The number of people opting to transfer out of their defined benefit pension schemes reached an all-time low last month. More savers are choosing to stay put due to market volatility caused by COVID-19. This follows a series of changes made by the Financial Conduct Authority in which over 700 licensed IFAs gave up their permission to provide pension transfer advice*.
A defined benefit pension (also known as a ‘final salary’ pension) is a type of workplace or occupational pension that pays you a guaranteed income in retirement based on your salary and the number of years you’ve worked for your employer, rather than the amount of money you’ve contributed to the pension.
Advantages of DB pension transfer
One advantage of having a defined benefit pension is that it lasts as long as you do. If you happen to live longer than average, then its the scheme that finds the money to fund your retirement income.
By contrast, if you transfer your defined benefit pension rights into cash and manage it yourself, you are taking on the uncertainty about how long you are going to live. There’s clear evidence that people tend to under-estimate how long they will live, so it’s a risk that you will run out of money prematurely. On the other hand, you may be so worried about running out of money that you spend your pension fund too slowly, and do not enjoy the full benefit of your retirement savings.
Disadvantages of DB pension transfer
Whilst defined benefit pension rights can be very valuable and attractive, they can also be rather rigid and inflexible. For example, a scheme may have a set pension age and although taking an early pension may be possible, it may not be on favourable terms. In this case, taking your pension earlier may mean it is much lower than if you had waited until you reached pension age. Similarly, a scheme may have generous arrangements for married members who leave behind a widow or widower, but these may be of no value to unmarried members of the scheme.
If you take a pension transfer to convert your defined benefit pension rights into cash and put the money into a flexible pension arrangement instead, then you benefit from the new pension freedoms which allow you much more choice about how you use your money. In addition, the cash amount that you are offered will generally reflect the average cost to the scheme of providing benefits to widows and widowers, so if you are a single person you will get some of the value of that provision which you would not have done if you had stayed in the scheme.
How can I know what is right for me?
At present, if you are a member of a defined benefit pension scheme you have the right to ask the scheme to offer you a cash lump sum in exchange for your entire defined benefit. This lump sum is known as a cash equivalent transfer value (CETV). If the transfer value is more than £30,000 you are required to seek independent financial advice before deciding whether to proceed with the transfer. This advice must be provided by, or at least checked by, a qualified pensions transfer specialist such as Herbert Scott holding all relevant licenses.
The Financial Conduct Authority has updated its rules about how advisers are to assess whether a transfer is a good idea. As part of this process, since Autumn 2018, advisers have been required to present you with a ‘Transfer Value Comparator’ (TVC). In simple terms, this is a measure of how the money you have been offered by your pension scheme compares with the value of the pension you are giving up.
In brief, the adviser has to work out the sum of money that would be needed today to buy you an income (through purchase of an annuity) that matches the pension you are giving up, if it were to be invested up to your retirement date on a ‘risk-free’** basis.
How Herbert Scott can help you
At Herbert Scott, we can use our cashflow technology to explore the various options available to you and find out if cashing in your defined benefit pension is suitable. When can I retire? How much can I spend on dream trips overseas? Can I afford to give money to my children? These questions, and many more, can be addressed and do not need to feel daunting.
This part of our work is an empowering process which lies at the heart of our service and feeds into our investment discussions. We will calculate the optimum level of return you need from your investments to achieve your lifetime goals, and blend this with your feelings about investment risk, to agree on the most suitable portfolio for you.
Are you wondering if you can afford to retire early? Or have you had a redundancy offered due to COVID19 and are approaching retirement? We may be able to help you consider the opportunities with help from a CETV option.
Please contact us on 01273 407500 to explore your options further.
**A cash/deposit based fund