Final Salary Pension Advice – In 2015 the Government implemented changes to how those saving for retirement could take their benefits. This new legislation was widely referred to as Pension Freedoms.
Final Salary Pension Advice
These changes did not apply to those whose retirement benefits were held in a Defined Benefit (DB) arrangement, commonly called a Final Salary Pension Scheme.
As a result there has been huge interest from people with DB benefits in transferring these to a Defined Contribution (DC) arrangement that they can then use to take advantage of Pension Freedoms. There are reports that the number of requests for transfers has tripled since the introduction of pension freedoms. Typical examples of DC arrangements are personal pensions and stakeholder pensions.
We understand this can be a little daunting and so we’ve put together a summary to help you understand the sorts of things you need to consider carefully before deciding if transferring your DB benefits is right for you.
Anyone who has DB benefits with a transfer value over £30,000 is required by law to take financial advice before they can transfer to a DC arrangement.
Final Salary Summary
Why Transferring might be right for you
Interest in transferring benefits out of a DB scheme is nothing new. However, many people who transferred did so even though it was not in their best interests to do so. Regulatory guidance then shifted so that the starting position for advisers was that DB transfers were not in the best interests of the member.
However, since the introduction of Pension Freedoms, for many people transferring their DB benefits into a DC arrangement that will allow them to take advantage of the new legislation may now be the right thing for them to do. Here are some of the reasons why transferring may be right for you.
- HIGH TRANSFER VALUES
Defined Benefits schemes promise to pay members a certain amount and in order to meet these obligations the trustees invest in low risk investments such as Government bonds and gilts. Due to recent low gilt yields the cost of meeting these obligations has increased for DB schemes and therefore the transfer values on offer for some schemes have been extremely generous. Following events in 2016 such as the European Union Referendum and the US Presidential Elections gilt yields have been at an historic low level, but that could mean these high transfer values may not be sustained.
It is important to understand what your retirement timeline looks like. Will it be a gradual transition? What do you intend to do once you retire? Whilst the benefits in a DB scheme are more certain it may be you need the flexibility of the new pension freedoms to enjoy a certain lifestyle while you are still relatively young and won’t need as much income as you get older. This will have a bearing on whether the benefits from your DB scheme will actually meet your needs fully. However, if you decide to transfer out into a DC arrangement then you will lose the certainty your DB scheme offers and your fund value will be subject to investment risk in the future.
It might be that you wish to take your benefits in stages over a period of years to give a more tax efficient income stream in retirement, which is not possible under a DB scheme.
- TAX-FREE CASH
How tax-free cash entitlement is worked out is very different for DC arrangements than for DB schemes. And in many cases, under current market conditions, this results in a higher amount of tax free cash being available under a DC arrangement.
Depending on your financial circumstances, access to as much tax-free cash as possible may be your number one priority if you have debts to pay off such as a mortgage. Paying these off might mean you have more disposable cash even with a lower income.
- DEATH BENEFITS AND INHERITANCE
One of the key changes Pension Freedoms has brought about is the ability for beneficiaries to inherit their loved one’s entire remaining pension benefits without having to pay tax if they pass away before age 75. For many people this factor alone will be the reason they want to transfer as often the death benefits available for a DB member will be much less.
If you transfer your benefits and pass away after age 75 then anything that remains can still be passed on and is normally taxed at your beneficiaries’ marginal rate of income tax when they take withdrawals from the fund.
Unfortunately not everyone enjoys the same health. If you have health issues that might mean your life expectancy is unfortunately not as long as the average for someone your age then your DB scheme does not take account of this. This means when you pass away your dependants will receive reduced benefits depending on the rules of the scheme. If you have no dependants then your benefits from your DB scheme will simply stop when you pass away unless there is a guaranteed period the pension has to be paid for.
If you were to transfer to a DC arrangement then you could take advantage of an enhanced annuity which could provide an attractive alternative for those who are not in good health and could provide a higher income than if you took the income available from your DB scheme.
It may be your wish to prioritise passing money as a lump sum to your beneficiaries on death. If you are in serious ill health and transfer your benefits then should you pass away within two years there could be a potential Inheritance Tax liability.
Whatever the reason, your health and lifestyle could have a bearing on whether or not a transfer is in your best interests.
- SCHEME SOLVENCY
In the current climate with some pension schemes being underfunded you may be worried about the possibility of not receiving all the benefits you are expecting when you retire. The Pension Protection Fund is available to protect members of DB schemes that are not able to meet their liabilities. However, it is important to understand the caps and restrictions on pension benefits that may apply in these instances and so it is best to discuss this with your adviser.
Why Transferring may NOT be right for you
If you transfer out of the DB scheme then how much you have to live on will depend on how well the funds you are invested in have performed rather than the length of time you have worked for a company and the salary you have earned.
You will also be taking on the responsibility for how the investments perform rather than leaving this to the trustees of the DB scheme. This could mean that the value of your fund increases significantly but it could also mean it falls in value. It is therefore important you carefully consider what your attitude to risk is. There is more certainty with a DB scheme than with a DC arrangement.
Whatever you decide, please remember that past performance is no guide to the future and with investments like these there are no guarantees. There is a risk that the value of your plan could go down as well as up, depending on investment performance (and currency exchange rates where a fund invests overseas), and may fall below the amount paid in.
INCOME FOR LIFE
We all hope to live to a ripe old age and if you stay in your DB scheme then it will pay you an income until you pass away. If you transfer your DB benefits to a DC arrangement then there is no guarantee the benefits won’t run out before you pass away.
For most DB schemes the income you receive will increase each year to help protect it against inflation. You can still do this even if you transfer your DB benefits but this will have an impact on how long your fund will last.
GUARANTEED INCOME FOR YOUR DEPENDANTS
If you have a spouse or civil partner then your DB scheme will provide them with an income if you pass away before they do, subject to the rules of the scheme. If you have others who are financially dependent on you such as children then the scheme may also provide them with a pension.
You can still provide these benefits to your dependants even if you transfer out of the DB scheme but this would need to be paid for from your pension fund. If you choose not to provide these benefits but still want to leave them something you’d need to make sure there was money left in the fund when you pass away.
LIFETIME ALLOWANCE LIMITS
There is a limit to the amount of pension savings you can build up without being taxed. This is known as the Lifetime Allowance (LTA) and for the last few years the Government has reduced this amount. This figure has been as high as £1.8 million but for 2017/18 it is now £1 million. If you have not previously protected your LTA then any benefits you have over £1 million would incur a tax charge when you take these.
For defined benefit pension schemes, the value for LTA purposes is calculated by multiplying the first years’ annual pension by 20 and adding any tax-free cash on top of this. This figure can often be lower than the transfer value being offered by the DB scheme where valuations can be 30 times the expected first year’s annual pension. If transferring your DB benefits could push you above the LTA and mean you may incur a tax charge then transferring may not be right for you.
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