Should I transfer my defined benefit pension?
If you have a defined benefit (DB) pension, you may be offered the option to transfer it into the more common type of pension (defined contribution). This is a big decision and an irreversible one, so it’s important to understand exactly what this means, and what the pros and cons for you might be.
What is a defined benefit pension scheme?
A DB pension (also known as a final salary pension) is a special type of workplace pension. Instead of building up a pension pot over time, it provides you with a guaranteed annual income for life, based on your final or average salary (hence the name).
DB pensions are often seen as more generous, because it would take an above-average defined contribution (DC) pot to be able to buy an annuity that pays you the same amount as a DB scheme.
If my DB pension is so good, why transfer?
Despite the attractions of a DB pension, in some ways it is not as flexible as a DC pension pot. You can’t vary the income you take from it, nor draw out larger lump sums (apart from the tax-free lump sum offered by some final salary schemes). Also this kind of pension cannot be inherited by your beneficiaries.
Your pension’s ‘transfer value’ is the size of the pension pot you would receive in exchange for giving up your DB pension. Some providers will offer generous transfer values, and this may be seen as a strong incentive to switch. The choice you face is essentially this: having more money to spend now, versus having a guaranteed income for the rest of your life – which may work out as more money or less, depending on how long you live.
Are all DB pensions transferrable?
Not every DB pension is transferrable. Private sector schemes, and some public sector ones, will be ‘funded’ – that is, supported by a central fund. This is the only kind from which you can transfer. Other public-sector schemes (such as the NHS pension) are ‘unfunded’, meaning they are supported directly by the taxpayer. You can’t transfer out of this kind of pension.
What are the possible benefits of transferring?
Transferring your DB pension to a DC pension pot means you can access your pension flexibly, and also pass on any unspent pension to your loved ones when you die.
For smaller DB pensions with transfer value of just a few thousand, there may be a stronger argument for transferring them – as in such cases the guaranteed annual income may not be very much.
What are the risks?
If you transfer your pension you won’t be able to transfer it back, so tread carefully and do your sums before making your decision. You will expose yourself to the risk of your pension one day running out, or of failing to achieve as high an income as you would have received from the original scheme. Ultimately, you are trading certainty for uncertainty.
How to decide
Having money to spend now may be very appealing, especially if there is a pressing demand for it. However, if your pension’s transfer value is over £30,000, the law requires you to seek financial advice before the transfer can be made. Some providers further insist that you get advice on smaller transfer values as well, to protect themselves if you later decide you’ve made the wrong decision.
Taking advice helps you to weigh up your long-term needs against your short-term plans, and may reveal benefits of your pension that you haven’t considered. Here's a real-life example of such advice in action:
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