With their reputation as the gold standard of pensions, having a final salary scheme can make you the envy of your peers. But rising transfer values and the new pension freedoms might make it worth ditching the guaranteed income that they offer on retirement.
Nearly all final salary schemes allow you to transfer what is known as the ‘cash equivalent transfer value’, which represents the value in cash terms of your existing benefits. But Martin Tilley, director of technical services at Dentons Pension Management, says he has seen clients whose transfer value has increased from £300,000 to £400,000 over the course of 2016.
The main reason transfer values are on the up is the low interest rate environment. Steven Cameron, pensions director at Aegon, says: “Final salary pension scheme trustees set transfer values to give those who leave a fair deal. As most of their assets are held in bonds, which have seen their yields plummet as a result of low interest rates, it now costs more to compensate a member who transfers out.”
The high cost of maintaining pensions to final salary scheme members can also be an incentive for trustees to offer enhanced transfer values, as it may reduce their costs over the long term.
“Transfer values are at a peak,” adds Mr Tilley. “It’s impossible to say where they might go but, with interest rates so low, they may well fall back again in the future.”
The pension freedoms introduced to defined contribution (DC) schemes in 2015 can also make a transfer more compelling. A DC scheme is based on how much money is paid into your pot and investment growth on top of that, rather than being linked to your salary. If you transfer a final salary scheme, it would usually be to a personal pension, where after age 55 you can withdraw as much or as little capital and income as you like, using the drawdown facility.
Fiona Tait, business development manager at Royal London, says: “Instead of having to buy an annuity, you can now choose to access your pension pot when you need it. This isn’t an option with a defi ned benefi t scheme such as a final salary pension.”
These freedoms allow you to leave any unused pension pot to a relative or friend. Not only is it free of inheritance tax but, if you die before age 75, it can be taken income tax-free too. Even if you die after age 75, your beneficiary will only be taxed when they make withdrawals.
What’s your final salary scheme worth?
Putting a figure on how much your defi ned benefit scheme could be worth if you transferred isn’t easy. James Baxter, partner at Tideway Wealth, says: “How much you’ll get will depend on everything from your age and the scheme details through to the size of the employer. We’ve seen people being offered transfer values ranging from 15 to 40 times the pension income they had built up under their defined benefit scheme, so it’s definitely worth exploring what’s on offer.”
Although valuations can vary enormously, certain criteria can tip the balance in your favour. “The most attractive valuations tend to be for people aged 50-plus and where the retirement age was 60 rather than 65,” says
Mr Baxter. “Smaller schemes can also be less generous than those offered by large companies.”
The level of inflation built into your pension income can also affect your transfer value. For example, someone with a pension linked to Retail Prices Index (RPI) inflation can expect an income multiple of around 28 for a retirement age of 65 or around 35 if the retirement age is 60. But if there is a fixed increase, this can lead to a higher multiple.
“The highest I’ve seen was for a pension with a fixed annual increase of 3%. The transfer value was 40 times the annual income,” adds Mr Baxter. To help you get an idea of the figures you’re dealing with, Tideway has developed a series of calculators, which are available on its website (Finalsalarytransfer.com). These include a calculator to give you a rough estimate of the transfer value you would receive and how much you might be able to leave your benefi ciaries under different scenarios.
Pension schemes are also able to provide details of your transfer value online or by post.
Stay or go?
To transfer out, you’ll need to have not retired and started taking benefits. Deferred members who have left the company but not retired may also transfer out.
However, not all defined benefit schemes allow transfers out. Ms Tait explains: “Some public sector schemes, such as those for nurses, teachers and civil servants, don’t have a ‘pension fund’ as such, so members can’t transfer out.”
When you receive the transfer value figure, Simon Nicol, pensions principal at Thomas Miller Investment, recommends a quick calculation to determine how attractive it is. “Divide the transfer value by the annual pension income you’ve built up to get your income multiple,” he says. “If you’re close to retirement, anything over 25 offers value with 30-plus particularly good. If you’re younger, the multiple will be lower – for instance, 23-plus is good if you’re in your 40s. “This is a rough guide, though, as all sorts of other factors can affect your decision too.”
Factors to consider
First and foremost, you need to be comfortable with how a transfer might affect your retirement. “Some people prefer the certainty of receiving a guaranteed income; they don’t want the worry of having to invest their money,” says Mr Tilley. “Being able to sleep at night is important.”
As well as your appetite for risk, other personal circumstances can affect your decision. “Poor health can be a reason for transferring,” says Claire Walsh, a chartered financial planner at Aspect8. “If your life expectancy is shorter than average, it can be more attractive to take the money.”
This money could go into drawdown, with any remaining fund going inheritance tax-free to your dependants, or it could be used to buy an enhanced annuity. “Defined benefit schemes don’t take your health into consideration, but through buying an annuity you could get an income enhancement of up to 30% for common issues such as smoking, high blood pressure or cholesterol levels,” says
Kay Ingram, divisional director of individual savings and investments at LEBC. Your marital status could also influence what you do. Many final salary schemes provide a pension for your spouse if they live longer than you. If you’re not married, check whether your scheme will provide this benefit to your partner.
It may also be that you simply don’t need this extra pension income. Mr Nicol explains: “If you’ve got other sources of income, it could be worth transferring into drawdown to leave the money to your dependants.” If you left it in the final salary scheme, then the amount paid to your dependants after death would depend on the scheme’s rules.
You may also want to consider the fi nancial position of your pension scheme. If the employer becomes insolvent, and there isn’t sufficient money in the pension scheme to cover all its future pension liabilities, it could end up being transferred into the Pension Protection Fund.
This safety net doesn’t guarantee you’ll get the same pension benefits. Anyone already retired will receive the same pension, but if you’re under the scheme’s normal retirement age you’ll only get 90% of your entitlement, subject to a further cap of £33,678 a year (tax year 2016/17).
Tax can also affect your decision, especially as high transfer values can mean you bust the £1 million lifetime allowance for pensions if you move your money.
For example, with a final salary scheme a calculation of 20 times your annual pension plus any tax-free lump sum is used to determine the value of your pension.
But with transfer values often using higher multiples, if you move the money there is a risk you will exceed the lifetime limit and face tax penalties on any excess. “A tax charge is not a reason not to transfer,” says Ms Tait. “But you do need to be aware of the tax implications if you have a large pension pot.”
These higher multiples for transfers can also work in your favour on the tax front. Ms Ingram explains: “You’ll usually get a higher amount of tax-free cash if you transfer, which can be useful if you want to pay off a mortgage or clear credit card debts.”
All the focus on transfers is likely to lead to changes in the regulation surrounding them. This could see transfer value analysis including more focus on pension freedoms rather than the investment return. It could also introduce greater flexibility, including partial transfers.
“This could be the optimal solution for some people, giving them a smaller guaranteed income from the final salary scheme to cover their expenditure, plus a cash lump sum to invest more adventurously,” explains Ms Tait, whose firm is calling on the government to facilitate this.
But whether or not this comes into force, with transfer values at a high, shifting your fi nal salary scheme may be worth considering. “Transfer values have increased significantly over the past few years,” says Mr Nicol.
“It’ll cost you nothing to get a transfer value from your scheme to see how things stack up.”
“Transferring my scheme suited my needs”
After 22 years working at Weetabix as an IT developer, 65-year old Stewart Bailey (pictured above with his wife, Shani) was made redundant just 18 months before he was due to retire.
“I received a compensation package, which gave me time to consider what I should do with my pension. I’d been a member of the final salary scheme, so I’d built up a decent pension but I wasn’t sure I wanted to take it.”
The issue was his home, which had been in his family for more than 65 years and was also where he’d been born. But when he and his wife, Shani, bought it in 2000, they’d taken out an interest-only mortgage, intending to repay the loan from Stewart’s tax-free pension cash.
“We didn’t want to move, but the lump sum I would have got from my final salary scheme wasn’t enough to clear the mortgage,” he explains. “We would have had to take out another mortgage and keep paying that in our retirement.”
As this didn’t appeal, Stewart spoke to a financial adviser from Grove Pension Solutions about transferring his pension. “He recommended that I transfer my pension into a drawdown scheme. This enabled me to release enough tax-free cash to pay off the mortgage,” he explains.
“I’ve decided to stay put for now”
Alan Smith* a 55-year-old bus driver lives in Sussex with his partner, Dawn. Although he enjoys his job and has no plans to retire, all the publicity surrounding pension transfers grabbed his attention. “I have two personal pensions and membership of two final salary schemes, including one from the 15 years I worked at Scottish & Newcastle brewery. I’d read about transfer values increasing and, as my partner and I aren’t married, there’s no guarantee of a widow’s pension, so I wanted to know whether I would be better off transferring these schemes.”
To find out, he spoke to Claire Walsh, a chartered fi nancial planner from Aspect8 in Brighton. She carried out a transfer value analysis for Alan, which showed that it would be diffi cult to replicate the benefi ts he would get from his fi nal salary schemes.
“It didn’t make any sense to transfer my final salary schemes,” says Alan. “I did want to release some cash to get a new bathroom, though, so Claire recommended that I cashed in one of my personal pensions.”
She also recommended that if his circumstances or health changed, it could be worth assessing the situation again.
* Names have been changed to protect anonymity.
Moneywise top tip:
Take independent financial advice Given the complexities surrounding a transfer, and the ramifications if you make the wrong decision, independent financial advice is highly recommended. Indeed, if your transfer value is greater than £30,000 it is a legal requirement.
Central to this advice is a transfer value analysis. This assesses the investment return – known as the critical yield – you would need to achieve on the transferred cash to replicate the pension benefits on your final salary scheme. As well as taking this figure into account, an adviser will also look at your circumstances to determine whether you would be
better off transferring.
Advisers typically charge £1,500 upwards to carry out the analysis plus a percentage of the transfer value if you do move. You also need to be aware that an adviser might recommend that you don’t transfer. In theory, you can still move your pension, but, thanks to mis-selling issues in the past, some advisers may refuse to arrange the transfer. Likewise, pension providers may not be willing to accept the case. Given you’ll be paying fees, it’s worth checking their stance on this at the outset.
To find an independent financial adviser in your area, vist our How to find an ISA page.