Leave or Remain? The final salary pension decision
First published on 21 of February 2017 • Updated 03 of April 2019
Final salary pensions may be gold-plated, but are you also sitting on a transferrable gold mine? Neil Adams of Drewberry Wealth weighs up the pros and cons of transferring to a personal pension, and offers a way to calculate your potential benefits.
Gold-plated. Gold standard. Or how about the less glitzy ‘copper-bottomed’ or ‘cast-iron guarantee’? However you look at it, final salary (or defined benefit) pensions have a formidable reputation as the pinnacle of retirement savings, the most attractive option available.
As the name implies, a final salary pension (if you have one) is provided by your employer. You save into it during your working life and in return you receive a guaranteed income each year after a pre-agreed date (usually your retirement date). Better still, the amount usually rises annually to keep pace with inflation.
Yet final salary schemes are becoming as scarce as… well, gold dust. Existing schemes are slamming the door to new members, and only the largest employers and the public sector still offer them. As a result, the number of people who still have such pensions is dwindling fast.
The decline of final salary schemes
Why are so many final salary schemes closing? In a word: affordability. Pensioners today are living longer, while the investment performance of many funds has been underwhelming. As a result the cost of providing final salary pensions has spiralled upwards, triggering some serious alarm bells.
Employers have long been nervous about the long-term expense of providing final salary pensions, but the final straw was arguably the UK’s vote for Brexit, which sent shockwaves through the financial community. After the vote, final salary pension funds were keener than ever to offload their promises to pay pensions for life, and were willing to take a bigger short-term hit to stave off longer-term costs. And so the dollops of cash dangled in front of members as incentives to leave the scheme skyrocketed.
These cash lump sums are known in the jargon as ‘cash equivalent transfer values’ (CETVs). To keep things simple, we’ll call them final salary pension transfer values. These sums are what your pension fund will offer you to transfer out of your final salary pension scheme. By leaving, you forfeit any right to future payments from the scheme, but in exchange you get a pot of pension cash – which may well be substantial.
Should I transfer my pension?
That’s a tricky question, and one that will depend entirely on your circumstances. A good way to start is to estimate your transfer value with the Drewberry Final Salary Pension Transfer Value Calculator. Enter some basic details and it will provide you with an estimate of what your transfer value might be.
Once you know this figure (and you should check with your pension scheme to confirm the exact sum) you have a lot of thinking to do. Remember, no matter how tempting the transfer offer might be, you’re giving up a guaranteed income for life. You’ll also be solely responsible for investing your new pot of pension cash and will be exposed to market volatility – how much you are exposed will depend on your investment choices.
On the other hand, there are many potential benefits to taking the money. Final salary pension transfer values are unlikely to ever be this high again, as they have been artificial boosted by the eagerness of schemes to offload their members. So there may never be such a good chance to get so much bang for your buck.
Moreover, you won’t have to worry anymore about the fund’s continued solvency. Even the government has concerns about the ongoing viability of final salary pension schemes, in light of the financial strain they were under more than a decade ago.
In 2005 the government set up the Pension Protection Fund (PPF) as the pension provider of last resort for those whose final salary schemes end up underwater. However, the pension the PPF offers you if your own fund becomes insolvent before you retire is subject to a maximum cap, so it could be a lot less than you were expecting.
The advantages of transferring a final salary pension
One of the biggest draws for those considering transferring out of their final salary scheme is the far greater level of flexibility when it comes to accessing your retirement savings.
Thanks to pension freedom, you now have a wide array of options available to you for securing a retirement income. The most traditional is to buy an annuity, but annuity rates are stuck in the doldrums due to low interest rates, and there’s no longer a requirement to buy one. Against that, annuities do still offer you a guaranteed income if you’d prefer to have that security.
The main alternative to an annuity is income drawdown (often called just drawdown). This is where your pension pot is reinvested in a way designed to generate an income that you can withdraw as and when you need it. You’re also entitled to take 25 per cent of your pension pot as a tax-free lump sum. Both of these become possible if you transfer a final salary pension into a personal pension, thus exchanging a guaranteed income for life for a pension pot.
Control income tax and inheritance tax
Another point to note about final salary schemes is that they usually die with the pensioner. Although some schemes will offer a 50 per cent pension to the spouse of the deceased, that too will stop on the spouse’s death – so none of the pension passes to the children. So if you and your spouse should die prematurely, that final salary pension may end up proving poor value.
But what if you transfer? Assuming you don’t immediately buy an annuity after transferring out of your final salary scheme, you will be in a position to pass on your pension savings to your beneficiaries in the event of your death, if there is still money left by that time. In some instances, your beneficiaries can even inherit your pension pot free of inheritance tax.
You can also maintain better control over income tax. By entering an arrangement such as drawdown, you can also adjust the yearly income you receive to prevent you spilling over into a higher tax bracket. However, if your final salary scheme shoves you up a tax band from the outset, there’s not really much you can do.
Advice on pension transfers
If you’re thinking of transferring out of your final salary pension scheme, you should always seek independent financial advice before proceeding. In any case, if your transfer value is over £30,000 then seeking advice is a regulatory requirement.
Once you’ve consulted your financial adviser, you’ll have all the necessary information to hand and the pros and cons laid out for you by an expert. Only then can you make an informed decision about whether a pension transfer is right for you.
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Neil Adams is an IFA at Drewberry Wealth Management.