What happens in a pension transfer?

If you’re one of the many people with a defined benefit (final salary) pension scheme, you may be aware of the option to transfer it into another kind of pension. But this is a risky strategy and you should never do it without seeking advice. So we couldn’t believe our luck when IFA Ajay Khosla of Cockburn Lucas decided to transfer his own pension, and tell us all about it.

Since the arrival of pension freedom, it has been possible for people with a defined benefit (DB) / final salary pension to transfer it into a defined contribution pension. People do this to gain the flexibility of pension freedom, though it means losing the benefits and guarantees of their existing pension. Recently, the cash equivalent transfer values of DB pensions – that is, the total amount a provider will pay for them – has risen sharply. Independent financial adviser Ajay Khosla decided the time was right to transfer his into a self-invested personal pension (SIPP).

Over to Ajay:

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‘I have been a financial planner for over thirty years, and as a qualified pensions transfer specialist I routinely work with clients who have DB pension schemes. Until recently, I would never have considered recommending a ‘transfer out’. Why take on board the risks and lose those valuable guarantees?

But with the recent surge in cash equivalent transfer values (CETVs), and an increasing number of occasions when I’ve recommended clients consider a move, my thoughts turned towards my own DB pension from my years at Standard Life. What began as an academic exercise very quickly escalated into more than that, once I saw my own CETV!

The choice: rising transfer values vs long-term security

My Scheme has been ‘frozen’ for over 10 years now, but in the last three years the CETV value has increased from around £500,000 to over £800,000. In short, over three years it has ‘earned’ more than I have! This surge prompted me to look at my own options as I would do for a client. Should I give up the valuable guarantees in favour of pension freedom, and so reshape my retirement planning?

My first question for myself was the one I ask all clients in this position. ‘What is it about a guaranteed pension, payable for the rest of your life, that you don’t like?’

Rewind! The back story…

To answer that question properly, we need some context. Who am I? I am a family man blessed with three daughters: one married, one soon to be married and one living abroad at university – interesting times!

I’m 56, am in pretty good shape and enjoy the fruits of a successful career – foreign holidays, nice cars and the finer things in life. I don’t want all that to stop when I stop working – which won’t be anytime soon, as I have a really good work/life balance and enjoy my job more than ever. However, I don’t want to be found dead at my desk. So I want to plan for a long and happy retirement with my wife and family, perhaps still working at 60 but certainly not at 65.

A closer look at my DB pension

My Standard Life pension scheme would guarantee me a pension of around £25k a year from the age of 60, four years from now. The scheme allows for a 50 per cent widow’s pension if I predecease my wife; however, my daughters wouldn’t receive anything once we both go. This is a huge consideration for me because naturally I want to leave my wife and family in as comfortable a position as possible. My first thought was that, rightly or wrongly, a ‘transfer out’ is an opportunity to take the ownership away from Standard Life pension trustees and effectively turn this into family money that could cascade down the generations.

A person in this position faces two daunting choices: firstly, the actual decision to move, and secondly the decision around who should manage such a big sum. Fortunately, being a financial planner I was far better placed to weigh up my options.

Once I’d conducted my usual thorough analysis, I concluded that a transfer of the pension pot (and my subsequent control over it) provided me with a fantastic prospect to transform my family’s financial future. The flexibility and control offered by the new pension rules encouraged me to think about my overall planning needs in a different way.

Making my decision

With the help of my family and my colleagues at Cockburn Lucas, I weighed up my options. I could see that £25,000 per year for life would be very welcome – but it wouldn’t be ‘life-changing’. On the other hand, a £800,000 pension pot might well be, for all the family. Likewise, the widow’s pension of £12,500 was not to be ignored. But my daughters would not benefit, as they would if I took the pot in its entirety and managed the funds well.

The decision-making process came down to a few very simple issues. The first was control. As a financial adviser, I feel able to make investment decisions for my own pension pot rather than leaving it up to the scheme trustees. Having it in a SIPP means I can take as much or as little risk as I want (risk management being core to any investment strategy).

The second issue was choice. Pension freedom meant that, if necessary, I could access the money now without penalty (DC schemes allow access from age 55) rather than wait until I reached 60 or take a big early-retirement penalty.

The third issue was flexibility. I would have complete control over the level of income drawn, which would have potentially huge benefits from a tax-efficiency perspective. Rather than being charged for a fixed pension of £25k, which would be taxed in the usual way, I could take a smaller pension if I had part-time earnings, or increase my income up to the higher rate tax band if I didn’t. My chosen SIPP provider has the facility to go into ‘tailored drawdown’ which allows me to mix tax-free cash with taxable income to maximise my tax allowances.

Lastly, I considered the risk. Taking all the figures into account, I judged that losing the guarantees of my DB pension did not pose too high a risk to my plans. With a transfer value of just over £800K, I could invest the sum in a relatively cautious strategy with a realistic target return of 3.5 per cent per annum. This would effectively match my forfeited pension, equating to around £28K a year. Admittedly this wouldn’t be guaranteed (unlike the DB pension) but the growth would be on top of the lump sum, which I could leave untouched for my wife or daughters in the future. If my investment strategy gives returns which exceed this level, I could either take out the extra growth as needed, or leave it in the fund to offset the effects of inflation. Continued growth might allow for increased withdrawals in the future.

My transfer strategy

It bears repeating at this stage that no-one should contemplate doing anything like this without first taking expert advice. Even as a financial adviser myself, I was grateful to have two other pension transfer specialists at Cockburn Lucas peering over my shoulder every step of the way! The FCA advise that all DB scheme members should be treated as if they are going to stay put, and a very strong case must be made to consider a transfer out.

Now that I was confident in my own decision, I needed to decide on an appropriate investment solution that was likely to deliver my required returns. It would need to stay the course over 30 years, in the kind of unpredictable world that had already delivered Brexit and Trump.

Having identified the vehicle, a Self-Invested Personal Pension (SIPP) with the necessary bells and whistles – tailored and flexi drawdown, inherent drawdown, and whole-of-market investments (shares, ETFs, investment trusts etc) – I then wanted to appoint an investment manager with a blend of investment strategies.

I chose to invest £300K in a ‘targeted return’ portfolio, which aims to provide a return of 3.5 per cent pa after costs, with the remaining funds to be invested in a more traditional manner, in a multi-asset portfolio with a lower aggressive risk mandate for the longer term, and a Third Party Discretionary Manager providing ongoing day-to-day management.

This gave me a well-diversified portfolio which I would expect to make at least 3.5 per cent pa above inflation, on average, net of fees. This will keep me happy for now; but like any client, I’ll be reviewing, along with a colleague, the investment strategy on a six-monthly basis to ensure the funds still reflect my financial objectives, appetite for risk and the prevailing economic climate. If the fund is no longer as good a fit, we’ll make changes to get it back on track. This process is an ongoing journey. Who knows – at some stage in the future I may even consider buying an annuity!

But would it be right for you?

If, like me, you have a ‘frozen’ DB scheme from a previous employer, it’s possible that you too could be presented with a once-in-a-lifetime opportunity. It appears that some schemes are virtually bribing some members with higher than usual CETVs, just to get the liabilities off their books. Will the bubble burst soon? Who knows?

What I do know is that I’ve made an informed decision based on my current knowledge. I consider that I’ve made fully informed decisions, for the right reasons, for myself and my family in 2017. And no-one can ask more than that.

Let me be clear: a ‘transfer out’ of a DB scheme will not suit everyone. At Cockburn Lucas, we regularly say ‘No’ to clients after analysing their situations and objectives. But if you have a preserved pension statement filed away in the draw, then dust it off and show it to a qualified financial planner or pension transfer specialist. At worst, you’ll have a reassuring confirmation of guaranteed benefits that are worth hanging on to. Alternatively, you could be in for a very nice surprise!

The views expressed in this article do not constitute financial advice. Everybody’s circumstances differ and regulated professional advice is required before proceeding with a pension transfer.


Ajay Khosla is an IFA and investments & pensions specialist at Cockburn Lucas.