What do you need to consider regarding a defined benefits pension transfer?
Pensions freedoms introduced three years ago mean that people are able to do what they like with their retirement savings. If you are on a defined benefit (DB) pension scheme (also known as final salary schemes) you may be offered the opportunity to transfer out of your pension scheme in return for a fixed sum.
DB schemes promise savers a certain level of income after retirement, this is also known as a ‘final salary’ scheme. Usually this income increases in line which means it offers some protection against the effects of inflation. Typically, you could expect to be offered in excess of 20 times your annual pension value as a lump sum to transfer out of the scheme. However, in some cases it could be much higher and cases where the lump sum offered is more than 40 times are not unusual. For instance, someone on a £10,000-per-year pension might be offered between £200,000 and £400,000 as a lump sum to transfer to another pension.
As life expectancy has risen, the cost of DB schemes, widely considered the ‘gold standard’ of pension schemes, has risen. Indeed, the default position of the Financial Conduct Authority (FCA) is that to transfer away from a DB scheme is not in an individual’s interests. Companies now tend to provide less generous direct contribution schemes to newer employees.
Why would you consider transferring out?
DB pensions are very rigid in their structure. You receive X amount of money every month until you die. This doesn’t give you an enormous amount of flexibility if you plan initially to have a few years of activity after retirement before settling down into a more frugal life in your later years.
Transfer values have really shot up recently. Pension firm Xafinity claims that a 64-year-old entitled to a £10,000 yearly pension starting at 65 would get £31,000 more today than they would have received in June 2017. This is making an increasing number of people explore the possibility of transferring out, but it is a complex subject and important to consider all the implications.
What downsides are there?
First and foremost, on a DB pension you are guaranteed steady earnings which will increase every year for the rest of your life.
Transferring out means you need to take responsibility for your own savings, so If your circumstances change in later life and you don’t have enough savings left to cover these changes, you could find yourself in a rather difficult scenario.
DB pension schemes offer real peace of mind – something that is hard to match when managing your own pension as a lump sum., If you transfer away, you take responsibility for your own investments.
Secondly, think about what it is you are offered. A large sum of money paid out in one can often seem more valuable than it is. Think about how the amount you are offered compares to the regularity and consistency of a DB scheme’s income.
What’s more, if you transfer out you could be faced with a large tax bill. The current lifetime saving limit for pensions is £1.03 million. If the value of your pension is in excess of this amount, you may face a tax charge of up to 55% tax at the time you take your benefits. Bear this in mind, if you are offered a payout which will take you close to the threshold.
If you are considering the option to transfer out, you should see a financial adviser. In fact, if your pension is worth more than £30,000 it’s the law to receive financial advice from a suitably qualified adviser before transferring out of your scheme.
If you are a member of a DB scheme and would like to hear more, please contact us.
Craig Harrison is Managing Director for Creative Wealth Management, having joined Creative Benefit Solutions in 2008. He is among the highest qualified advisers in the country, holding the title of Chartered Financial Planner in addition to the Investment Management Certificate (IMC). When not working, Craig is an occasional runner and cyclist which helps combat his love of food, especially cheese and red wine!