There has been a lot of media attention recently on Final Salary Pension schemes (also known as Defined Benefit or ‘DB’ schemes). This mainly concerns the level of underfunding of these schemes when their assets are measured against their liabilities, but more recently, it has been on people considering transferring their money out of the schemes.
A final salary pension scheme provides a guaranteed income from the date of your retirement for the rest of your lifetime, normally along with the option for a tax-free lump sum (which, if taken, will result in a lower level of pension income), and some specified death benefits.
Largely, these pensions do not allow people to take advantage of the new rules under the Pensions Freedoms Act. This has seen a growing demand from people with deferred pensions, i.e. they are no longer active members of the pension scheme (usually because they are no longer at the company), to switch their pension benefits to a personal pension plan that is under their own control and will give them access to pension flexibilities, such as accessing the pensions cash or leaving the pension fund to loved ones and other beneficiaries.
Many DB pensions come with guaranteed benefits and transferring this type of arrangement will mean swapping those benefits for a cash sum that can then be transferred to a personal pension arrangement.
This cash sum is effectively the pension lump sum, plus the income that is expected in future, and is called the ‘cash equivalent transfer value’ (CETV). It is calculated by the scheme’s actuary, in accordance with specific guidelines, which include standard assumptions about how long you will live, the scheme’s funding position, the size as well as type of benefits you have built up in the scheme, when you left service and any increases to benefits in the meantime, as well as when payments are due to start.
Recently, due to a fall in 10-year bond yields by which Pension Schemes value their liabilities, the value of these transfers has increased quite dramatically, to their highest ever levels.
At Lowes we have noticed increases this year of over 10% for CETVs calculated just months apart for the same member from the same scheme.
For example, a client of Lowes was provided with a transfer value from his old employer’s pension scheme of £358,869 in June 2016. In November 2016, they received an updated value of £401,027, which reflects an increase of £42,158 or nearly 12% for the same benefits from the same scheme. The client is divorced, in relatively poor health, and has other assets but would now like to draw some pension benefits tax efficiently to facilitate partial retirement, plus being able to pass pension funds on to children and grandchildren as a legacy. In contrast, he wasn’t able to do any of this by staying in the Final Salary Pension scheme. For this reason, it is not surprising that more and more people are examining whether it is of benefit for them to transfer out of their DB pension.
We are certainly not suggesting that every deferred member of final salary/DB schemes transfer benefits to a plan under their own control. But if they are interested in considering their options they should talk to us.
Any advice process should at the least consider your goals, your health and that of your spouse/partner, your financial needs, attitude to investment risk and any assets or liabilities that you have, in addition to carrying out a comparison of your final salary/DB pension scheme benefits with that of transferring to a plan under your own control.
There are risks, of course, to transferring benefits away from a final salary/DB pension scheme, which is why the starting point for transfer advice is that it is better for someone to remain a member of a final salary/DB pension scheme. For example the pension income you receive may be lower than that you could have received under the original pension scheme; the value of the pension fund on transfer away from a final salary/DB pension scheme will fluctuate and can fall as well as rise; and many final salary/DB pension schemes also benefit from increases in pension benefits when they come into payment, which will be lost on transferring out.
This, of course, is why the decision needs careful consideration and advice bearing fully in mind your own personal circumstances.