Should I transfer my defined benefit (final Salary) pension?

There was a time, not all that long ago, when the answer to this question was very simply: No – save in the most exceptional circumstances.

However due to more and more defined benefit schemes running into trouble and the introduction of pension freedoms, this question is being asked more frequently now than ever before.

It has been widely reported the extent to which existing defined benefit schemes are now in deficit, and the trend appears to be worsening. Earlier this year leading pension and employee benefit consultancy, JLT Benefits, reported that 26 FTSE 250 companies had disclosed pension liabilities of more than £1 billion – the largest of which at £4.91 billion. During 2015 a further 155 companies disclosed defined benefit pension liabilities of less than £100 million.

The Pension Protection Fund (PPF); which since opening its doors in April 2005 has taken over defined benefit schemes that have become insolvent, reports on its website that as of the end of March 2016, a total of 225,534 members have been transferred to the PPF. Total compensation paid out currently stands at £2.3 billion.

The introduction of pension freedoms

The UK is well known for having complex and ever changing pension legislation, but perhaps the UK government surpassed even themselves when they introduced the pension freedoms in April 2015. The sweeping changes mean that an individual now has the right to access their entire pension pot from age 55; however this is only available for members of defined contribution (money purchase) pension schemes.

The generosities were not, therefore, extended to defined benefit schemes, and to access these freedoms members of defined benefits schemes are required to first transfer their rights to a defined contribution pension scheme such as personal pension or a SIPP. The right to transfer is granted providing the scheme is not an unfunded public sector pension scheme such as the NHS, teachers pension or civil service arrangements.

The pension freedoms have inevitably led to an increased interest in defined benefit pension transfers; pension transfer analysis software provider Selectapension reported in April that use of its software has doubled in the 12 months that followed the introduction of the freedoms.

Are these valid reasons for transferring a defined benefit pension?

Whilst it is an inescapable fact that more defined benefit scheme are finding themselves in deficit and more and more schemes are closing the doors to new and existing members alike; a defined benefit scheme still offers valuable safeguarded benefits and surrendering these is not a decision that should be taken lightly.

Safety of the Pension Protection Fund

In the event that an eligible defined benefit scheme does become insolvent, it will receive valuable protection provided by the PPF. The PPF is partly funded by levies taken against eligible defined benefit schemes, and will generally pay 100% of the pension that is due providing you have passed the scheme’s normal pension age. For early retirees the level of protection is 90% of your pension, subject to an overall cap. The cap at age 65 is £37,420 from 1 April 2016 – which equates to £33,678 when we apply the 90% cap. The earlier you retired the lower the annual cap is set. If you have yet to retire then you will receive compensation based on the 90% level (subject to a cap) when you reach your scheme’s normal retirement age.

For the vast majority of people this level of compensation will surely suffice; it is perhaps then, only really those in senior positions, or in high paying professions such as airline pilots, who run the risk of losing significant parts of their pension if their scheme becomes insolvent. A recent example of which was in 2015 when 70 Monarch pilots had their retirement plans severely damaged after their scheme became insolvent and had to be rescued by the PPF. Of the pilots affected it was reported that some had been set to receive £69,000 per year but will now receive around £26,500. This is because the scheme’s normal retirement age is 55 and so this is the age related benefit cap that will be applicable. British Airways pilots have no doubt been watching events closely; their scheme is reported to be making good payments of about £300 million a year to plug its own deficits, which in 2012 stood at £3.3 billion.

Freedom to exchange the fund for cash

Following the introduction of pension freedoms and the ability to exchange pensions for cash, The FCA recognised the dangers this could pose to members of defined benefit schemes who may now be tempted to transfer to a defined contribution scheme to take advantage of this. To increase consumer protection, the FCA implemented new legislation that now means there is a requirement to have received regulated financial advice from a pension transfer specialist before a member of a defined benefit scheme will be permitted to transfer their safeguarded benefits in the scheme to another scheme with flexible benefits – if the cash equivalent transfer value of their total benefits in the scheme is over £30,000.

It should be remembered that while pension freedoms do permit access to the entire pot, only 25% of this remains tax free, the remainder will be subject to tax at the individual’s marginal rate; clearly cashing-out a pension scheme will attract punitive tax implications for the vast majority.

Certainly our view remains that despite increasing scheme deficits and the dangling carrot that is now pension freedoms; remaining in the defined benefit scheme will still be the best option for the majority of individuals.

Circumstances when a transfer might be considered

However there does remain certain scenarios when a valid reason to consider a transfer exists; this could be one or more of the following:

  • You are single and have no requirement for the spouse’s pension that is payable on death; the cost of which is factored into the transfer value.
  • You have an impaired life expectancy and as such the guaranteed income for life is less valuable for you or you are able receive a higher income from qualifying for an enhanced annuity elsewhere.
  • You have significant non-mortgage debt that you need to repay.
  • You have defined benefits in your scheme that are greater than those provided by the Pension Protection Fund and your scheme is in deficit.
  • You would like to take advantage of the ability to pass your pension fund on to future generations, through the flexibilities and inheritance tax benefits that a defined contribution pension scheme has.
  • The defined benefit scheme is only a small part of your overall wealth/retirement strategy and your capacity for loss and risk profile is such that the transfer of risk from your defined benefit pension scheme to yourself is acceptable to you.

Although the above circumstances might be tempting and provide valid reasons for considering a transfer, it is important to think carefully before you do so as a defined benefit/final salary pension is still considered the best type that you can have and you can’t change your mind in the future once you have left the scheme to transfer away. You should also consider that, unless you plan to purchase an annuity within the new scheme, the amount of pension you receive will be dependent upon the investment returns you achieve; unless you are experienced enough to manage this yourself, this will involve the extra cost associated with having this managed for you.

I am thinking of transferring, what do I do now?

Providing you have not passed or are within 12 months of the scheme’s normal retirement age, you have a statutory right to receive a cash equivalent transfer value (CETV); otherwise this will be at the trustees discretion.

You or your financial adviser will first need to write to the scheme trustees and request a CETV. Within three months the trustees are obligated to send you a Statement of Entitlement and this will set out all of the benefits that you are entitled to within the scheme and will include a transfer value that will be guaranteed for a period of three months. If the scheme is in deficit (and many are) then the trustees do have the power to reduce the transfer value; however they must first generate an insufficiency report to justify any reduction.

Speak to a pension transfer specialist  

If the cash equivalent transfer value is greater than £30,000 then you will be required, by law, to take advice from an FCA regulated pension transfer adviser that holds a specialist qualification; the pension transfer specialist will need to provide a statement to your trustees confirming that advice has been provided before you will be allowed to transfer.

The pension transfer specialist will provide you with advice about the benefits that you are giving up and the annual return after costs that will be needed to replicate these benefits in any new scheme; this is known as the critical yield. To achieve this they will need to complete a transfer value analysis (TVAS) report using the details contained in your Statement of Entitlement. Once this process has been completed and the advice has been received you will be able to proceed with the application to transfer if that is what you have decided.

As a final note, we would like to stress again that a fixed, inflation protected pension, that also provides benefits for a partner on your death is extremely valuable, and often the amount you will receive for transferring out will be less than the cost of buying that type of pension in the open market. Whilst it might make sense in certain circumstances, it is important to obtain professional regulated advice before you make any decisions and if your transfer value is greater than £30,000 then you have a legal requirement to do so.

If you are considering transferring your pension, or would like to receive advice regarding your pension planning as a whole; please fill in the contact form and speak to a pension transfer specialist at First Equitable who will be able to assist you further.

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