Retiring soon? Should you transfer your defined benefit pension?
Apparently, it was ex-world heavyweight champion (and famous grill salesman) George Foreman, who said: “The question isn’t at what age I want to retire, it’s at what income.”
Successful retirement planning is all about making the right choices; many of which need careful consideration, because they can never be changed. One such decision may involve your defined benefit (also known as final salary) pension. A few years ago, the number of people transferring their defined benefit pension was relatively small. However, research from The Pensions Regulator, showed that in the year to 31st March 2017, 67,700 people transferred their pension away from a defined benefit scheme.
Much of the rise can be attributed to higher than normal Cash Equivalent Transfer Values (CETVs) as a result of low-gilt yields and the Pension Freedoms which members of Defined Benefit pension schemes can only access by transferring their pension to a Defined Contribution (money purchase) pension scheme.
A defined benefit pension provides:
- a guaranteed income;
- inflation protection; and
- a pension for a surviving spouse or civil partner and, depending on the scheme rules and your circumstances, a pension for anyone else who is deemed to be a ‘dependant’ when you die (e.g. an unmarried partner, a child under age 23 or a disabled relative).
So, if you are approaching retirement, why would you consider giving up these valuable benefits by transferring your defined benefit pension?
Advantages of transferring
- By transferring into a Flexi-Access Drawdown arrangement you could have greater flexibility in how and when you want to you draw your income.
- You may also be entitled to a larger tax-free lump sum if you transfer away from your defined benefit scheme.
- When you die, you will be able to leave any money remaining in your pension to your nominated beneficiaries, who will be able to take an income or a lump sum. If you are aged 75 or older, or have a pension fund in excess of the Lifetime Allowance (currently £1 million), your beneficiaries will pay tax on any money they receive.
- In certain circumstances, for example if you suffer from ill-health or are single, you may be able to get a higher income by buying an annuity with your CETV than you can get by taking an income from the scheme.
- If your employer was to go bust, your pension would be moved into the Pension Protection Fund (PPF). The PPF usually pays 90% of the income your defined benefit pension would have paid. For a 65-year-old this is capped at 90% of £38,505.61 i.e. £34,655.05 per annum. The cap reduces for younger people and rises past the age of 65. This means if your pension fund is large, and your income is expected to be greater than this limit, you could be worse off financially if the scheme ended up in the PPF.
- Transferring away from the scheme may allow you to retire early, and without a penalty being applied by the scheme for early retirement.
Disadvantages of transferring
- You will give up a guaranteed, inflation proofed, income.
- You will give up a potentially valuable spouse’s pension and/or dependant’s pension.
- By transferring from the scheme, you will expose yourself to investment risk, which could reduce the value of your pension fund and, consequently, your income.
- There is no guarantee the income you get following a transfer from your defined benefit scheme will continue for the rest of your life; you do not have this risk if you remain a member of the defined benefit scheme.
- You may get less income by transferring from the defined benefit scheme to a defined contribution (money purchase) scheme. Furthermore, and unless you buy an annuity, the income you do receive isn’t guaranteed and nor will it necessarily keep pace with inflation.
Some schemes have started to offer a partial transfer option. This allows members to split their pension; leaving part in the existing scheme and transferring a portion away.
While still relatively rare, and potentially complex, partial transfers might offer you the best of both worlds. For example, you could leave, say, a £15,000 a year pension in your defined benefit pension scheme to provide you with a guaranteed baseline income and transfer the balance to a flexi-access drawdown fund from which you can draw a flexible income in the knowledge that your family can also inherit any unused drawdown fund on your death.
Before making any decisions, it’s worth checking your scheme to see if they offer this option.
If the cash equivalent transfer value (CETV) of your accrued defined benefit scheme rights is more than £30,000, you must seek appropriate advice from your Financial Adviser, before any transfer to a defined contribution (money purchase) scheme can proceed. A transfer represents a one-way street, there are no U-turns and you can’t change your mind. Taking advice is therefore an essential step to ensure you make the right decision, and one which you don’t regret later.
Accessing pension benefits early may impact on levels of retirement income and is not suitable for everyone. You should seek advice to understand your options at retirement.