Since the introduction of Pension Freedoms in 2014 we have seen a significant increase in requests from clients wanting advice on transferring their final salary (also known as defined benefit) pension schemes to defined contribution pensions (also known as personal pensions).
Whilst the Pensions Freedoms act has made personal pensions much more attractive, the FCA still take the stance that the starting point for advice in this area is that it is generally NOT a good idea to transfer out of a final salary scheme to a personal pension. So why has the demand for this advice increased dramatically and why do the FCA take the above stance? This article aims to deal with these questions as well as covering the Pro’s and Con’s of the two types of scheme.
Firstly, the demand has increased for several reasons –
- In recent years transfer values have increased significantly due to the calculation methods that actuaries use to determine the cash equivalent transfer value of a final salary scheme. We have seen clients whose transfer values have risen by hundreds of thousands over the last 2 years and, quite understandably, many people are wanting to capitalise on this while they have the opportunity.
- Pension freedoms rules introduced the ability for personal pensions to be bequeathed to your partners and then your children, meaning that the fund value’s built up can stay in the family if all of the funds are not spent before death. Defined benefit schemes often only allow a spouse to receive 50% of the pension income with no benefit for children.
- Increased transfer values inevitably have increased the tax free cash available under personal pensions. Currently, the 25% tax free amount available under a personal scheme is often higher than the tax free cash available within the final salary scheme.
- A personal pension, accessed under the new flexi-access rules, allows members to take as much or as little as they want from their pension fund whereas a final salary scheme gives a set income and/or tax free cash and,once you have made your decision, there is no ability to amend this. With many people believing that they will be more active in the early years (and thus are attracted to withdrawing more funds when younger) but less active in later years (and so will need less income) there is no doubt that taking income under flexi-access can be more flexible and meet the income needs of retirees in a more flexible way.
So why does the FCA still feel that the default option is to stay in a final salary scheme?
Well the main reasons are the fact that the income from a defined benefit scheme is guaranteed for life, it is often linked with inflation and has no investment risk for the member. To quantify this into numbers the FCA have now introduced a new style of analysis report called a Transfer Value Comparator (aka a TVC). This TVC will show in graphical form both the transfer value offered by the defined benefit scheme and the estimated risk free cost of replacing the income offered by the DB scheme through an insured annuity. In simple terms, this means you will receive a simple image showing what the transfer value needs to be to offer the same income that you have been offered by the DB scheme.
You can see an example of this above where the member has been offered a transfer value of £700,000 but will actually need a fund of over +
£1.3 million if they want to buy an annuity to match what the final salary scheme is offering.
With defined benefit pensions often being of high value, low risk and (usually) offering an index linked income guaranteed until death (and then usually 50% of this income payable to spouse) you can see why it is important to make the right decision and why the FCA are keen to ensure you only seek advice from firm with pension transfer permissions and where the advice process covers all angles.
At Ideal we specialise in this area of advice…..and we don’t just stop at the Transfer Value Comparator when helping you to decide which route you should take.
We undertake a detailed fact finding process around your retirement objectives and your retirement needs. We establish ALL assets and liabilities and how they affect your retirement needs. We produce several cash flows that help you to identify what rate of return is required on a personal pension to match the income offered by a DB scheme, what rate of return is required to ensure you don’t run out of funds in retirement, how much you can spend each month without worrying about running out of money, what happens if the market crashes at various times and what the differences will be to your heirs and beneficiaries based on your spending requirements if you die at various ages, both before and after retirement. We compare the potential tax free cash figures and we also compare the ask you to complete a psychometric questionnaire to help us identify the level of risk (if any) you are comfortable taking with your pension funds.
Finally, we put all of this work into a comprehensive but easy to understand report and then go through this report page by page to ensure you fully understand the pro’s and con’s involved and how the analysis of all the figures relates to you and your family.
If you have a final salary or defined benefit pension plan and you would like advice on whether to transfer or stay in the scheme contact firstname.lastname@example.org
The scheme must have a minimum CETV of £250,000.