To younger people entering the workplace, final salary pension schemes (otherwise known as defined benefit pension schemes, or DB schemes) are seen as luxuries from a bygone era.
DB schemes are traditionally much more lucrative than a defined contribution (DC) scheme because they guarantee the retiree a proportion of the level of income they earned during their career rather than relying on them to save themselves.
In recent years they’ve been phased out by employers because people are living for longer and the uncrystallised liabilities are wreaking havoc with corporate balance sheets. However, a new trend has emerged for those with final salary pensions to consider cashing them in and moving them to a defined contribution scheme.
So, what is a defined benefit pension transfer?
A defined benefit pension is provided by your employer’s pension scheme and is determined by your final salary and your years of service. A defined benefit pension transfer allows you to swap your future secure pension income for a cash sum transfer value which can be transferred to an alternative pension arrangement. The individual is then in charge of their own money, and takes on the management of their funds and inherent risk in return for an unknown future income but more flexibility.
Transferring a final salary pension may be attractive, but it may not be suitable, and advisers will review transfers on a case-by-case basis.
Why are DB pension transfers suddenly gaining popularity?
Coverage in the media reflects historic highs in final salary transfer values, and consequently people are sharing stories with their friends and colleagues. This is prompting more and more people to ask if a DB pension transfer could be the right option for them.
Another reason why DB pension transfers are becoming more popular is the recent pension freedoms. Once you transfer a pension to a DC scheme, which is more flexible, you can take a tax free lump sum and defer the income until you need it at a later date. The death benefits under a flexible arrangement are also attractive to many. Under a final salary scheme the income typically stops on death of both the member and spouse and there is nothing to pass on to the next generation. Under a DC scheme there are flexible death benefits which means the remaining pot of money can pass on to family. There’s a lot more flexibility with the new arrangements, which is appealing for some people.
Transferring a final salary pension may be attractive, but it’s not the right option for all.
Another factor influencing transfer values is gilt yields. Currently these gilt yields are low, increasing the cost of the DB scheme and the size of the transfer value people can receive. This has been driving interest and more acceptances.
How are transfer values calculated?
Cash equivalent transfer values (CETVs) are calculated by the scheme actuary and will vary between schemes but the main factors that the CETV is based on are:
- How far away you are from retirement
- Your salary
- Your service with the company
- Any rules about how your pension will increase, and any other benefits from the scheme
- Assumption on future annuity/interest rates
- The value of gilt yields
When would a DB transfer be appropriate?
Let’s imagine a client – a lady whose transfer value would be over £900,000 at the moment. She’d been told she might have a high transfer value by a colleague, which is what prompted her to contact her Wren Sterling adviser. While it looks like a lot of money, she wants to make sure she’s doing the right thing as these funds could quickly evaporate due to poor future investment returns, charges and the lifestyle she wants to maintain.
One factor that we also look at is the Critical Yield. This is essentially a calculation of the investment return required to match the benefits being given up in the old scheme. Whilst this is not the only factor we consider it is an important one as we would be reluctant to advise on a strategy we know would significantly financially disadvantage the client in retirement.
In this case, her family owns many other assets and she isn’t relying on this income. The investment returns required are not too onerous so she could transfer it without it affecting her future and the new strategy will allow her additional flexibility and the opportunity to leave a legacy for her family which is important to her. If you need security of income, an annuity or final salary is likely to be the best way to go, rather than a flexible drawdown arrangement.
When would a transfer be inappropriate?
The point of a pension is to provide you with an income in retirement, not to provide a legacy – yet this is one of the main reasons individuals look into a pensions transfer.
The main reason an adviser would recommend against a transfer would be because they didn’t think the client could afford the risk and would impact on their retirement.
Let’s imagine another client. A gentleman who wants his adviser to look into a transfer for him so that he could provide a legacy – as DB schemes cannot be passed on to the next generation. He and his wife have a total transfer value of just over £300,000 between them, and he feels he could easily achieve a better return – but he doesn’t have many other assets set aside though and was very reliant on the income from the scheme in retirement, so in this case his adviser recommends that his pension is not transferred.
Why is a financial adviser so important to the process?
If your CETV is worth £30,000 or more and you’re considering a transfer, you are required to seek regulated financial advice. Not every financial adviser is able to advise on DB pension transfers as additional qualifications are required. Also the firm needs the appropriate FCA permissions to carry out this business, which Wren Sterling has.
When considering a pensions transfer, a financial adviser will take a holistic view of your finances, not only considering an individual’s appetite to risk, but also discussing the provision in place for their spouse. Even if a pension transfer isn’t the right option, financial advisers can look at other products which could achieve a person’s financial goals. For example if a legacy is important to a client we can look at alternative ways of providing this such as whole of life cover or funding an alternative pension if appropriate.
What does the process look like?
At Wren Sterling we go through a series of stages to decide whether a DB pension transfer would be right for you. First, we conduct a ‘fact find’ to learn about your finances and how you want to manage them and assess your financial objectives. Then we’ll get a transfer value analysis report and make an assessment on which of your options would be most suitable to you. If the transfer is appropriate we are then able to recommend a suitable vehicle to accept the transfer and an appropriate investment strategy to achieve your goals.
|Some advantages to transferring||Reasons not to transfer|
|Reliance:If a person is not reliant on the money for retirement income (i.e. they have other pensions and investments to give them a retirement income)||Investment performance:This may be worse in a new scheme and leave the clients in a worse position than before. This is absolutely fundamental|
|Legacy: Final salary schemes cannot be passed on to the next generation on death of both the owner and spouse||Reliance: The holder's spouse is reliant on the income|
|Investment control: Transferring to a DC scheme gives more flexibility||Insufficient assets: If clients are relying on a DB scheme for retirement income because there are not many other savings and investments available, a transfer might not make sense|
|Value: Transfer values are artificially high at the moment due to low gilt yields||More appropriate products: If a client wants to create a legacy for example, it might make more sense to review protection policies to see if a life insurance policy will have the same effect without compromising the security of a DB scheme|
|Ill health: If the DB pension scheme member is unwell and likely to die in the near future, cashing in will ensure a legacy can be left for future generations|
Please note, this table is not exhaustive and there may be other reasons, on both sides, for approving or rejecting a pension transfer request.
The value of your investment and income from it can go down as well as up and you may not get back the full amount invested. Accessing pension benefits early may impact on levels of retirement income and is not suitable for everyone.
You should seek advice to understand your options at retirement.