pension arrangement or defined contribution company pension scheme where an individual makes their own contributions, or makes contributions jointly with an employer and has to decide how to access their benefits at retirement, the amount an individual receives from a final salary pension at retirement is guaranteed (assuming the sponsoring employer survives). The only decision to make at retirement is should you take a tax free cash sum and reduced pension or just pension.
A guaranteed amount is the key advantage of final salary pension schemes but there are several other major advantages that include:
- Index-linking. This means that pension income will go up each year to keep pace with rising prices. Increases are often capped at a maximum level e.g. 2.5% each year but some schemes offer more generous inflation proofing.
- Death in service payments to your spouse if you die before reaching pensionable age.
- Spouse and dependents pension if you die before or after retirement.
- Full pension if you have to retire early through ill health.
- Reduced pension if you retire early, usually at age 55 but some schemes have a protected retirement age of 50.
WHY CONSIDER A FINAL SALARY PENSION TRANSFER
Given the above advantages it may appear that transferring out of a final salary pension scheme would be financial madness. Any individual seeking advice on a final salary pension transfer before April 2015 would, in the vast majority of cases, be advised to stay with their current scheme.
Immediately following the 2015 pension reforms the advice, for many, would still be to remain with the existing scheme but with transfer values at an all time high, the increasing risk that some final salary schemes may be forced to be re-negotiate their terms with members or, worst case scenario, fail a transfer is at least worth considering as a possible option.
For certain individuals, there may be advantages in a final salary pension transfer including:
1.Transfer values relative to future pension entitlements are higher now than ever before. In some cases they can be forty times (or more) multiple of the initial annual payment offered by the final salary pension scheme. For example those entitled to a final salary pension of £25,000 p.a. may be offered a transfer value of £1,000,000.
2.The new tax rules (effective April 2015) mean it is now possible to transfer the value of a final salary pension scheme in order to bequeath it to children after you die. The 55% tax rate that applied has been scrapped which means beneficiaries will pay no tax when inheriting the benefits if you die before age 75 and only pay tax at their marginal rate of income tax when withdrawing benefits if you are over 75 at date of death.
A final salary benefit can be a significant family financial asset. A final salary pension transfer gives you control of this asset, which can now be passed down through the generations free from inheritance tax.
3.A transfer offers you flexibility over how much you draw from your fund and when. It is probable you may wish to draw significantly more in your mid to late 60’s than in your early 80’s. A final salary pension does not offer this flexibility.
4.Your final salary pension scheme will normally continue 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.
5.If the transferred fund is invested appropriately it may be possible to equal (or even surpass) the benefits offered by the final salary pension scheme whilst keeping the original capital intact.
6.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 but this is a complex subject covered in more detail in our free guide to final salary pension transfers.
Across the 6,000 (or so) UK final salary schemes it is estimated that there is a total funding gap of almost £1 trillion between what companies currently have set aside and the pension payments those companies are committed to according to consultants Hymans Robertson.
Of course, this does not mean schemes will fail to honour their original commitments but for some there will be little choice but to try to re-negotiate terms or change calculations. In the worst case some schemes may fail and move into the Pension Protection fund.
FINAL SALARY PENSION TRANSFER – RISK FACTORS
The above may appear attractive but there are significant risks including:
- Once you’ve made your final salary pension transfer, there’s no going back.
- 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. 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. Otherwise 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 the final salary pension scheme will be your only or main source of income in retirement and you have little or no tolerance to this income fluctuating or (worse) running out then it will almost certainly be best to stay with the scheme.
WHY PROFESSIONAL FINAL SALARY PENSION TRANSFER ADVICE IS SO IMPORTANT
It is a legal requirement to obtain appropriate financial advice when seeking to transfer a final salary pension with a value of £30,000 or more. Pension providers will refuse to accept any final salary pension transfer application when it cannot be proved that financial advice has been received. Once a transfer has been actioned there is no going back so given the potential risks involved it is important to obtain the advice you need to make an informed decision.
To protect yourself you should check any Independent Financial Adviser is authorised and regulated by the FCA – You can check on the FCA website at http://www.fca.org.uk/. It is important to note that not all Independent financial advisers are qualified or prepared to offer advice on Final Salary Pension Transfers and it is best to select one that has experience of the transfer rules and procedure. For a no obligation discussion based on your own individual circumstances call 0800 043 8341 or Email firstname.lastname@example.org. Alternatively, should you have any questions simply complete the contact box below and we will Email an answer.
The information in this article does not constitute financial or other professional advice. You should not take action on the basis of this article without seeking regulated independent financial advice that addresses your specific circumstances.