You might well have seen in the media much talk about the option of transferring out of final salary pension schemes, otherwise known as occupational or defined benefit (DB) schemes.
In this post, Jessica McGowan, a pension specialist at Riverfall Financial, cuts through the confusion surround final salary pensions transfers, and asks, ‘what’s all the fuss about?’
Final Salary Pension Transfers Explained: The Basics
If you are a member of one or more final salary pension scheme(s) operated by your current or previous employers then you have always had the right to exchange the benefits afforded by such a “defined benefit” (DB) scheme for a lump sum that would then be invested in a “defined contribution” (DC) fund to provide you with an alternative retirement income than you would otherwise have had from the DB scheme.
Until recently however this was very rarely seen as an advisable option as the guaranteed, inflation adjusted pension from the DB scheme was viewed as an unbeatable risk-free perk and any lump sum that was passed on at your death would attract a significant tax liability.
The fact that the Pensions Regulator estimates that 80,000 transfers were made in the last year alone is an indication that things have changed. Much of this change has been attributed to the “pension freedoms” changes introduced by the government in 2015 which gave people much greater control and ownership of their retirement savings.
The abolition of the tax that was levied on pension savings upon your death, which also occurred in 2015, has arguably had an even greater influence on current thinking than pension freedoms.
If you receive a final salary pension, then on your death it is likely that your surviving spouse will receive between half to two thirds of your pension income; some schemes have dropped to 37.5% spouse’s benefits. This amount will cease altogether on the death of the remaining spouse, children will receive nothing unless they are aged under 23.
The removal of the “death tax” on unused pensions now means that a fund held under a DC arrangement can be passed on from one generation to another free of tax, if the saver dies before the age of 75. If they die after 75 then tax is paid at the income tax rate of the person who inherits the income or a flat rate of 45% if taken as a lump sum.
The transfer value is the lump sum amount that your final salary scheme will offer you to leave the scheme and is actuarially calculated on, amongst other things, your life expectancy. Low interest rates have contributed to significant increases in the multiples being offered by some schemes leading to higher lump sum offers that can appear very attractive.
Why should I consider transferring?
Listed below are some of the advantages that exchanging your final salary scheme for a lump sum might be. Every scheme is different and each person’s circumstances are unique which is why it is important (and required by law if your pension fund is worth more than £30,000) to take advice from a financial adviser who holds a specialist pension transfer qualification.
- Access to your pension at age 55.
- 25% of the invested amount available as tax free cash at age 55.
- 100% the fund value for the surviving spouse as either income or capital.
- The remaining pension fund can be left to your children.
- You can decide when to retire, providing your fund is sufficient for the lifestyle you want.
- You can have a phased retirement.
- You decide how much income you take and how your funds are invested.
- You can adapt your retirement plans if you suffer ill health.
- You don’t have to worry about the viability of your employer’s scheme.
The attractions of taking a significant lump sum of cash are obvious, as are the dangers which is why it is vital that you take advice from an adviser you can trust, not only with the decision of whether to leave your scheme or not, but also someone who can help you with the long-term responsibility of managing the money you receive so that it takes care of your retirement needs and is passed on efficiently to your family in the event of your death.
The value of pensions and the income they produce can fall as well as rise. You may get back less than you invested.
But, there has never been a better time to look into the potential benefits of leaving a final salary pension scheme.
Please note: transferring out of a final salary scheme is unlikely to be in the best interests of most people.