7 Reasons to Consider Trading in Your Final Salary Pension
Until a few years ago, there was little argument; ‘final salary’ (also known as ‘defined benefit’) pension schemes were the best around. These pensions delivered a guaranteed income based on your final salary for the rest of your life and usually provided a pension to your spouse after your death. Not only this but they often provided an income those without this kind of pension could only ever dream of.
So what’s happened and is now the time to re-assess final salary pensions? Three major events have taken place in the past few years that have changed the final salary pension landscape and it is worth a quick look at each one.
The changing final salary pension landscape
New pension freedoms. Recent changes in pension legislated (often referred to as ‘Pension Freedom’) have changed the rules of the pension game. The new freedoms allowed those in ‘money purchase’ pensions (not final salary schemes) the ability to encash their entire pension from age 55 onwards meaning instant access to their money should this be required. Not only this, but on death, the entire remaining value of a money purchase pension can now be passed on to your family as a lump sum, usually tax-free. Neither of these freedoms apply to final salary schemes as you don’t have your own fund value, just a promise to pay an income for as long as you live.
Falling gilt rates. Gilts are loans to the government. An IOU that the government agrees to pay interest on then repay the loan. This is seen as one of the safest forms of investment and one that many final salary pension schemes use as an investment to help meet the payments to those in retirement.
In recent years, gilt rates have been falling, falling and falling some more and today stand at record lows. This means that final salary pension schemes must have more in the pot to ensure they can pay those retiring in future years. In some cases, this additional funding does not materialise and pension scheme deficits arise (see below).
Another result of falling gilt yields is the ‘cash equivalent transfer value’ that many of these pension schemes offer. This sounds complicated but essentially it’s just the amount a scheme will give you to walk away and transfer your pension elsewhere. As these schemes need to allocate higher and higher amounts (due to low gilt yields) the value that they will give you to transfer your pension away goes up and up. In many cases these amounts are at record levels making a transfer look more attractive.
Pension scheme deficits. There are around 6,000 final salary pension schemes still running in the UK. There were many more than this in years gone by, but many have closed as they were seen to be too expensive and troublesome for employers to run. Many had run up large deficits with the level of funding seemingly inadequate to pay future pensioners. According to the latest report into final salary pension scheme deficits by the accountants PricewaterhouseCooper, the total deficit in these schemes is £710bn. That’s billion – not million and it’s growing at around £100bn a month. In other words, these schemes have a black hole that is rapidly approaching a trillion pounds.
Pension deficits of this kind can send companies under and high-profile failures such as the recent BHS pension scheme have done much to raise public awareness of this issue. In many of these cases, the Pension Protection Fund is used and means pension savers get a far lower pension than they were promised. There are now over 220,000 people relying on the pension protection fund so these are far from isolated incidents.
Why might you consider transferring your final salary pension?
Transferring a final salary pension scheme usually involves moving it into a ‘personal pension’ or ‘SIPP’. This is a pension you control rather than being run on behalf of an employer. So why might you consider transferring your final salary pension? There are 7 key reasons:
1. Death benefits: When you die, you can usually pass on your remaining pension tax-free to your family.
2. Health issues: If you are unlikely to live a long life, you can access your full pension earlier and enjoy it while you are still able.
3. Access: You can access you transferred fund at any time from age 55 onwards and do not have to wait for your ‘normal retirement age’.
4. Flexible withdrawals: You can choose to draw your income flexibly, taking more when you need it and less when you don’t.
5. Personal control: You control your own pension and decide on your own investment strategy. You won’t be reliant on your old company scheme to ensure your pension is well-run.
6. Income tax planning: You can manage the income you take from your pension to control your income tax liability.
7. Investment growth: Thanks to higher transfer values, the investment growth required is often fairly low. You could even end up with a larger income in retirement if you transferred pension grows strongly.
Beware – the grass isn’t always greener
There is no doubt that there are sometimes good reasons to transfer a final salary pension but there are also many good reasons to leave it be. To give up a guaranteed income and replace this with an unknown return from your investments is not always a smart move. Not only this, but most final salary pensions link your income to inflation so it will rise each year in line with the price of goods and services you buy. Transferring away could leave you worse off and this could materially impact your retirement lifestyle.
The decision to transfer a final salary pension scheme is often an extremely complex and difficult one. Many factors in the equation are unknown and this means making the right decision is tricky. Amongst all the uncertainty, only one thing is always certain – seeking expert advice is the best move.
Financial planners will give their advice on a range of financial matters and it’s often a good idea to seek their advice. Final Salary pension transfers are one of the most complicated areas of financial planning and one that only financial planners with specialist qualifications and authorisation are able to advise on. The government thought it so important to take advice on these transfers that they mandated it for anyone with pension benefits in excess of £30,000.
Stick or twist? When it comes to final salary pensions, the decision is often tricky. What’s for sure is that there are sometimes good reasons to transfer a final salary pension but in many cases they are best left well alone. The decision-making process is complex and a financial planner with appropriate qualifications should always be consulted before you make any decision.
The bottom line is this; you should weigh up your options carefully as your decision could impact your lifestyle in retirement, your financial security and the wealth of you and your family.
If you have a final salary pension and would like to talk through your options, or get more information or advice on what to do, please get in touch with us to arrange a free consultation.