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When to think twice about consolidation

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AR011100 06/2018

Whilst 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.

You are an active member of a workplace pension scheme

You should avoid transferring your pension if you are 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.

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.

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.

Although the pension is a promise, rather than an outright guarantee, you are still supported 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 usually protected up to a value of roughly £33,000-£40,000 depending on your age.

Some new pensions will not accept transfers from defined benefit pensions at all 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.

If the transfer 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.

This requirement to take advice also extends to any pension with guarantees including those with a guaranteed annuity rate and section 32 buyout plans (see below).

Pensions with a guaranteed annuity 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 don’t want the annuity it might still make sense to take it, as you can accumulate the income it pays into an ISA or pay the income back into a modern pension, which can be taken as cash. Even people who are no longer in work and earning can pay up to £3,600 a year into a pension up to 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 no longer exist, 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.

Like policies with a guaranteed annuity rate, it might therefore make good financial sense to take the pension and recycle the income into an ISA or a new pension (up to age 75).

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 bonuses

With profits has struggled to shake off the bad reputation it 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 whilst 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, the guarantees in some 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 policies are especially valuable or not.

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 get you lower charges but you may get more flexibility, choice and the ability to control your pension.

Some older pensions pay loyalty bonuses. 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.

Small pension pots

At retirement, you can take your pension in chunks or all at once. One quarter is tax-free, and the remaining three-quarters is taxable.

If you choose to take income withdrawals from your fund – that is, as soon as you withdraw as little as £1 of taxable money – the annual limit on the amount you can pay into pensions falls from £40,000 (the ‘annual allowance’) to just £4,000 (the ‘money purchase annual allowance).

If you buy an annuity, you get to keep the higher allowance of £40,000.

You also get to keep the higher allowance if the pension pot you cash-in is worth less than £10,000, even although three-quarters of the money is taxable. You can cash-in up to three ‘small pots’ of less than £10,000 without affecting the £40,000 annual allowance.

So, if you are close to retirement age, you plan to cash in some of your pension and you want to keep paying more money in, keeping small pension pots rather than consolidating them into a bigger pot could be a good idea.

Pensions that allow you to take a > 25% tax-free lump sum

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 out for that 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 scheme

  • Contracted-out money purchase scheme

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, and this is important to you, then 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 are 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 these when transferring. Although these benefits can be replaced with new insurances, these could be more expensive, you may be declined, or you may 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.

And finally…

If you are finding the process or the considerations of consolidating your pensions daunting, you should consider seeking regulated financial advice.


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