Transferring a final salary pension is a big decision that cannot be undone once you have made it. You, therefore, need to be sure that it’s the right thing to do before you move forward.
What exactly is a final salary pension? What are the reasons to stay on your current pension scheme, or potentially move out of it?
Those are some of the questions we will be dealing with in this article. Please be aware that this content is for information purposes only, and should not be taken as financial advice. Speak with a financial adviser prior to making any decisions about transferring your pension.
Indeed, if your final salary/defined benefit pension is worth over £30,000 then you are required by law to seek independent financial advice if you are considering a transfer.
Overview of final salary pensions
A final salary pension (sometimes called a defined benefit pension) is a type of pension which you receive from your employer. They are sometimes called “gold plated” pensions because they are increasingly rare. Many people view the benefits as not only industry-leading but also difficult/impossible to replicate elsewhere through other pension schemes.
These pensions are different from the more common type of workplace pension, known as a defined contribution pension. Under this scheme, both you and your employer contribute to your pension pot over time. Under a defined benefit scheme, however, your employer promises to pay you a specified annual income when you retire – for life.
The precise amount you get varies under a defined benefit scheme, depending on factors such as your earnings during employment, your accrual rate and your total years of service. The income you receive is usually index-linked, meaning that as the cost of living rises each year so does the income you receive.
Why would I think about transferring?
If this all sounds like a brilliant deal which you would need a good reason to give up, you would generally be right. For most people, it would be fair to say that switching from your final salary pension to a different scheme will not offer the same level of benefits.
With that said, however, there are good reasons to consider switching to another scheme in certain situations. For instance, you cannot pass on your final salary pension to your descendants in the form of an inheritance, like you can with a defined contribution pension.
When someone transfers from a final salary/defined benefit pension, the scheme provider usually offers a “transfer value” – which refers to the sum of money you receive for leaving the pension scheme and putting it into a new pension.
Not all providers will allow you to transfer into a new scheme. These include taxpayer-backed defined benefit pensions (i.e. “unfunded”), such as NHS pensions. If you should, therefore, check that your provider will let you transfer out of the scheme, if you are considering it.
Advantages of a transfer
Here are some of the reasons people usually consider transferring out of their final salary pension into a defined contribution pension:
#1 Inheritance
As mentioned above, you cannot pass on your final salary/defined benefit pension to beneficiaries. If you die and leave a surviving spouse, then the scheme usually pays out some benefits to this person. However, once they die the pension does not usually pay out to children. A defined contribution pension pot, however, can usually be passed on as an inheritance.
#2 Employer stability
Since it is your employer who is promising to pass out your income when you retire, what happens to your pension if your employer goes bust?
Usually, the company pension scheme will be dealt with by the Pension Protection Fund. However, you are unlikely to receive your full benefits (e.g. annual inflationary increases).
#3 Your lump sum
If you want access to a lump sum at the beginning of your retirement, then some final salary schemes allow you to do this. However, they often provide a poor deal for converting some of your pension money into cash compared to a defined contribution scheme. In the latter case, you can usually take the full 25% tax-free lump sum you are entitled to.
Disadvantages of transferring
With some of the advantages of transferring your pension now specified, here are some of the reasons why people often choose to remain on their defined benefit/final salary scheme:
#1 Stability
With a defined contribution pension, your money is usually invested quite heavily in the stock market and so your income might fluctuate depending on how your investments perform. With a defined benefit pension, your employer is obliged to pay you a specified amount. So you know with greater certainty what your retirement income will be.
#2 Inflation protection
A defined benefit pension will usually raise your income in line with inflation. That means that as the price of food, fuel and other goods/services go up each year, your pension does not lose purchasing power over time. With a defined contribution pension, you will need to make your own income provisions to account for rising inflation.
#3 Future guarantees
You likely do not know how long you will live. That means you do not know how long your retirement income will need to stretch out for. With a defined benefit pension, your income is guaranteed for the rest of your life. With a defined contribution pension, you need to decide how your pension pot will be able to provide for your lifestyle over potentially 30+ years in retirement.
Summary
The topic of pension transfers is very complex and everyone’s personal circumstances are different. This means that a pension transfer might right for some people, but not for others.
A lot depends on what is important to you. If you most value being able to pass on your pension to your children, then a pension transfer might be high on your mind. If, however, the most important thing to you is income stability and certainty in retirement, then staying on your current defined benefit scheme might be the better option.
Even in these cases, however, there are exceptions and it’s important to weigh up your options carefully with an experienced, independent financial adviser to make sure you are making the right decision for you based on the best available information.
