How to transfer out of a final salary pension

Transfers from final salary pension schemes have snowballed since Brexit, as the cash sums on offer to members have reached levels of 30 or 40 times the pension payable at retirement. Giddy sums are offered because gilt yields, which are used to estimate how much cash is required at today’s rates to pay for future benefits, are at historic lows.

The attractions of transfers have also been boosted by rule changes allowing cash to be taken from a pension from age 55 and residual funds to be bequeathed on death. Over 100,000 people have already taken a transfer, and many more would like to but are being thwarted by procedural hurdles.

The main difficulty is in finding a financial adviser happy to take on this type of transaction. An adviser’s involvement is essential, as the government insists that people with over £30,000 at stake take independent financial advice to understand the guarantees they’re giving up. This safeguard has run into difficulty because fewer than 3,000 of the UK’s 20,000 IFA firms have the special qualification required to advise on transfers; more importantly, many that do have decided not to get involved as the compliance risk and professional indemnity insurance premiums for transfer business are high.

Advisers fear a rerun of the ‘pension review’ of the 1980s and 90s, which led to billions being paid in compensation to clients wrongly recommended to give up company schemes for personal pensions.

There is a particular issue around so-called ‘insistent clients’, the label given to clients who advisers believe should remain in their final salary scheme but who still want to leave. Most advisers will not facilitate a transfer for an insistent client. A pension scheme’s trustees will demand certification in writing that the member has taken advice, but if the IFA does not approve, most will simply refuse to provide this documentation.

An essential part of the advice process is the generation of reports, which are complex and time-consuming to put together. Consequently some advisers will demand a hefty fee, whether or not they sign the paperwork allowing the transfer to proceed. Transfers are large sums of money and there is concern that this might influence the advice offered. Worryingly, some readers have also reported that advisers aren’t interested unless they are allowed to manage the fund going forward.

When a transfer goes ahead, the fee should be at the lower end of 1-2 per cent of the cash value, but a few ramp it up to 4 per cent or more.

Firms that run the receiving schemes, such as self-invested personal pensions (Sipps) or personal pensions, are also nervous about reputational risk if a miss-selling scandal subsequently materialises. For example, Hargreaves Lansdown requires a positive recommendation for a transfer from a final salary scheme into its Sipp, and even then will only accept one from an approved list of advisers.

Transfer process

The first step in the transfer process is to apply to the pension scheme trustees, asking for a transfer value statement.  Schemes tend to be laggardly, so be prepared to chase. Some are proactive, however – a few banks even publish individual transfer values on their member web pages.  Ask for a statement predicting what your annual pension is likely to be at retirement, as surprisingly pension values are often stated in today’s money; and for comparison purposes, if you have reached 55, what the pension would be if you took it early. 

Once the scheme has issued a transfer offer you have three months to complete it, as it will then lapse. Technically, your scheme only has to make one transfer offer in every 12-month period, but most schemes are keen to offload their liabilities, and only the most intransigent would not refresh a lapsed offer. However, there is no certainty that the new offer will be as high.

- Pros and cons of cashing in a final salary pension

The next step is to send the offer to your adviser who will explore your financial profile and attitude to risk, and why you want to transfer. The adviser will want to see good reasons for doing so – such as paying down debt, leaving an inheritance to children, greater flexibility in when benefits are taken (which may involve tax mitigation), or perhaps a requirement for cash upfront for a business opportunity or to get your children on the housing ladder. 

If both partners in a couple have benefits under a final salary scheme, it may make sense for one to transfer out so that both can enjoy greater wealth and flexibility in the early years of retirement, knowing their long-term income still has a guaranteed underpinning.

Critical Yield reports

An adviser who thinks they can work with the responses you have given will run a Critical Yield report, which will show, for varying annual withdrawals and levels of investment performance, the age at which your fund will run out. This is then incorporated into a personalised Suitability Report on the transfer. You should probably be focussing on the line showing the outcome based on future annual investment returns of 3-4 per cent. 

James Baxter, partner at Tideway Investments, which has completed over 1,000 transfers since 2015, warns that the three-month guarantee period is not as long as it sounds. ‘We have to do ID checks on members, make sure we have all our “know your customer” information and go through our engagement process with members before we can start advising,’ he explains.

‘These rules are set by our regulator and all reputable advisers will have a strict procedure on boarding process like this. If it’s all happening very quickly, warning bells should be ringing!  If there is any information missing from the scheme offer then we need to go back to the scheme, and many are generally under-resourced to handle the current level of transfers and take 10 -15 days to respond to information requests.To be sure of meeting a deadline the submission process should ideally start 10 working days before the deadline, so if members don’t come to us for a few weeks after they receive their offers, then three months can get tight.’

- Fiinal salary pension changes will cost average pensioner £20,000

If you are near the lifetime allowance (LTA), which is currently set at £1 million, you will need to apply to HMRC for an LTA certificate, so that withdrawals up to that level (beyond the tax-free cash element) are taxed only at your marginal rate of income tax. You do this online and a certificate will be generated immediately (

However, the LTA is a concern for people with transfers that are nudging the current limit of £1 million, as the LTA regime is harsher on money purchase pensions such as Sipps than in a final salary environment.

Currently someone with a final salary pension worth up to £50,000 per year will come in under the LTA, as the calculation is based on a notional 20 times pension. If you transfer into a Sipp, however, this will prompt a ‘crystallisation event’ (a test against the LTA) even if no income is drawn; with current transfer values at 30-40 times the pension, it will likely exceed the allowance (though no tax is payable then). If you subsequently withdraw anything above the LTA, you will face a tax charge of 55 per cent on any amount taken as a lump sum and 25 per cent on regular income; the two rates broadly equate, as you will also pay income tax on that income.

The LTA can also act as a penalty on investment performance.  This is because reaching age 75 prompts a second crystallisation event, where the fund (minus the amount originally crystallised on designating funds for drawdown) is again tested against the LTA.  If, in the intervening years, the residual fund has grown handsomely, then you could face a tax charge on any excess drawn over the then-prevailing LTA.

This means that it may be wise to err on the side of a low-risk investment strategy in drawdown; moreover, even if you do not need income immediately, it could be worth your while withdrawing cash and investing it elsewhere to pre-empt this situation.

Advisers can't negotiate

A common misconception is that the adviser might be able to negotiate with the scheme to improve the transfer offer, but the scheme actuary sets out the transfer calculation factors which apply to all members. However, they do move in line with gilt yields.

But transfer values are still high and edged up again in April, according to the Xafinity Transfer Value Index, which is based on a member aged 64 entitled to a pension of £10,000 each year, starting at age 65. So far the best time to transfer was October 2016, when the average transfer for these criteria was £244,000; by the end of April this had dropped, but only to £237,000.

Some people consider a transfer because they believe their employer or former employer is financially unstable. The collective liabilities of UK’s 600 private schemes currently exceed £2.1 trillion, and many dwarf their sponsoring companies. There has been a lot of discussion about reducing accrued pension benefits to keep the system sustainable, particularly by indexing benefits in line with the consumer price index rather than the retail price index, but that appears to have been kicked into the long grass.

Nathan Long, senior pension analyst at Hargreaves Lansdown, points out that the deficits – like transfer values - have risen sharply because pension liabilities are calculated with reference to gilt yields. ‘It really is a case of just not panicking,’ he says. ‘I have a lot of confidence in the Pension Protection Fund safety net, and after the election the Pension Regulator will have stronger powers to recover late or missing payments from an employer on behalf of a scheme.’

Consider a transfer from a final salary scheme if.....

1. If the guarantees in the final salary scheme are less relevant to you, for example if you are in ill health.

2. If you are single or have no children under 18 or in full-time education who would benefit from generous dependents’ pensions.

3. If you want to ensure the fund can be inherited.

4.  If you want to take the cash element early, perhaps to pay off outstanding debt or set up a business.

Finding an adviser

• The Money Advice Service publishes a directory of IFAs who have the pension qualification. Tideway Investment Partners and Intelligent Pensions both specialise in this arena.

• You might also find a local adviser via specialists such as O&M Pension Solutions or Selectapension, which undertake the number-crunching work for IFAs.

• Pension providers Prudential and Scottish Widows have also entered the fray on the back of huge demand.

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