Pensions freedoms introduced three years ago give people greater flexibility with how they take the benefits from their personal pension. Defined Benefit (DB) schemes, commonly known as Final Salary pension, do not provide the same level of flexibility.
If you are on a defined benefit (DB) pension scheme you may be offered the opportunity to transfer out of your pension scheme in return for a fixed sum.
DB schemes promise savers a certain level of income after retirement, such as a final salary. Transferring out means that you could be offered between 25 to 30 times your annual pension value as a lump sum. For instance, someone on a £10,000-per-year pension could be offered between £250,000 and £400,000.
As life expectancy has risen, the cost of DB schemes, widely considered the ‘gold standard’ of pension schemes, has risen. Companies now tend to provide less generous direct contribution schemes to newer employees.
Why would you consider transferring out?
Although DB pensions provide generous guaranteed benefits, they are very rigid in their structure. You receive X amount of money every month which increases each year until you die. This doesn’t give you an enormous amount of flexibility if you plan initially to have a few years of activity after retirement before settling down into a more frugal life in your later years. However, it is a guaranteed payment for life.
Transfer values have really shot up recently. Pension firm Xafinity claims that a 64 year old entitled to a £10,000 yearly pension starting at 65 would get £31,000 more today than they would have received in June 2017. This is making an increasing number of people explore the possibility of transferring out but it is a complex subject and important to consider all the implications.
What downsides are there?
First and foremost, on a DB pension you are guaranteed steady earnings for the rest of your life. Transferring out means you need to take responsibility for your own savings. If your circumstances change in later life and you don’t have enough savings left to cover these changes, you could find yourself in a rather difficult scenario.
DB pension schemes offer real peace of mind – something that is hard to match when managing your own pension as a lump sum. Here, you have to take responsibility for your own investments.
Secondly, think about what it is you are offered. A large sum of money paid out in one can often seem more valuable than it is. Think about how the amount you are offered compares to the regularity and consistency of a DB scheme’s payouts.
What’s more, the current lifetime saving limit for pensions is £1.03 million. The lifetime allowance is tested when taking benefits and any amount over this limit is subject to a 55% tax charge. Bear this in mind, if you are offered a payout which will take you close to the threshold.
If you are considering the option to transfer out, you should see a financial adviser who will assess your circumstances and future objectives to determine the most appropriate course of action. In fact, it’s the law to seek independent financial advice if you have a DB pension worth more than £30,000, before transferring out of your scheme.