1 December 2023
Upon retirement, you may face several decisions regarding your finances and how to maintain a reliable income.
There are many different ways in which you can do this, with final salary pension transfers a potentially beneficial option depending on your circumstances.
Final salary transfers do have an element of risk, so it is important to understand their intricacies and potential drawbacks to allow you to make more informed decisions in the future.
This article will seek to provide advice and answer any relevant questions, including:
A final salary scheme, also known as a defined benefit pension, can provide a guaranteed income for the rest of your life following your retirement. The value of your defined benefit is calculated using a percentage of your salary at the point of your retirement, which is then multiplied by the number of years you have been in the scheme.
Unlike a defined contribution (also known as money purchase schemes) wherein an employer or employee make regular contributions to a savings pot, the amount you receive under a defined benefit scheme is guaranteed and paid directly to you.
There are two types of defined benefit schemes, these are:
Typically, you will get access to your defined benefit pension at either your scheme’s normal retirement age or earlier if you take early retirement. Usually, this may be set at 60 or 65 years old and is the age at which your employer, via the pension scheme and Trustees would begin to pay out your benefits.
It may be possible to defer the age you begin to receive your benefits, and by holding off on receiving these benefits until a later age, you could experience an increase in your yearly income post-retirement.
Generally, the rules regarding this vary between schemes, so it is worth checking with your scheme before making any decisions.
However, a defined benefit transfer involves you waiving your right to a guaranteed income in exchange for a lump sum paid to a different pension arrangement. This lump sum, known as your pension scheme’s cash equivalent transfer value (CETV), would then typically be invested in a money purchase scheme.
If the transfer value is greater than £30,000 then you will need to take financial advice from a pensions specialist. Whoever you transfer your money too will want to see evidence that you did take financial advice.
The cash equivalent transfer value (CETV) is a lump sum intended to be equivalent to the cost of the same pension that would have been provided to you and is determined by several factors including your age, accrual rate, life expectancy and salary when you retired.
The cash equivalent transfer value is then typically invested into either a personal or stakeholder, a pension drawdown vehicle, a scheme held by another employer or a self-invested personal pension, also known as a SIPP.
By agreeing to a final salary transfer, you are acknowledging the associated risk factors, especially if the cost of securing your income is higher than anticipated, leaving you unable to match the benefits that would have been provided by the ceding scheme.
As a result, you may find yourself being financially worse off throughout your retirement should you opt for a transfer than if you had remained a member of the scheme.
This is not to say that you would be worse off in transferring your pensions, since the cost of securing an income may be lower than anticipated, and your fund’s value could increase in the future.
You may also have other reasons for transferring, such as inheritance tax planning, so the security of income may not be your primary need.
Should you have a defined benefit in the private sector, then it is likely that you are able to transfer your fund out. However, this may not be the case if you are in a public sector scheme or if the pension has been moved in a Pension Protection Fund (PPF) as a consequence of funding issues.
Those who work in the public sector are often members of final salary pensions. For instance, this can include those who work in the NHS, the police force and the army among more. Despite this, public sector workers are often part of unfunded schemes, where the pensions they receive are from the government rather than their direct employer.
Consequently, it is not possible to transfer in this case as the schemes are unfunded.
As a result, it is entirely dependent on your scheme whether or not you are able to transfer your pension, so it is worth checking with the scheme and trustees.
By transferring, you may be unable to unlock much needed cash from it, which you could use to pay off any debts and provide a valuable retirement income. However, the process is risky and you should always weigh up the advantages and disadvantages of such a decision.
Often regarded as golden pensions, a defined benefit pension will provide guaranteed retirement income, with yearly inflation increases and spouses benefits making the scheme an attractive option to those approaching retirement age.
If you have taken a transfer out to a money purchase type arrangement then in order to receive an income for life, that could increase with inflation, you would need to buy a pension annuity. An annuity is a form of insurance which can allow you to exchange your retirement savings for an income for life.
Below are some of the advantages and disadvantages associated with pension transfers:
The pension reforms of 2015 may mean you could be entitled to transfer from a private scheme to a money purchase scheme and take advantage of the freedoms that were provided.
This alteration to the pension freedoms has offered a new retirement option for thousands of people while resulting in a spike of transfers from defined benefit to money purchase schemes.
If you were to die prior to turning 75, any funds remaining in your pension pot are inheritance tax free. If however, you pass away over the age of 75, the funds can still be inherited by your beneficiaries, but they are subject to income taxation at their marginal rate.
By transferring, your retirement pot changes from a being a theoretical amount to a cash amount, which gives you and your family a lot more flexibility.
By doing a transfer, you may be able to invest your funds elsewhere as a result of the increased flexibility. For instance, you could invest some funds in more adventurous investments, investment bonds or your beneficiary’s future, such as education and healthcare.
The Financial Conduct Authority suggests that in the majority of cases, by transferring you are more likely to be financially worse off. However, as always it depends on your individual circumstances so in some cases you may be better off in transferring.
By transferring away, you will lose all of the guaranteed benefits that are associated with your scheme.
If you move to a money purchase scheme, life expectancy may mean that your money runs out. Under a final salary scheme, your income would have been guaranteed for life.
As a consequence, it is important that you consider the benefits and guarantees provided by your scheme before choosing to transfer away. Getting financial advice will help you decide whether you can afford to lose the guarantee.
By opting to transfer, you are choosing to move it to an investment of your choice. Once invested, you are putting your income at risk, and your income is dependent on the success of your investments. Of course, it is absolutely recommended that you take financial advice from a transfer specialist before you undertake any investment decisions.
Once you have transferred, any benefits provided by the Pension Protection Fund are lost. The Pension Protection Fund is a scheme that acts as a backup to support you if your employer’s scheme should fail.
Known formally as a self-invested personal pension, a SIPP is a form of investment vehicle you can transfer your pensions into. When looking to transfer your money it is therefore only natural to think about whether you should transfer your final salary pension to a SIPP.
Generally, you may find that you will be financially better off remaining in a defined benefit scheme instead of transferring your pension into a SIPP.
This is also supported by the Financial Conduct Authority, who suggest pension transfer options are risky and could leave you at risk of old-age poverty going forward. This is obviously dependent on your financial circumstance.
In order to transfer to a SIPP from a defined benefit pension scheme, you have to gain a cash equivalent transfer value from your last employer. Before you transfer into a SIPP you should certainly take some advice.
The advisor will help you understand whether the transfer is offering you value and whether transferring out of your scheme is the right choice for your situation.
If you are thinking about transferring out of a pension scheme, it is worth turning to a pension transfer specialist for financial advice to aid you in your investment decision.
Professional financial advice can also help you in finding secure investments with low risk, should you opt to transfer out of your pension scheme.
These days, there are many sources on the internet that can calculate whether or not the cash equivalent transfer value is representative of good value and whether or not transferring is a sensible option.
That said, it is not a requirement to know your cash equivalent transfer value at hand when calculating, and an estimate can be generated using the annual pension income you should receive.
Pension transfers can provide an opportunity to unlock cash from your pension scheme, although they do not come without risk. There are many pension transfer options available so you must get financial advice before making any decisions.
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