The subject of defined benefit pension transfers is just as topical now as it was in July 2016, when we asked the question To transfer or not to transfer.
In fact, with an estimated 80,000 defined benefits pension transfers completed in the year ending 31 March 2017, there’s more reason than ever to take another look at the pros and cons of transferring. So here’s the ‘sequel’ to our original article.
Rising transfer values
One of the first steps in considering a defined benefit transfer is to request a transfer value from the administrator of your defined benefit pension – often from the trustees of the pension scheme sponsored by your current or a former employer. This is the lump sum of money the trustees are willing to offer you in return for you leaving the scheme.
What might the trustees offer you?
In simple terms, if the trustees think it may cost them £100 in today’s money to provide your promised benefits in retirement, they may offer you a transfer value of approximately £100 if you choose to leave.
Ø This money cannot be simply transferred into your bank account and spent.
Ø It must first be transferred into an alternative pension arrangement before other uses can be considered.
As with all future financial predictions, this transfer value offered by the pension scheme will include reasoned assumptions about the future, including future life expectancy, inflation and interest rates.
In recent times, life expectancy has been rising, and long-term interest rates have been falling. These movements have combined to increase the cost of providing the promised future benefits, so transfer values have been rising.
Gilt and gilt yields – lower gilt yields mean higher transfer values
One of the factors which determine the amount trustees might offer a transferee is the yield (or return) paid on long-dated government bonds (gilts). Long-dated gilt yields are used as a measure of long-term interest rates. When these yields fall, the cost of meeting future pension promises will rise, as will the associated transfer value.
Gilt yields constantly vary, and have shown some increases over recent times, but they are low by historical standards. These low yields have increased the cost of providing the promised future pension benefits, so transfer values have also been increasing.
Rising transfer values, coupled with the introduction of the new pension freedoms, have promoted new interest in defined benefit pension transfers.
Transferring from a final salary pension is an important decision, so it’s important to make sure you understand the implications fully before proceeding. The support of an adviser will help, but here are four things to consider that could make transferring more attractive, and four that could make transferring less attractive. This list does not cover all considerations in all situations, but it hopefully provides food for thought.
The new pension freedoms give you much greater flexibility around what you can do with your pension savings – once you reach the age of 55 and if your pension is not in a defined benefit arrangement. For example, you could take all your pension savings as cash, or you could flex your withdrawals to meet your changing needs in retirement. There are many issues to consider before taking advantage of these flexibilities – and we have discussed them before – but if you are keen to use them, then you may be more inclined to pursue a defined benefit transfer.
Pensions are intended to support you in retirement, ideally for as long as you live. The defined benefit pension guarantees a set payment for the rest of your life, but your life expectancy in these circumstances is based on averages. In effect, those with shorter lives are subsidising those with longer lives.
If you die when in receipt of a defined benefit pension, the money available to others will depend upon the rules of your specific pension scheme. If you transfer your money out of the defined benefit pension to a defined contribution pension, there is greater flexibility in how this money can be shared with others. It is likely that a defined contribution pension would pay your dependants – or any other beneficiaries you may have chosen – the value of your pension pot. If you die before age 75, any pension benefits can usually be passed on free of tax. If you die on or after age 75 any benefits will be taxed at the beneficiary’s marginal rate.
The government has set up the Pensions Protection Fund to protect people from difficulties caused by employer insolvency – but the fund has limitations.
>Read more about the Pensions Protection Fund
As a member of a defined benefit pension, the responsibility for providing your retirement income (for life) sits with your pension scheme, not with you. This certainty brings many people considerable peace of mind
Regardless of the pension arrangement you hold, investing money has a role to play. However, in a defined benefit pension the risk and responsibility associated with managing your money sits with the pension scheme. If you transfer out, this risk transfers to you. Some may be willing to carry this investment risk, but others less so.
Defined benefit pension rules are set on a scheme-by-scheme basis. Many, however, promise to pay an income in retirement that keeps pace with price rises. This could be very valuable in a high inflation environment. If you transfer out of a defined benefit pension, the responsibility for your income keeping pace with prices transfers from your pension scheme to you.
Benefits for survivors
Most defined benefit pension schemes will provide a pension for a surviving widow or widower. If you transfer out of a defined benefit pension you could use the associated transfer value to set up an alternative pension arrangement that also does this, but it may be more expensive to match the survivor benefits promised by the defined benefit pension.
There is clearly no single and universal ‘yes/no’ answer to the question of whether you should transfer out of a defined benefit. Your decision should be based on your own circumstances, needs and aspirations. It is undeniably a significant decision that should only be approached with care and consideration.
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The support of a financial adviser is a regulatory requirement if your defined benefit pension is valued at £30,000 or more. We take a look at the way the process works.