Should I transfer my final salary pension?
You can transfer a final salary workplace pension to unlock the cash from it, but you need to be aware of all the facts before you consider transferring a final salary pension.
What are the benefits of final salary pensions?
Defined benefit and final salary pensions give you a guaranteed income when you come to retire, which often rises with inflation each year and pays attractive death benefits to your surviving spouse.
To get a guaranteed, inflation-linked income with a defined contribution pension, you would need to buy an annuity. For example, a pension pot worth £500,000 would only buy you an annual income of just over £15,000 a year.
That is why it is usually best to leave your money in a final salary pension rather than transfer it to a defined contribution scheme.
Why transfer my final salary pension?
As part of the April 2015 pension freedoms, you may be permitted to transfer from a private defined benefit scheme to a defined contribution pension after taking advice from a regulated financial advisor.
If you have a defined contribution pension, you can withdraw as little or as much as you like from the age of 55; managing your savings more flexibly through income drawdown, rather than having to buy an annuity.
Inheritance tax benefits
Another change is the removal of the 55% tax on your remaining pension pot after you die. Under the current rules, if you die under the age of 75, your funds can be inherited tax free. If you die aged over 75, it can be passed on as a lump sum subject to income tax at your recipients personal rate.
How much will I get if I transfer my final salary pension?
If you do decide to transfer your final salary pension, the amount you get to invest is known as the ‘cash equivalent transfer value’, which is calculated by your final salary scheme.
You must then invest this ‘amount’ in either a pension scheme with another employer or a personal, self-invested or stakeholder pension.
The cash-equivalent transfer value is basically the amount of money your pension scheme would need today to make sure it could cover the cost of the benefits you were guaranteed to receive in the future, were you not to cash them in.
Usually, transfer values have been calculated as a multiple of around 20 times the annual income due at retirement.
For example, a final salary pension worth £10,000 a year would produce a lump sum of £200,000. More recently, transfer values of 30-40 times the final salary benefits have been offered.
High transfer values have been driven by two main factors – companies’ desire to reduce their schemes’ liabilities and the current low-interest-rate environment.
The two are linked. Low interest rates over the past decade have meant low gilt yields, and as pension schemes are funded by investments in gilts, companies are finding it harder to afford promised pension benefits. They have offered higher or ‘enhanced’ transfer values, as a result, to rid themselves of future pension liabilities.
Gilts and your final salary pension
Many schemes invest in UK government bonds, or ‘gilts’. These are essentially loans to the British government in exchange for a fixed rate of interest, with the loan repaid at a future date.
Gilts are seen as low risk, as the UK government is unlikely to go bust and therefore not repay its debts, which is useful for pension schemes because they pay incomes for decades and need secure investments.
However, returns on gilts have fallen in recent years. To the extent that current 15 year gilt rates (as of April 2020) are averaging under 0.6%. So, if the scheme assumes that growth on its investment is going to be lower, it would need a larger lump sum today to cover the cost of your future pension benefits, meaning a larger cash equivalent transfer value for you.
How long could a final salary UK pension transfer take?
The first stage You request a ‘statement of entitlement’ from your pension scheme
After one month Your pension scheme should notify you that you need to take professional financial advice
After three months Your pension scheme confirms the ‘transfer value’ of your pensions and will send the paperwork with a deadline to take financial advice
After six months This is your deadline to confirm that you want to transfer your pension and provide proof that you’ve taken financial advice
After nine months This is the deadline for your pension scheme trustee to complete the transfer
What have been the problems with pension transfer advice?
Unfortunately advice in the past has been poor, people have been persuaded to cash out and put their money into unsuitable high-risk and high-cost investment funds.
The regulator’s view is that advisers should start from the assumption that a transfer will be unsuitable for most people. Under new rules, all pension transfer specialists will be required to hold a specific qualification for providing advice on investments by October 2020.
The regulator stopped short of a ban on a fee for advice is only paid when a switch goes ahead.
To make you think twice about transferring, the FCA also now requires advisers to provide you with what’s known as ‘the transfer value comparator’ (TVC).
Should you consider a final salary pension transfer?
Opting to cash in a DB scheme is not a decision to be taken lightly. It is for good reason that the regulator has taken a keen interest and warned advisers to take a very cautious approach when talking to potential transferees.
It has tightened rules have seen a number of advisers exiting the market, and latest figures show that pension transfer activity is starting to slow. yet many savers will continue to be tempted by the eye-watering lump sums on offer.
There are certain circumstances in which transferring can make sense, but getting professional pension advice is essential. You need to have a clear understanding of the risks of swapping safeguarded benefits for flexible ones.
A guaranteed income for life remains the gold standard for pensions. Forgoing this opens up the possibility that you’ll have less to live on than expected and you could even run out of money altogether.