Should I quit my defined benefit pension scheme?
Tens of thousands of savers have ditched the security of a defined benefit (DB) pension since the launch of pension freedoms in April 2015. This type of pension usually pays out a guaranteed, inflation-linked sum in retirement.
Individuals have switched in favour of managing their own retirement pot through a defined contribution (DC) scheme such
as a self-invested personal pension (SIPP).
With a report by influential trade body the Pensions and Lifetime Savings Association (PLSA) suggesting 3m members in the weakest DB schemes have only a 50/50 chance of getting their full pension; this demand is unlikely to ease any time soon.
Furthermore, many savers are attracted to the extra flexibility created for DC savers by the pension freedoms and the ability to pass on funds tax-efficiently after death.
But the process of transferring is not straightforward and comes with real risks.
Seeking financial advice
If you want to transfer your DB pension and it’s valued at £30,000 or more, Government rules require that you speak to a regulated financial adviser first. You can search for an adviser near you on www.unbiased.co.uk.
Financial advice is extremely valuable – particularly in relation to complex areas such as pension transfers – so it’s worth listening carefully to what they tell you.
Advice doesn’t come cheap. According to adviser search provider Unbiased, specialist defined benefit transfer advice costs around £1,500.
Even if you’re willing to pay that, many advisers simply aren’t taking on pension transfer business either because they don’t have the qualifications or they fear being sued further down the line.
An adviser will talk you through a whole series of issues that factor into whether or not a transfer is right for you.
One of these is the transfer value – this is the cash amount your DB scheme is offering you to give up your guaranteed pension.
The size of the offer will depend on a number of factors including your age, whether your pension is inflation-proofed and the yield (that is investment return) on Government gilts (if the yield is low, the transfer value will be high). Your transfer value will be expressed as a ratio.
For example, if you have a DB pension worth £10,000 a year and you’re offered a transfer value of 20:1 you’ll get £200,000 in exchange for giving up your guaranteed pension.
Clearly such cash offers are extremely tempting but remember you’ll be giving something up that’s incredibly valuable. DB pensions usually come with inflation protection – meaning the real value of your income will be maintained – and also often guarantee to pay your spouse an income after you die.
Is the scheme sponsor safe?
In light of the PLSA report you might be concerned the company that’s supposed to pay your DB pension won’t survive as long as you do. This is perfectly logical but it’s worth noting that even if the scheme sponsor hits the wall you won’t be left empty handed.
The Pension Protection Fund (PPF) provides a valuable safety net for DB members in the event their employer (or ex-employer) fails.
If you have already retired and were receiving a pension from your scheme before it went bust, the PPF will pay you 100% . You’ll get the same level of retirement income as when the scheme you’re a member of failed.
Payments relating to pension rights built up from 5 April 1997 will rise in line with inflation, subject to a cap of 2.5%. Payments relating to service before then will not increase.
If you retired early and had not reached your scheme’s ‘normal pension age’, or had yet to retire, when your employer went bust, you’ll generally receive 90% of the income you would have received.
However, this is also subject to an annual cap on compensation depending on how old you were when you retired. The PPF maintains a list of cap levels for each age. The earlier you retired, the lower the annual cap set to compensate for the longer time you will be receiving payments.
For example, the cap at age 65 is just short of £35,000 a year (when the 90% compensation level is applied).
Payments will increase with inflation in the same way as someone who has already retired.
So in short, while the failure of the company that is supposed to pay your pension will reduce your retirement income, you should still get most of it.
What do you want from your pension?
Whether or not to transfer will depend on your own personal circumstances and goals. Some people will already feel they have enough secure income to fund their day-to-day spending and are therefore able to cash-in the rest (although remember this will be taxed in the same way as income).
Others will be attracted to the tax treatment of DC pensions which allows you to pass on your entire fund tax-free if you die before age 75 or at your recipient’s marginal rate if you die after this age. Furthermore, you can now pass it on to anyone – it doesn’t need to be a spouse or dependant.
Whatever you decide, remember that your pension first and foremost needs to provide an income that lasts throughout your retirement – a period that could last 30 years or more. In most cases, keeping your DB pension will remain the best way to do this.
Senior Analyst, AJ Bell