All-time-high transfer values for defined benefit schemes have proved highly attractive to scheme members – but for many it still makes sense to stick.
The number of pension savers cashing in defined benefit (DB) pensions has shot up since radical pension freedoms were introduced in 2015. But despite the eye-watering sums on offer, you may want to think carefully before giving up the gold-plated benefits such pensions provide.
According to Office for National Statistics figures, the value of transfers between all types of pensions soared to £34.2 billion in 2017, almost treble the £12.8 billion transferred in 2016.
One of the most tempting transfers on offer is from a DB pension into a personal pension, thanks to the huge transfer values available. DB pensions are particularly valuable, as they pay out a set income each year based on a multiple of the number of years worked in a company and a proportion of a pension holder’s final salary. The transfer value of these DB pensions can be as much as 40 times the annual income from them, making transferring out very tempting.
Here are five reasons to transfer your defined benefit pension, and five reasons to stick with that guaranteed annual income.
1. Flexibility factor
DB schemes typically offer inflation-linked income. But the pension freedom changes allow retirees to access their savings more easily, and transferring out of a DB scheme does indeed provide increased flexibility.
Alistair McQueen, head of savings and retirement at Aviva, explains that some pension holders want greater control over how much pension income they take and when. ‘Some may want to spend more income in the early years of retirement, when they possibly have a greater appetite for adventure,’ he says. ‘Others want defined amounts at specific times to meet certain needs. By transferring out of a DB pension, you will have this greater flexibility from age 55.’
2. Health matters
DB schemes pay out an annual income until you die. However, Martin Tilley, head of technical services at Dentons Pensions, says those in poor health may benefit from transferring their pension. A DB pension scheme will hold a view on ‘pooled mortality’, which means the provider believes that most scheme members will live to a certain age on average. ‘But if you do not reach the average age,’ he says, ‘your asset is lost to you and is used to provide benefits for other people [who live beyond the average age].’
McQueen adds that if a retiree transfers out because of poor health, they can use their pot to purchase an enhanced annuity that gives them a higher income in retirement.
3. Personal circumstance
Your marital status, your financial situation and the number of pension plans you have will have a bearing on whether you should transfer out.
Michelle Cracknell, chief executive at the Pensions Advisory Service, says transferring may be an option ‘where you have a small DB pot and also a larger DB pension that will provide your retirement income’. She adds that some people may ‘not need the extra retirement income, as they already have sufficient income’.
McQueen says most DB pensions assume savers are part of a couple and factor income payments accordingly. ‘This means some of your pension wealth is “held back” to provide a secondary pension [for your partner]. If you are single, there will be little value in this pension.’
4. Inheritance issues
While DB pensions will continue to pay an income to the surviving spouse of a deceased scheme member, the pot ‘dies’ when the spouse dies. If you have other dependents you would like to leave money to, transferring may be the right option, as a personal pension can be passed on as an inheritance.
‘If you die before the age of 75, any unused [personal] pension wealth can be passed on tax-free,’ says McQueen. ‘From age 75, any unused [personal] pension wealth can also be passed on, but withdrawals will be subject to income tax.’
5. Scheme solvency considerations
One concern with a DB pension is that the company providing it may eventually no longer be able to do so, in which case pensions are referred to the Pension Protection Fund (PPF). The scheme pays out 100 per cent of the annual income being received by those who have already retired, capped at £39,000. Those who have not yet retired or who retired, before their scheme’s set age will receive 90 per cent of that annual income.
Justin Corliss, Royal London’s business development manager, says the cap is ‘largely irrelevant’, as ‘most people will not have a DB pension of anything like that’. However, he warns that while the PPF pays an increased income each year, as DB schemes do, the ‘statutory minimum [increase] may be lower than the pension offered’.
1. Tax planning pain
Transferring out of a DB pension can cause a tax headache for those with larger salaries. Tilley says a DB pension paying income of £50,000 a year has a transfer value – the total sum received over the lifetime of the pension – of around £1.5 million. However, the lifetime allowance for pension income is just £1 million. Income in excess of that amount is subject to additional taxation. ‘If you take that £1.5 million out and put it in a personal pension with a lifetime allowance of £1 million, then the best part of £500,000 becomes a taxable benefit and you pay 55 per cent tax on it,’ he explains. ‘Transferring seems less reasonable when you hit the higher levels of income.’
2. Investment risk
DB income is guaranteed, and that guarantee is managed and paid for by your former employer. Transferring into a personal pension entails taking on the investment risk that comes with managing your own money, and the risk that your money may run out.
‘If you transfer, you take on investment risk,’ says Tilley. ‘You will be the one staying awake at night thinking about market volatility. If you lose a fair bit of capital early in the drawdown process, it is difficult to make that money back.’ It is not just the responsibility of investing your money wisely that you will need to think about, but also how much money you withdraw every year to ensure your pension lasts your lifetime.
3. Inflation menace
Inflation is the silent assassin ready to wipe out the spending power of your pension. But DB income is inflation-linked, so your income will rise to compensate for inflation.
Corliss says many people ‘underestimate the impact’ of inflation, especially when investing money. Now that inflation has started to edge back up again after years of flatlining, it needs to be considered. He says: ‘It is difficult because the impact of inflation is almost invisible in the present; it is hard to notice the difference between last year’s costs and this year’s. It is only when you compare this year’s costs and those 10 years ago that it is brought home.’
4. Spousal security
Ensuring your spouse is taken care of after you die is a good reason to stay in a DB scheme. McQueen says buying this sort of guarantee outside of a DB scheme is possible, in the form of a joint life annuity, but it is expensive.
‘You lose the economies of scale provided by a DB scheme, which means it will probably cost you more to secure this secondary pension via the other route, and the secondary pension may be less [generous],’ he says.
5. Peace of mind
The most compelling argument for staying in a DB scheme is certainty, especially if it is your only source of pension income. Tilley says the scheme offers ‘regular payments that will last your lifetime, and that is peace of mind that you will have your bills covered, however long you live’. Tilley also notes that members have no worries about costs, as DB schemes are paid for by the employer.
Three reasons to be cautious
A pension is typically a person’s largest asset after their home, so a pension pot is an attractive target for scammers. The most prevalent scams are cold calls that try to entice you to transfer your money into, typically, unregulated investments focused on esoteric assets such as graveyards and rainforests. Any unsolicited texts, phone calls or emails offering help with your pension should be ignored. If an investment sounds too good to be true, it almost certainly is.
2. Rogue advisers
Pension transfers are a specialist advice area, and not all financial advisers are suitably qualified to manage them. To ensure the transfer is done properly and in your best interests, find out whether the person doing the transfer has the necessary qualifications. Check the FCA’s register to see what permissions that person or company holds.
3. Stiff charges
Before transferring away your pension, shop around. ‘It is fair to say DB transfer is complicated and heavily regulated, and those who do it carry liabilities for a number of years, so it is likely to be more costly than other types of financial advice,’ says Justin Corliss of Royal London. In addition, consider the ongoing cost of advice if you do transfer.
Julie Wilson, a chartered financial planner at PenLife Associates, sets out a typical example of the type of DB pension transfer she routinely deals with.
Clients: John, 60, and his wife Janet, 59. They have three children and are retired
Assets: Property worth £750,000 and investments of £250,000. No debt
Income: John’s pension income is £25,000 a year. Janet’s is £15,000 a year. They will both be eligible for a full state pension in future
Outgoings: £30,000 a year
John has an additional DB pension of £30,000 a year, but the couple don’t need this guaranteed annual income, as they already have a surplus of £10,000 a year after outgoings. Instead, they want to use the pension, which has a transfer value of £780,000, to cover five main priorities:
1. Funding for travel abroad to see their children
2. Access to money to give to their children
3. The ability to leave any unused money to their children
4. Protection for any unused funds from inheritance tax
5. Financial security in the event that John dies prematurely. He is in good health, but his parents died in their early 60s.
Wilson says: Transferring out of the DB scheme would achieve all the couple’s objectives. ‘They have a high tolerance for loss, because their base costs are covered by their existing income,’ she adds. ‘A fall in the value of the fund would not have a great impact for them.’