Over the past year, we have written extensively on transfer from final salary pension schemes. The choice between a pension transfer (or not) is not straightforward. We thought it useful to simplify the issues, as far as possible, calling up previous posts to deliver the detail.
What Is A Final Salary Pension Transfer
A transfer from a final salary pension scheme means giving up your scheme benefits in return for a cash value. This fund is then invested in another pension scheme. The transfer delivers access to the potential benefits of a flexi-pension drawdown arrangement.
Everything changed with the Chancellor’s budget of 2014, (effective April 2015). Before the pension freedoms, those holding defined contribution type pensions schemes only had one real option at retirement, to purchase an annuity. Although an annuity potentially delivers similar benefits to a final salary pension each of those benefits comes at a cost.
The pension freedoms introduced flexi-pension drawdown as an alternative to an annuity. A drawdown arrangement delivers control over a pension fund so the pension holder may make their own decisions on investments and withdrawals. Crucially drawdown offers the opportunity to pass on whatever remains in a pension fund to children (or another beneficiary) on death with no inheritance tax.
Those in defined benefit (final salary) pension schemes have no access to drawdown arrangements. If they wish to access the potential benefits of a pension drawdown arrangement they must transfer out of their final salary pension.
In short, a transfer from final salary pension scheme delivers control over how and when an individual may access their pension. It delivers the flexibility to take a desired level of income and the option to pass on the full value to beneficiaries on death.
A transfer carries several risks and the benefits of a final salary pension should not be given up lightly. It is important to consider the pros and cons of leaving an existing final salary pension scheme in detail before making a decision.
Mistakes can be costly so the UK government have 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
For many years final salary pensions have been the pension gold standard. They have offered many advantages over defined contribution type workplace based schemes. The benefits of a final salary pension 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.
- Reduced pension for early retirement. This is usually allowed at age 55 but some schemes have a protected retirement age of 50.
Pension income is 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.
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. Before April 2015 the advice to those considering a transfer was, in the vast majority of cases, was 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. However, with transfer values at an all-time high a transfer is an option at least worth considering for some.
For certain 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. In some cases, they can be forty times (or more) 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.
- The new tax rules (effective April 2015) mean it is now possible to transfer the value of a final salary pension scheme to bequeath it to children after you die. The 55% tax rate that applied was 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 the 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.
- A transfer offers you flexibility over how much you draw from your fund and when. It is probable you may wish to draw more in your mid to late 60’s than in your early 80’s. 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.
- A transferred fund invested appropriately may equal (or even surpass) the benefits offered by the final salary pension scheme whilst keeping the original capital intact.
- 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.This is a complex subject covered in more detail in our free guide to final salary pension transfers.
Transfer From Final Salary Pension – Risk Factors
The above may appear attractive to some 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 equal) 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 if you are better off where you are.
- If you do transfer your investment will need ongoing management. If you need 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 manage your fund or pay someone to do so. As you get older managing a fund may be more of a problem for you.
- There will be fees associated with the transfer and with (most likely) ongoing management of the investment fund.
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.
Before committing to a transfer it is important to consider (and be comfortable with) the following:
- You have the financial resources to tolerate the risks involved in the pension transfer option.
- You are comfortable with the extra responsibility involved in looking after an investment on an ongoing basis.
- You fully understand the benefits you would leave behind in your defined benefit scheme, including options for early and late retirement.
- You understand what you will do with the defined benefit pension transfer value if you take it and have a firm plan in place.
- You understand the tax implications of the pension fund created by the transfer.
- You have performed a critical investment return assessment to look in detail at what investment returns are required to match the expected returns from your final salary pension. If inflation were to rise, interest rates and investment returns would also rise as well so you need to understand the real investment return target over and above the rate of inflation.
- If you opted for protection against the lifetime allowance at A-Day in 2006 you need to understand how this impacts on your transferred fund.
There are three main drivers that have made a transfer from final salary pension scheme worth considering. It is important to remember pension scheme trustees are under no obligation to inform pension holders of movement in transfer values or the potential advantages of a transfer.
Historical low-interest rates have reduced Gilt yields. As Gilt yields fall transfer values tend to rise. The impact of Brexit, cuts in interest rates and quantitative easing have had an impact on Gilt yields and increased transfer values. The level of that increase in transfer value is at the discretion of the pension scheme trustees but in general transfer, values are at an all-time high. The relevance of a high transfer value is discussed in more detail below.
Final salary pension deficits are at an all time high, due to historic low-interest rates and Gilt yields (see above). In the worse case, this could mean a final salary pension scheme falls into the Pension Protection Fund (PPF). Resulting in a 10% cut in pension benefits and a potential benefits cap on future payments.
It is often claimed defined benefit pension values are guaranteed, which is largely true. However, that guarantee only applies if the sponsoring employer survives to pay out full benefits. A transfer from a defined benefit scheme puts you in control.
The Importance Of The Transfer Value
In basic terms the higher the transfer value the lower the rate of investment returns required to match the benefits offered by the defined benefit scheme and hence the lower the risk. A high transfer value delivers the headroom to be relatively cautious with your investment strategy while retaining the value and flexibility that comes with the transfer route.
The target should be to leave the capital sum largely intact while living off the investment returns. The capital sum may then be passed on to beneficiaries on the death of the pension holder and their spouse.
A key measure is the ‘critical yield’. This shows the investment return required (each year) from any new arrangement to match the benefits of the defined benefit pension scheme you are giving up. But even this measure has its critics so it is best to not rely on this measure alone.
Pension Transfer Values – Some Examples
Mrs Y aged 54 approached us in April 2016 for advice in relation to her final salary pension scheme. Our initial advice was for her to remain within the scheme and revisit her options on attaining age 55. It recently came to our attention that transfer values from the scheme had increased significantly. We requested a recalculation of her transfer value and found that it had increased by 84%
Miss X contacted us for advice in relation to her pension scheme. As she had attained age 55 she had applied to her previous employer for an immediate pension. The scheme offered a full pension of £15,018 p.a. or a tax-free cash lump sum of £89,140 and a reduced pension of £12,794 p.a. The transfer value offered exceeded £550,000 and represented approximately 37 times the income offered by the scheme.
Mr W had worked for a high street Bank for 25 years leaving service in 2005. On approaching 55 he wondered what options were open to him. Mr W had requested a transfer value in May 2016. The transfer value at that time was £750,000. The transfer value in August 2016 was over £870,000.
The historic advice (when transfer values typically ran at 20 times or below) was to stay with a final salary scheme but with transfer values increasing it may be worth at least obtaining a cash equivalent transfer value and making some basic calculations. This can be completed at no cost.
A transfer may be particularly attractive to those who are single or in poor health. It can also be of interest to those whose prime objective is to pass wealth down through the generations and/or when an employers ability to meet their long-term commitments to the scheme appear to be in doubt.
Generally, a transfer is only suitable for a minority of members of final salary pension schemes.
Transfer From A Final Salary Pension – Process And Costs
To obtain a cash equivalent transfer value and make an initial assessment of the viability of a transfer is a free service offered by many of those advisers qualified and authorised to advise on transfer from final salary pension schemes.
Should you wish to discuss your pension options with a financial adviser we strongly suggest you choose one with the relevant permissions. Using an adviser without permissions or an intermediary can cause delays and increase fees should you decide to take action.
If an individual wishes to trigger a transfer then a number of costs may apply including:
- The cost of advice.
- The cost of setting up a pension scheme to accept the transfer.
- Costs for managing the investment going forward (if required).
The final salary transfer process can take up to twelve months but generally can be actioned in significantly less time. It is important to note a transfer is not allowed if an individual is less than 12 months of their normal retirement date.
Why Professional Final Salary Pension Transfer Advice Is 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 a transfer application when it cannot be proved that financial advice was 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 required to make an informed decision.
Watch Out For Scams
Final Salary Pension transfer values can be significant and that, unfortunately, attracts the scammers so it is important to be on your guard. Some scams can be quite sophisticated so it is important to diligently check out your advisers and ask plenty of hard questions. Be particularly careful of anything ‘offshore’ and remember if anything appears to be too good to be true it probably is.
Be particularly wary of any cold calls or emails and carefully check the credentials of anyone you talk to. Financial advisers should all be FCA authorised and regulated and be able to prove it.
In the past considering a defined benefit pension transfer may well have been a waste of time and effort, but now for some, it is at least worth considering. Download our free guide to learn more, visit our frequently asked question section.
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.
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