When it might – and might not – be a good idea to bring them together
A generation ago, it made good sense to have more than one pension. The reason for this was that most pensions invested in with-profits funds. The performance depended on things like how well that particular provider invested your money, how financially strong they were, and how the returns were distributed amongst different groups of customers.
As it was impossible to say how well each company would do in advance, spreading your regular or lump sum investments between several companies reduced the risk of having all your savings with the company that, in hindsight, produced the lowest returns.
Today’s pensions and savings plans are different. You can choose a wide range of investments within one pension or savings plan, which means that you don’t usually need more than one. When you take out a modern pension, such as a self-invested personal pension, you are only paying the pension provider to carry out administration. You might also choose to invest in funds managed by or curated by the same provider, but you can also choose from (usually) thousands of other funds available from other fund managers.
More employers means more pensions
Since the demise of defined benefit pensions in the private sector, most of us who have a workplace pension have a defined contribution pension.
Modern workplaces also mean that most of us no longer work for the same employer for the whole of our working life. Brits can now expect to work for an average of six employers during their working life. With workers who earn £10,000 a year or more being automatically enrolled into pension saving from the age of 22, this is likely to mean that full-time employees accumulate five or six pensions along the way.
So, what are the advantages and disadvantages of consolidating? What should you look out for when choosing a new home for your retirement fund? And are there pensions you should leave where they are?
Why it could make sense to bring all your pensions and savings together
The convenience factor
It’s much easier to manage one pension than half a dozen. Rather than have to check values with a number of pension providers or schemes, you only have to deal with one. And you only get one annual statement.
You’re more likely to take an interest in your pension if you see it as one larger amount of money, rather than a collection of smaller pots. In Australia, where pension saving has been compulsory for the last 20-odd years, they reckon that once someone’s pension is equal to their annual salary, they take a lot more interest in it.
You can control your pension more easily. Your current pension may limit your fund choices or, in the case of some trust-based pensions, the trustees may dictate the fund you must have. Transferring to a single pension allows you to cast off these shackles and take control. That doesn’t mean you have to pick your own investments if you don’t want to. Most modern pensions also offer ready-made funds, matched to your personal needs, for those who don’t want to choose from thousands of different funds.
You could end up with a bigger pension pot. Older pensions generally have higher charges, so moving your pension to a modern one could reduce the cost of administration and fund management. A small reduction of 0.5% a year might not sound like a lot, but it could increase your eventual pension pot by 15% over your whole working life. Charges are also usually lower the bigger your pension pot is.
Tracking and switching
It’s often easier to track and switch your investments if they’re in one place. Modern pensions allow you to see where your pension fund is invested and how it is performing - online and in real-time. You can follow your progress and use tools to see if you’re on the right track towards a comfortable retirement.
When you should think twice about transferring
While there are many advantages to be gained by consolidating your pension, be wary that some of those old pensions may be more valuable than you think. Make sure you understand whether your existing pensions have some advantages that you would lose if you transferred.
Workplace pension schemes
You should avoid transferring your pension if you’re an active member of a workplace pension scheme. This is because your employer will probably be paying in money on your behalf – and you would lose this if you chose to stop that pension and transfer it.
When consolidating pensions, look only at those where contributions have already stopped, or individual pensions that your employer is not paying into on your behalf.
Older defined contribution pensions
Old pensions generally have higher charges than new pensions, but this isn’t always the case.
Some older pensions have already deducted most of their charges up front and their ongoing charges are competitive, even by today’s standards. Transferring in this situation may not result in lower charges – although you may get more flexibility, choice and the ability to control your pension.
Another potential advantage of older pensions is that some pay loyalty bonuses, which are added if you keep your pension for a long time. In this situation, it may be worth hanging onto your old pension rather than transferring it to a new one. You should weigh up the value of the loyalty bonus against any advantages a new pension would bring (such as lower ongoing charges, more choice and greater flexibility).
Specific types of pension
There are also some specific types of pension where you may be better leaving your savings or promised pension where it is:
- Defined benefit pensions
Defined benefit – also called ‘final salary’ or ‘average salary’ pensions – promise to pay you a fixed level of pension each year when you reach the pension scheme’s normal retirement age.
The pension is a promise, rather than an outright guarantee. But even if the sponsoring employer goes bust, the government has an insurance scheme – called the Pension Protection Fund – which usually takes over the running of the scheme. In such circumstances, your benefits are normally protected up to a value of roughly £30,000.
If the value of your defined benefit pension is more than £30,000, you will have to take regulated financial advice before transferring. In most cases, the adviser is likely to recommend that you don’t transfer your defined benefit pension due to the valuable promised pension it will provide.
Some new pensions will not accept transfers from defined benefit pensions as a matter of principle, because they do not believe it is in their customers’ best financial interests to transfer out of one of these pension schemes.
- Pensions with a guaranteed annuity option or rate
These are usually older-style money purchase or with-profits pensions, originally taken out between the 1970s and the early 1990s.
These pensions have an option to convert your accumulated pension fund into an annuity at a guaranteed rate, which is usually much better than current annuity rates. Typically, the guaranteed rate is twice the rate that you would get on the open annuity market today.
This makes pensions with a guaranteed annuity rate valuable, and it is usually in your best financial interest to take the higher guaranteed annuity.
Even if you don’t want an annuity, it may be worth taking one and then waiting until April 2017, when it is expected that you may be able to sell your annuity for a cash lump sum or a transfer to an income drawdown pension. However, it’s still not 100% certain that selling your annuity will be possible. This will depend on whether buyers enter this new market and also whether they will want to buy your annuity.
Even if you end up keeping the annuity, you can accumulate the income it pays – or pay the income back into a modern pension, which can be taken as cash. Even people who are no longer in work, and don’t have earnings, can pay up to £3,600 a year into a pension until they reach the age of 75.
- Section 32s or ‘buyout’ plans
Section 32 policies, also known as ‘buyout’ plans or bonds, are pensions that aim to replicate the pension benefits payable by the State Second Pension or State Earnings Related Pension Schemes.
Although these government pension schemes are no longer available, Section 32 policies must pay pensions in line with what these old state pension schemes would have provided at state pension age.
Because the cost of buying these benefits has risen sharply in recent years, the cost to the insurance company of buying the benefit is usually a lot higher than the money available within the plan.
This means that, like policies with a guaranteed annuity rate, it could make good financial sense to take the pension and sell it (after April 2017) if you can find someone who wants to buy it. Alternatively, you could recycle the income you receive (up to age 75) into a new pension.
Note that it is not usually possible to cash in a Section 32 policy in advance of state pension age if there isn’t enough money in the plan to pay the guaranteed benefits.
- With-profits funds with guaranteed growth rates or guaranteed sum assured and bonuses
With-profits funds have struggled to shake off the bad reputation they gained when endowment policies failed to repay the mortgages they were linked to.
However, some with-profits policies carry an annual growth guarantee of 4% a year, while others guarantee that the value of your savings won’t fall – essentially a 0% guarantee. Considering that most government bonds are currently offering a yield of 1.5% or less, these guarantees in with-profits policies are extremely valuable, particularly if the underlying fund is invested in assets such as shares (equities) that have the potential for long-term growth.
Generally speaking, with-profits funds that have guaranteed growth rates and invest most of the fund in shares – often referred to as a high ‘equity backing ratio’ – are the most valuable.
If in doubt, consult a qualified financial adviser, who will help you understand whether your with-profits investments are especially valuable.
- Pensions that allow you to take > 25% tax free
Perhaps the most well known and best loved feature of our pension system is the ability to get a tax-free lump sum from the age of 55 onwards. Most people assume that they can only take a quarter of their fund as a tax-free lump sum, and this is true for the vast majority of pensions.
However, some older pensions taken out before 2006, allowed you to build up more than 25% of the fund as a tax-free lump sum. When the pension tax rules changed in April 2006, these higher tax-free lump sums were protected. These special rules applied to occupation money purchase pension schemes, which may have been individual or workplace pensions.
The pension names to watch for – the ones which may entitle you to more than a quarter of your fund as a tax-free lump sum – include:
- Executive pensions
- Small self-administered pension schemes (SSAS for short)
- Section 32 policies
- Contracted-in money purchase schemes
- Contracted-out money purchase schemes
If you have one of these, check with the trustees, or pension provider, whether you are entitled to more than the standard 25% tax-free lump sum. In most cases, you would lose any higher entitlement if you transferred to another pension.
- Pensions with a protected pension age under 55
Up until April 2010, it was possible to take your pension benefits from age 50, rather than the current minimum age of 55. Some pension schemes had this right to take benefits at age 50 written into their rules. In addition to members of company pension schemes, a small number of people in specified professions – such as professional football players – were entitled to take benefits earlier than age 50 from personal pensions.
People who had a right to take their pension early were protected when the pension tax rules changed in April 2006.
If you think that you may have the right to take your pension before age 55, or before age 50 in the case of specified professions, you can check with your existing pension scheme or pension provider before transferring to a new pension.
- Pensions with built-in life cover or waiver of premium benefit
Some pensions have built in life cover, which usually pays out a set amount in the event of death before your chosen pension age.
Waiver of premium benefit is an insurance that pays your pension contributions for you in the event that you’re unable to work due to illness, accident or disability. Although less common than it used to be, some pensions still have this insurance attached.
If your pension includes either of these benefits, you will probably lose them when transferring. Although new replacement insurances may be offered, these could be more expensive, or you may be declined or have exclusions applied if your state of health has changed significantly.
Weigh up the pros and cons carefully and make sure you do your homework on replacement insurances before you cancel your existing pension.
If you do decide to transfer...
If you do decide that bringing pensions and/or investments together is right for you, the next stage is to decide on a new home for the money you’re consolidating.
There’s plenty to think about. You can read a short article to help you weigh up the important considerations: