Record numbers of people are transferring out of their defined benefit pension schemes in exchange for a fixed pot of money. But is this new ‘gold rush’ finally running out of steam? Article by Nick Green.
Holders of defined benefit (final salary) pensions have been transferring them at an unprecedented rate, according to the latest figures from the FCA. Defined benefit pension schemes, which are workplace pensions that provide members with a guaranteed income for life from their retirement age, can be exchanged for a defined contribution pension, which is an investable pot of money accessible from the age of 55. People are apparently doing this nearly six times more often than they were in 2016, a year after pension freedom was introduced.
The FCA sounded a note of caution over the figures, suggesting that part of the reported increase may be due to more firms providing the transfer data. However the figures (gathered from 54 pension providers) nevertheless indicate a dramatic increase over the two years – though there are signs that the rate is now slowing. Consulting firm LCP found that the rate of quotation requests (people asking for a pension transfer valuation) fell by 0.1 per cent in the second quarter of 2018, and is down by 0.3 per cent since the third quarter of 2017. Nevertheless, the rate (1.6 per cent of all deferred scheme members) is still more than twice as high as it was before pension freedom. The total value of money transferred has risen from £7.9bn in 2016 to £20.8bn in 2017.
Pension providers put the brakes on transfers
One reason for this slowdown may be that transfer values – which have risen steeply over the past two years – may finally have peaked, while another may be the highly publicised troubles with major pension schemes such as British Steel and BHS. An additional spanner in the works has been a recent court case ruling. The High Court has ruled that Lloyds Banking Group must equalise its final salary pension benefits between male and female staff, which may cost the group up to £150m. This ruling could have major implications for pension transfer values in general, and according to Royal London some scheme have put a temporary block on pension transfers as a result.
How do final salary pension transfers work?
A DB or final salary pension guarantees you an income for life from an age agreed under the scheme rules – usually somewhere between 60 and 65. If the scheme is a ‘funded’ scheme (i.e. depends on a central pension fund) then the provider may offer you the chance to transfer out of it in exchange for a fixed pot of money. All private sector final salary schemes are funded schemes, as are some public sector ones. However, many public sector pensions (such as teachers’ and NHS pensions) are ‘unfunded’ – that is, paid for by the taxpayer. You can’t transfer out of this kind of pension.
If your DB pension is transferrable, you can ask the scheme to give you a cash equivalent transfer value (CETV) which is calculated based on a number of factors and assumptions. These can be quite tricky for the layperson to understand, which is why the government makes it compulsory to take financial advice on a transfer if the CETV is £30,000 or over. Transfer values can look quite generous at first glance – a pension that pays £10,000 a year may have a CETV of well over £250,000 – because of the value of having a guaranteed income for life. Many schemes also insist on members taking advice even for CETVs under £30,000.
Here you can find out what happens in a defined benefit pension transfer.
The pros and cons of a DB pension transfer
The advantages of transferring out of a DB pension are:
- Access to a larger sum of money now
- Transfer rates are still generous
- Flexibility – you can take your pension in a number of different ways
- You can pass on any unspent pension pot to your family tax-free when you die
The risks of transferring out of a DB pension are:
- You lose out on a guaranteed lifetime income, so you may run out of money
- You may get less money in the long term
- You don’t have unlimited flexibility, as drawing out very large sums at once will result in a heavy tax bill.
The decision whether to transfer out or stay in your DB scheme will depend very much on your personal circumstances, which is why taking independent financial advice is so important.