Defined benefit, or final salary, pensions are so valuable they have a reputation for being “gold-plated”. Anyone would be mad to leave such a prized pension, in that case, then? Maybe not.
Final salary pensions provide a secure level of income payable for life, with some inflation protection and a dependant’s pension. For most retirees, who will rely on pension income to pay the bills for themselves and a partner through the decades of retirement, this is a great deal.
But transferring out of a defined benefit (DB) pension can be an attractive option. Transfer values – the amount of cash the pension scheme will pay you to leave with a lump sum, rather than an income for life – are at near-record levels.
It’s important to remember those high values are an indicator of the value provided by a defined benefit pension, in terms of providing income that is protected from the ‘Big Three’ – inflation, investment and longevity – risks that can have such a huge impact on retirees.
Transferring out of a final salary pension is all or nothing, you can’t generally just transfer a bit, and it’s irreversible. So financial advice is essential, and your adviser may decline to carry out the transfer if they think it’s a bad idea for you.
But there are some circumstances where leaving your defined benefit pension could be the right move.
Single person premium
If you’re unmarried or have no partner, the transfer value offered (which reflects the possible cost of providing benefits to a widow/widower) could be enough to provide the essential income you need while still leaving some left over for reinvestment or spending.
Enhanced annuity
People in poor health may find their shorter life expectancy lets them get just as good a deal by transferring out, in terms of income, but with a surplus to spend as they please. For example, by using some of the transferred DB pension to buy an enhanced annuity.
Avoiding penalties
Want to retire early? That could significantly cut the amount of pension income you get from your final salary scheme. Taking the money as transfer cash could leave you better off.
Enhanced transfer values
Your final salary pension scheme may offer you an enhanced transfer value (ETV), effectively a higher transfer sum to make it more attractive for you to transfer. An ETV can make a significant difference to the income you could secure outside the scheme.
Hardship
Transferring out of a defined benefit scheme into the more common type, a defined contribution pension, gives you more options in how to use the money from age 55. This could be an option in cases of serious financial hardship, for example.
Other income
Perhaps you have other sources of secure income that are sufficient to cover your needs. Or if you have two separate final salary pensions, one could be transferred to a defined contribution scheme, where it could be used to bridge the gap to State Pension Age, or top up income in the early retirement years when you want to spend more on hobbies and holidays.
IHT planning
A transfer may benefit your inheritance planning, to pass the fund directly to children or other beneficiaries. Also, a defined contribution pension where benefits have not been taken, what’s known as uncrystallised, can effectively be passed on without being subject to inheritance tax.
Pension scheme problems
If your pension scheme is in trouble, maybe the company is at risk of becoming insolvent, it may be worth your while to transfer. Where an employer fails, the scheme goes into the Pension Protection Fund, but this “lifeboat” may not pay your full benefits if you have not yet reached the scheme’s retirement age. Transferring may allow you to secure a higher level of retirement.
