Some of the most common questions we receive are regarding Final Salary Pension Transfers. Our clients want to know if we recommend transferring out of their Final Salary Pension in favour of a lump sum, and for what reasons. We have compiled this simple guide to the main benefits of Final Salary Pension Transfers. Just before we get on to these reasons, it is important to make mention of the fact that deciding to transfer out of a Final Salary, Defined Benefit Pension scheme is a big decision to make. We are of the view that for the majority of Defined Benefit Pension holders, they’re going to be much better off remaining in their scheme. However, we are also of the view that there are individuals where a transfer out of a Defined Benefit scheme can make excellent Financial Planning sense.
What is a Final Salary Pension Transfer?
First, we need to start by defining a Final Salary Pension. Also known as a Defined Benefit Pension (DB), it offers you a guaranteed annual income for the rest of your life. It is based on your final average salary and is pegged to inflation. They are often offered to employees in the public sector, less so now in the private sector.
Since 2006, Final Salary Pension recipients have been entitled to convert their pension scheme to a lump sum payment – of which can the be transferred to a Personal Pension, normally a SIPP. The lump sum is based on a Cash Equivalent Transfer Value (CETV). The CETV is usually offered at between 25 to 30 times of your future annual scheme pension income, but can be as high as 40 times. Pension scheme administrators determine your CETV based on a variety of factors that include your age, your retirement age, cost of living, your life expectancy and current annuity rates (which are low hence why transfer values are so high).
The Benefits of a Final Salary Pension Transfer
Benefits of transferring your DB pension, include:
- You get flexible access to your money
Once you reach age 55, you can access your pension flexibly. This means that you’ll get access to your pension money when and how you want to. You are also permitted to obtain 25% of your cash tax-free.
- It can allow you to retire early
Defined Benefit Pension schemes will operate a Normal Retirement Date. This will mean that you can only start receiving your pension income once you reach a certain age. Some schemes will allow for early retirement, however, that this could be at a significant cost due to an ‘early retirement’ discount factor being applied. In your own Personal Pension you’ll be access all of your pot at age 55.
- Leave a tax-free inheritance for your loved ones
You can nominate anyone you wish to receive the remaining value of your pension after you pass away, free from Inheritance Tax. If you were to pass away before the age of 75, your beneficiaries would receive your pension pot tax free, if you die after the age of 75 they will pay tax at whatever they take out, at their marginal rate of tax. You can also choose to ‘skip’ generations and thus pass your pension pot onto your children. In my experience (Chartered Financial Planner, arranged many transfers out of DB schemes), this is often the number one reason for DB pension holders considering transferring out of their pension scheme).
- Potentially save on income tax
If you don’t need any extra income, you can leave the funds in your pension pot, and you won’t have to pay any income tax. You may also choose to take just the right amount to stay within a particular income tax threshold. The point is that you can choose to take income as and when you like to maximise the tax efficiency of that income drawdown. Compare this to a Final Salary Scheme Pension which will pay out the income whether you need it or want it at that time.
- Take greater control over your investments
If you make the switch to a Self-Invested Personal Pension, you can invest your money into an investment portfolio that is better aligned to your own attitude to risk or investment asset choices. This could, potentially, allow you to reap higher returns, as you will have complete control over how your money is invested and withdrawn. So, you may opt for a higher risk portfolio which may offer the chance for potentially higher returns (and losses) or choose to invest in different sectors. You may also wish to invest in funds that have an Ethical, ESG (Environmental, Social, and Governance) or Sustainable Investing mandate.
- Currency Flexibility
Perhaps you’ve retired abroad, or thinking about doing so in the future. Within a SIPP you could chose to invest in any myriad of underlying investment currencies thus removing your exposure to GBP exchange rate volatility.
- Remove Scheme Insolvency Risk
The fact of the matter is that many Defined Benefit schemes are under significant financial strain. Whilst the Pension Protection Fund is in place to provide compensation to those whose DB schemes go under, it doesn’t provide complete protection and it provides much less protection where the pension holder has yet to retire. By transferring out of your scheme to your own pension, you are no longer exposed to the financial health of the scheme.
Deciding to Transfer Out of a Final Salary Pension
Deciding whether to transfer out of your Final Salary secured pension to a unsecured flexible, Personal Pension is a decision that you should very carefully. Once you’ve transferred out, there is no undoing the decision. When you transfer to your own Personal Pension all of the investment and inflation risk is now on you. There are countless stories of DB pension holders that have transferred out of their scheme and have lived to regret the decision. Therefore, it’s absolutely vital that you consult with a pensions expert who can help you to decide the best course of action for you. Remember, if you have a transfer value higher than £30,000, you are legally required to seek the advice of a specialist.
Do you want to know more about the options for transferring your Final Salary Pension? Do you have questions about any aspects of the process? We provide a fee-free initial ‘triage’ which will provide you with a quick assessment as to whether a Final Salary Pension Transfer has the potential to work for you. This process is designed to rule out situations where a Pension Transfer is unlikely to be of benefit.
If you’re interested in transferring your Final Salary Pension scheme, have obtained a CETV of more than £500,000, get in touch with us today for a fee-free initial meeting to understand your options.