The key points to consider when making the massive decision to transfer from occupational pension schemes to money purchase schemes, including personal pensions and Self Invested Pension Schemes (SIPPs).
The historic view is that “it’s always wrong to come out of a defined benefit or final salary pension scheme”. Whilst this is still the default starting point, it’s no longer the case 100% of the time and to redress the balance here are six good reasons to consider the transfer option.
1) A final salary benefit can be a significant family financial asset, a pension transfer capitalises the value and gives you control of this asset, which can now be passed down through the generations without inheritance tax.
2) Pension transfer values are so high at present that a good deal of the investment risk associated with transfers can be removed. On some transfer values a 2% real investment return, after fees and inflation, will provide the same level of pension plus potential for residual value to be passed on.
3) Transfers offer you a complete flexibility over when and how much you draw on your pension account and are in complete contrast to a fixed monthly pension income. It’s inconceivable that 60-year old’s retiring now with the prospect of potentially 30 years or more of retirement will have the same cash needs year in year out until they die.
4) This flexibility extends to taking the cash as early as 55 and deferring the taxed pension until it’s needed. The potential uses of this early cash sum are extensive, from paying down the mortgages early, escaping from financial difficulties, Ill Health issues, or helping the next generation on to the property ladder.
5) A final salary transfer takes away the life expectancy gamble implicit in a lifetime income. It capitalises the benefit once and for all based on normal life expectancy, irrespective of your personal health now and in the future.
6) With flexibility comes the ability to be tax efficient. In virtually all the cases where we have recommended a transfer there has been the ability to save tax as compared to the rigid final salary pension benefits. These can include:
- A higher tax-free cash sum following the transfer.
- The ability to limit pension income to specific income tax bands.
- The opportunity to defer and minimise the impact of lifetime allowance (LTA) penalty tax charges.
Final salary transfers are not new, they have been a legal right to deferred pensions since the eighties.
So why are they now a more attractive option?
Considered opinion has been that that for the vast majority ‘best advice’ is to stay in schemes and so the option of a transfer has often only been brought to the attention of those with very big pension entitlements and by specialist advisers. In most cases they simply have not been discussed with members.
Employers are not able to provide advice on transfers and many financial advisers are not qualified to advise on them or have been prohibited from advising on them by compliance departments viewing them as too complex and too risky (for the adviser that is). So, for many the transfer option will never have been discussed.
So why consider them now, what’s changed?
There are two contributing factors:
1. Transfer values relative to future pension entitlements are currently very high due to exceptionally low gilt yields
2. The 2015 pension changes provide huge choice as to how pensions savings can be used in retirement, these choices are not available to those who go on to retire on a final salary pension but can be accessed via a transfer and will be attractive to many.
What is a Cash Equivalent Transfer Value (CETV)?
A cash equivalent transfer value (CETV) is the cash value placed on your pension benefits. This is the amount that is available to transfer to an alternative plan in exchange for giving up your rights under the scheme. It is necessary to apply for your CETV statement if you wish to transfer from the scheme.
What are Occupational Pension Transfer values based on?
As final salary pension schemes (just like annuities) must provide a fixed pension income in retirement, the most important investment return factor in the calculation used by actuaries to work out a cash equivalent transfer value is the risk-free investment return based on UK gilt yields.
Gilts or Government backed securities provide a guaranteed return to a future date and are used by the scheme actuary to discount the cost of future pension payments when calculating their current cash equivalent value and hence the transfer value.
As gilt yields fall the cost annuities and the value of cash equivalent final salary transfers rise. The exact opposite would of course be true if interest rates and gilt yields started to rise again. Transfer values will start to fall.
The removal of withdrawal restrictions in pension drawdown
Historically, if you did not buy an annuity and used the alternative pension drawdown, the permitted pension withdrawals were linked to annuity rates. So as annuity rates fell permitted withdrawal levels fell.
Now you can take as much or as little income from your pension drawdown account as you want as and when you need it.
The removal of the death tax
Many people ask what happens to my pension when I die?
Until 2015, if you were over age 75 on death the value of any unused pension account was taxed at 55% before funds could go on to the next generation. This so called ‘death tax’ has been removed completely and pension accounts can now be passed on to the next generation, intact and free from inheritance tax.
Whilst transfer value have always given more options to take cash early, or to vary income year to year, pension drawdown account withdrawals were limited, and residual pension accounts looked unattractive on death. So, the extra flexibility of the transfer route only went so far.
Now with these two changes personal pension account holders have complete flexibility as to how they use their accumulated pension savings ranging from:
- Accelerated withdrawals to provide extra cash from as early as age 55, including full encashment of the account, through to
- Deferred withdrawals and passing on pension account value to future generations.
These choices simply don’t exist to those who take a final salary pension, whose only choices are whether to take a tax-free lump sum at retirement, or whether to retire earlier or later. Once these choices are made final salary scheme pensioners are locked into a level of income that cannot be changed and will be worthless to the next generation.
Tax savings can come from a range of opportunities;
1. A larger tax-free cash sum available in many cases
2. Flexible income drawdown to minimise tax
3. Deferring withdrawals to pass value on to the next generation.
The most common way to use the extra flexibility of a transfer is to access the tax-free cash early but to defer drawing taxed income withdrawals until they are needed. This can’t be done with a final salary scheme where the taxed pension income must start as soon as the final salary pension lump sum is drawn.
You need several good reasons to give up guaranteed lifetime income and take on investment risks, costs and the extra responsibility of looking after your own fund.
Here are five points you will want to be sure of before proceeding with the transfer:
1. The transfer value represents at least fair value and ideally is generous versus the pension benefits left behind.
2. You are comfortable with the extra responsibility of looking after an investment fund.
3. You can cope with a lower level of income later in life if the fund gets run down, this is usually a function of having other sources of income and capital.
4. You can make better use of the alternative withdrawal options offered by the transfer route as compared to the scheme cash and income options.
5. You may have other income resources and do not need to draw income from your pension
For the second of these points it helps if you have had some experience of investing savings in things like ISAs, or perhaps an invested personal pension account from a different period of employment.
Having other savings and sources of income in retirement is a good way of mitigating the investment and longevity risks of going the transfer route. The ability to control pension income from one year to the next can often help those with other savings and income to be more efficient.
On the last point there are lots of ways in which individuals might want differing benefits to those offered by the scheme for example:
- It suits you and saves you tax to be able to take cash lump sum early and defer the income withdrawal.
- The transfer is big enough that you can preserve its capital value for the next generation whilst still having enough income at retirement.
Larger transfer offers can be compelling because they often belong to people with other assets and income such that they don’t need a guaranteed income at retirement and would prefer to use the transfer value in a completely different way, for example to preserve its value as part of the family assets.
But smaller transfers can also make sense where there is a clear way to use the money which makes more sense to the individual than to take the life time pension.
Ill health can be a compelling reason, if it’s clear your life expectancy has been shortened compared to the average then the chances are you and your family will get more cash from a transfer than staying in the scheme.
Whilst the case for transfers has become more compelling and attractive to a wider group of people a final salary pension remains a great benefit to hold.
So, if you are in any doubts as to the attractions of the transfer route for your own situation then default position should always be to stay in the scheme.
Staying in a defined benefit pension will also be the best option for you if:
1. You are attracted to a secure lifetime income, delivered with very limited risks and without effort on your part.
2. If you have little or no experience of looking after invested savings and don’t want this responsibility. Note that this can become a burden as you get older and unless other members of the family will help, or you have good professional advisers and fund managers.
3. If the final salary scheme will be your main source of income in retirement and you have little or no tolerance to this income fluctuating or even running out.
4. If the defined pension benefits offered by the scheme matches the year by year income requirements you think you will need. There is little point doing a transfer to simply try to replicate guaranteed benefits already provided by the scheme.
It is possible to transfer an occupational pension scheme, to a personal pension or a SIPP yourself. However, if the CETV is above £30,000 or includes safeguarded benefits or guarantees, then advice from a financial adviser is required.
To review your situation and consider if transferring your occupational pension scheme is suitable for you, please contact us – we look forward to hearing from you