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Kirk Rice Blog

Which Would You Choose? £1m Or £33,000 Per Annum Increasing By 3%pa for life.Written on May 10, 2018 by Kirk Rice LLP

Which Would You Choose? £1m Or £33,000 Per Annum Increasing By 3%pa for life.

I think it highly likely that everyone reading this article has themselves, or knows someone, who is considering a transfer offer from their final salary company pension scheme. An online search will reveal hundreds of tempting offers to review your pension options, with testimonials from well known journalists and even a politician.

For many of the people being offered these tantalising sums of money from a final salary pension, this will be the type of decision they probably have not made before. For most, they will also have very limited experience or knowledge of how to manage money.

Until 2015 the law required these same people to hand over their pension savings in return for a guaranteed income for life, buying an annuity. The annuity provider would have a long-term investment strategy in place to provide for the payments guaranteed to investors. They would employ investment specialists, actuaries to analyse the risks, accountants to monitor tax efficiency and a management team to ensure a profit is made, so that the company can continue to offer annuities in the future.

A scheme also carries out all these activities, as it provides final salary pensions as if it is an annuity provider to it’s members. Any profit is kept in the scheme to help provide for the next generation of pensioners.

Now, after transferring, an investor needs to do the same analysis and management for themselves to manage the very real risk of running out of money before they run out of breath.

The initial question above is an example of a final salary option for an individual at age 60 being offered a guaranteed £33,000 pa which will increase by an annual inflation of up to 5%. It also comes with the benefit that a spouse could receive a pension of 50% on the death of the member and continuing for life. Inflation has averaged about 2.8% over the last 27 years.

The scheme provides an option of up to £140,000 could be taken as a tax-free cash sum with a reduced pension of £26,800. To replace the income given up, clearly this money would need to be invested, and return at least 4.40%pa plus current inflation (say 2.8%, remember the income given up will increase each year) which would not be possible in any deposit account.

Without a doubt, it is extremely unlikely that a transfer value will be so generous that you are able to fully replicate the pension offered by the scheme.

Transferring is usually about whether the personal pension benefits may be better suited to your circumstances than the scheme. If you would like the security and certainty of £33,000 or £26,800pa, which will rise with inflation, then stay in the final salary scheme, do not transfer away.

If you transfer the £1m to a new personal pension (marketing you’ll see refers to SIPPS, Self Invested Personal Pensions, as the only place to transfer to, but very few people need one) then invest it, you will be able to make withdrawals each year to suit you.

A personal Pension may pay you 25% of your value tax free, and currently this is usually better than most Final Salary pension schemes.

If you have other taxable income during the year, you might withdraw some of your tax-free cash to defer paying income tax and keep more money invested for longer.

On your death, whatever is in the fund is left to your beneficiaries.

Should you not need the certainty of a scheme income for a spouse or dependent after your death, then a transfer might be appropriate.

If you have explored other ways to pay off debt, and the transfer will provide more tax-free cash to enable you to clear personal debts, then it is worth consideration.

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If the question had been: Which would you choose? £400,000 or £33,000 per annum. There will be investment management costs, administration fees and inflation, to consider when planning the investment strategy. Therefore, in my opinion, an investment return of more than 12% pa is required to provide a similar income and will require a relatively high level of investment risk. Most people I meet with Final Salary pensions tell me they are cautious, and would worry about times when their investment portfolio falls in value by more than 20%. At high levels of risk, falls can be much more extreme and lead to uncomfortable decisions.

When investment values fall, you may need to stop withdrawing money from your personal pension to preserve your assets. The more investment risk you take, the more likely there will be significant periods when this will occur.

It is essential to carefully consider more than just the number being offered and there is no one size fits all approach. The government has regulated that when a transfer value is £30,000 or more, that you need to take advice from a qualified and registered pension transfer specialist.

There are several other issues to be considered, and an adviser will spend time with you to understand your circumstances; explain investment risks and agree a level suited to you; your need for monthly and planned cash expenditure; will research the pension scheme and discuss the benefits structure; and finally recommend an investment strategy for any transfer that is suitable.

TAKING WITHDRAWALS MAY ERODE THE CAPITAL VALUE OF THE FUND, ESPECIALLY IF INVESTMENT RETURNS ARE POOR AND A HIGH LEVEL OF INCOME IS BEING TAKEN. THIS COULD RESULT IN A LOWER INCOME WHEN THE ANNUITY IS EVENTUALLY PURCHASED.

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If you are interested in discussing your final salary pension, please telephone Michael Powell on 01344 875 000 or email info@kirkrice.co.uk.

Please note: answers are given for general guidance only and specific advice should be taken before acting on any of the suggestions made. The information is based on current tax legislation which may change in future.

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