Kirk Rice Blog

Should I Transfer Out Of My Final Salary Pension Scheme?Written on May 16, 2019 by Kirk Rice LLP

The Question:

Should I transfer my final salary pension scheme? My colleagues and friends have transferred their pensions and tell me it will enable them to do more in retirement than if they stay in the scheme.  Are they right?

Kirk Rice LLP answers:

In my experience many people who have been members of a final salary pension have paid relatively small contributions (typically nothing or up to 5% of salary) and been offered transfer values in excess of £500,000 which seems an awful lot of money. It is not uncommon to see transfer values that exceed £1m. With these sorts of numbers being available most people are naturally interested in the transfer opportunity. It’s also clear that most people we meet who have never had final salary pension schemes have not been able to accumulate anywhere near this amount of money in pensions.

It is likely to be in the best financial interests of most members to remain in their final salary pension scheme (in the tax and pensions world these are referred to as Defined Benefit or DB schemes). A DB scheme promises a pre-determined level of benefits that is underwritten by an employer. It is very unlikely the transfer value can be used to provide benefits of equal value to those given up.

There is no substitute for quality personal financial advice specific to your own particular circumstances. You should be able to determine if you need to consider advice about a transfer from the key advantages and disadvantages set out below. A Pension Transfer Specialist adviser will be able to recommend whether a transfer is suitable or not. A scheme will not allow you to transfer without advice if the transfer value is £30,000 or more.

Advantages of Final Salary Pension (Defined Benefit) Schemes

Never run out of money

The scheme must manage it’s assets to make payments to you for as long as you live AND if a dependant survives you most schemes will make payments for as long as they live too. Whatever income you start with will increase annually with inflation, although there are limits to how much protection you’ll receive and it’s rarely better than 5%pa.

Each final salary pension scheme sets it’s own inflation calculation subject to being at least as good as the minimum legal standards. Schemes can set more generous rules than the legal minimum and apply discretionary increases if a surplus exists.

All income paid to you is subject to income tax and is deducted by the scheme prior to making payments to you using the PAYE system. You are responsible for your PAYE code in order to make sure the correct amount of tax is paid.  It is extremely rare for a scheme to offer a large enough Transfer Value that you can buy matching benefits on the open annuity market.

Serious ill health

If before you start receiving a pension you are diagnosed terminally ill you can ask your scheme for a conversion of future payments (usually 5 years income) into a cash lump sum.

Death soon after starting the pension

The scheme will always pay the first 5 years income. That is if you and all of your dependants die within the first 5 years, the balance of income will be paid to your estate.

These above events are relatively rare and the reduction in future income liabilities will improve the financial strength of the Scheme and contribute to reducing employer liabilities.

Tax Free Cash

The scheme will calculate a maximum cash sum it will offer you immediately with a lower pension income for life. You can spend this money as you see fit and you do not pay income tax on it.

Pension Protection Fund

If an employer becomes insolvent owing money to the pension scheme the Pension Protection Fund may take over the running of the Scheme.

This is designed to ensure that anyone already receiving benefits from the Scheme is broadly unaffected. If members are over the normal pension age of the scheme, or are in receipt of a spouses, dependants or ill health pension they will receive 100 per cent of the pension in payment when the company entered insolvency.

If a member is an early retiree or under the normal pension age of the scheme, they will receive 90 per cent of what they were promised.

PPF compensation is almost always substantially more than members would have received if they simply received a share of what was left in their scheme when their company became insolvent.

However annual increases to any pensions will normally be lower than the Scheme promised. Benefits accrued before April 1997 will not increase in payment. Benefits accrued after that increase in payment then at a maximum of 2.5%pa.

Once the PPF starts assessing a Scheme you cannot transfer out. The assessment period may be 2 years and sometimes the Scheme can stay out of the PPF and your right to transfer is restored subject to any Scheme restrictions. Once a scheme is in the PPF you cannot transfer your rights out. The PPF works by pooling all the assets of schemes and managing these investments at a lower cost than the schemes’.

Investment Risks

You do not bear any consequences of falling investment markets, responsibility lies with the trustees to manage the assets to meet the needs of members and for the employer to add money when necessary.

Investment markets will show growth over the longer term, say 15 years or more, it reduces the amount the employer needs to contribute and could reduce the risk of moving to the PPF.

Charges

The scheme’s size means it can buy professional services at a lower cost than you will pay for investment, tax and management of a personal pension.

Lifetime Allowance

A scheme pension benefit uses less of your Lifetime Allowance than the transfer value might because of the calculation method. You are more likely to be subject to paying Lifetime Allowance tax charges if you transfer.

Disadvantages of Final Salary Pension (Defined Benefit) Schemes

Single decision

You have to decide on tax free cash and income for a retirement period that could be more than 30 years long. The scheme will not allow you to vary the selection in retirement if your circumstances change.

Pension Protection Fund

Members who have not reached the scheme retirement age and anyone expecting a pension of more than £39,005pa should carefully consider the following disadvantages:

Members who have not reached the scheme retirement age will have their pension reduced by at least 10%.

Anyone who has retired early and is receiving a pension from the scheme, will have their early retirement pension recalculated by the Pension Protection Fund and the cut will be immediate.  The early retirement factors applied by the PPF could be different to the scheme and mean a reduction in your income.

If you have yet to retire or receive an early retirement pension when your scheme enters the Pension Protection Fund and the pension income exceeds £39,005pa the Pension Protection Fund will reduce your income to £35,106.

If your future pension is going to be subject to this cap, and you think your employer is going to be insolvent you need to act fast to make a transfer decision. Once the insolvency is announced or financial information suggests it is likely, you’ll not be able to transfer out of your scheme until the Pension Protection Fund has reviewed it’s viability. Not all final salary pension schemes progress to the Pension Protection Fund as they may have sufficient assets to meet their liabilities.

Inflation increases will be at the legal minimum standards which may prove to be less generous than the scheme had provided. This means no inflation rises for your accrued pension for membership periods prior to April 1997. All increases are capped at a maximum of 2.50%pa.

Tax free cash

Currently the factors in the calculations mean that after a transfer to a new personal pension you’ll be able to access a larger tax-free cash value (known as the Pension Commencement Lump Sum).

Inflexible income

A scheme pension cannot be suspended or varied to suit your circumstances and reduce the amount lost to tax. Some people have other income, particularly in the early years of retirement and are paying more than 20% income tax on some.

If you defer your retirement past the scheme’s normal pension age you cannot receive the income you missed. Your deferred pension will start at a higher value than at normal pension age, but it will generally take over 20 years for the total income paid out to match the pension payable from pension age.

Dependant’s benefits

If you will not have any dependant(s) in retirement then the scheme benefit is of no value to you.  You cannot choose non-dependant beneficiaries. The scheme calculates the group liability for pensions to dependants and this average is factored into your pension and adds to the transfer value.

Beneficiaries

If you transfer to a personal pension you can choose who you wish to share any pension money after your death.  They do not need to be dependants.

Serious ill health

After your pension income has started and you later suffer serious ill health, you cannot ask the scheme for an advance or increase in pension based on the fact you will not live as long as originally expected. Despite the fact you are going to die much earlier than expected, the scheme will not increase any dependant’s pension.

Death soon after starting the pension

The final salary pensions scheme only guarantees the first 5 years pension payments if you and all dependants die within that period.

If you invest your transfer value in a personal pension the remaining investment amount is available to your chosen beneficiaries. However, no one will receive a guaranteed pension income by default.

Investment risks

Investment portfolios have shown real growth over 15 years or more (retirement is a long term investment period) and effectively reduces the amount the employer needs to contribute. You cannot directly benefit from that growth.

Lifetime allowance

A scheme pension benefit is crystallised in a single event and will utilise any available Lifetime Allowance and create a tax charge where an excess exists. A personal pension can be taken in phased amounts and possibly delay the payment of any tax on the excess.

In most cases you are likely to be worse off if you transfer out of a final salary pension scheme. The cash value may be less than the value of the defined benefit payments to you and your eventual pension payments will depend on the performance of the new scheme, with the risk that the scheme does not deliver the returns that you expect.