Should you swap your final salary pension? 5 tips to help make the right pension decision for you



Posted on: 13th September 2017

The pension freedom changes in 2015 have had a huge effect on final salary pension holders. The ability to move from a defined benefit pension to a defined contribution pension has meant that thousands of people have been able to cash in their pensions for hugely inflated transfer values, leaving them with an enormous lump sum, and a considerable change in the future retirement prospects.

Should you join the final salary gravy train?

According to figures published in the Daily Telegraph, a full 80,000 people have given up their final salary pension entitlements in the past 12 months alone. The transfer values are almost unbelievably high, with one firm stating that it is moving around £50m per month our of final salary pension schemes and into pension holders pockets.

The staggering figures have prompted renewed fears in the financial industry that people are not being adequately warned about the value of what they are giving up.

Defined Benefit Pensions or Defined Contributions Pensions

Final salary schemes, or defined benefit pensions, promise to pay members guaranteed, inflation-protected incomes for life. This is highly attractive and offers security and value to those on the scheme. However, there are downsides. With a final salary scheme, the way in which you draw an income is tightly controlled. It is also not possible to pass on any of the pension to family, other than to your direct partner.

Although generally less valuable, “defined contribution” pensions are far more flexible. But they do come with risks. Savers have to remember that their investment might underperform, leaving them with less to take home. Defined contributions pensions are becoming the norm amongst employers, who are seeking to limit their liability to the unknown costs of meeting final salary promises.

Another way they are limiting risk is to buy employees out of their final salary entitlements – offering very large sums to transfer out of the system. This has led to the surge in “pension transfers”. The question many ask, is should they take the step and transfer out? Here are five things to consider before you look at transferring your final salary pension.

1. Look at the right numbers

The first step before moving any money, is to find out what you will be moving. Requesting a “cash equivalent transfer value” will allow you to see how much your pension scheme will pay you in exchange for your pension. The actual transfer value is straightforward enough, but finding what to compare it to is harder.  Your pension provider could provide up to four different figures, showing the value of the annual pension you are giving up.

These might include:-

  • Annual income at the time you left the scheme
  • Projected income, based on assumptions about inflation
  • An income discounted due to early access (normally because of severe ill health)
  • An income revalued to the present day.

Confusion can reign where a deal appears to be more generous than it really is, For example, the value of your pension at the time you became a “deferred member” might be £5,000 per year. In this instance, a transfer value of £225,000 looks great – 45 times multiple in cash. But, a “revalued” figure might  be closer to £10,000 per year. In this case, the multiple is X22 – not quite as large as originally thought.  

2. Consider the best time to transfer

Logic dictates that the nearer you are to retirement, the larger your transfer value should be. But this is not the case. There are a host of reasons why a scheme will offer more or less than perhaps you expect.

The funding position of your final salary scheme greatly affects the transfer value.  If investments perform well, the funding position will improve dramatically and transfer values could be higher. If a scheme is struggling and underfunded it may discount the transfer values offered.

3. Are you single or in ill health?

Most final salary schemes offer a spouse’s pension that will pay out a percentage of the member’s pension to a surviving partner.

Most schemes do not normally allow this benefit to be turned off, even if a member is single or their partner doesn’t need the extra income. In this case, transferring out of the scheme might be better suited to your circumstances.

In the same way, if you are in ill health, the death benefits available through defined contribution pensions might be more appropriate for your situation.

4. Bear in mind the ‘lifetime allowance’

Under UK law, all types of pension are subject to a £1m lifetime cap. Amounts in excess of the cap are subject to a charge once income is taken, or at the age of 75.

Final salary pension schemes are treated more generously by the system. The annual pension income is multiplied by 20 when tested against the lifetime allowance. With transfer value multiples of 35 or more common, savers could easily find they have exceeded the £1m limit simply by transferring. If taken as cash, the excess over the limit faces a 55pc tax charge.

5. How well do you trust the Government

Are the current rules going to be left unchanged? It’s a tricky question to ponder. Defined contribution pension rules currently allow incredibly generous flexibility. Yet successive governments have changed the rules on pensions almost every year. The current ability to pass your pensions down the generations in particular looks vulnerable. Rules have changed before, who’s to say the rules won’t change again?

Should you transfer your pension?

In many cases, savers are required by law to take financial advice before making such a move. For some, a transfer may be an appropriate step; for others it be a decision you come to regret. The best advice is to seek advice. Why not talk to us at Haven for simple straightforward advice. We can help you make the right decision for you, before you make a decision you will regret!