A cut-out-and-keep guide to defined benefit pension transfers
Since joining AJ Bell two years ago, I’ve had more questions from investors about defined benefit (DB) pension transfers than any other subject.
This spike in interest has undoubtedly been driven by the launch of the pension freedoms in April 2015, as well as a number of high profile company collapses (most notably retailer BHS and construction firm Carillion).
The numbers involved are striking. According to the Office for National Statistics, some £5.4bn of pension transfers took place in 2014. Fast forward to 2017 and this figure had risen to almost £35bn. The vast majority of this increase is likely due to savers leaving their DB schemes in the wake of the pension freedoms.
So what are the key things you need to consider when deciding whether to retain the security of DB or opt for the flexibility of a defined contribution (DC) pension such as a SIPP? And what hoops will you need to jump through if you decide you want to transfer?
TAKE YOUR TIME
Ditching a DB pension could be the biggest financial call you make.
Many make the mistake of rushing to a decision, particularly with commentators and newspaper articles suggesting transfer values – the cash lump sums companies offer in exchange for guaranteed pensions – are at record levels.
In most cases, however, the wisest choice will be to stick
with your DB scheme.
This transfer value will usually be a multiple of the annual income your pension guarantees. For example, someone in a DB scheme that will pay out an inflation-linked pension worth £10,000 a year from age 65 might be offered a cash lump sum of 20x this amount, or £200,000.
Clearly having such a huge cash carrot dangled in front of you is seriously tempting. But before snapping their hand off you need to think how you will fund your retirement lifestyle without that stream of income.
There are also a lot of complicated and uncertain factors you need to weigh up:
How much investment risk are you willing to take if you choose to swap DB for drawdown?
When will you need to start accessing the money?
How much will you take out?
Are you happy that the drawdown income won’t have the same inflation protection offered by your DB scheme?
For how long will you need your pension to last?
I’M WORRIED MY EMPLOYER IS GOING TO FAIL
In light of a series of high profile company failures, you might be concerned about the ability of your current or former employer to survive long enough to pay your pension.
If this is the factor driving your thinking, remember the Pension Protection Fund (PPF) provides a valuable backstop in the event the scheme sponsor goes bust.
The level of compensation you get from the PPF depends on your circumstances. If you have already retired and reached your scheme’s ‘normal pension age’ you should get 100% compensation, although you may lose some inflation protection.
If you have yet to retire or you took your pension early then your annual payment will usually be cut by 10%, though is also subject to a cap. For a 65-year old this is set at just over £39,000 a year. You may also lose some inflation protection.
So while falling into the PPF is far from ideal, the scheme provides a valuable insurance policy for DB members which must be taken into account.
You can find more information on the PPF and the compensation it provides at www.pensionprotectionfund.org.uk
LISTEN TO YOUR FINANCIAL ADVISER
Rules introduced alongside the pension freedoms mean that anyone who wants to transfer a DB pension worth £30,000 or more is required to take regulated financial advice first.
This can vary in cost – Unbiased, an adviser directory, reckons for a £100,000 pension this would usually come to about £1,500.
If you’re desperate to get your hands on the cash, you might be tempted to treat this as a rubber-stamping exercise. This would be a mistake – you’re paying for an expert to talk you through the options and the potential long-term implications of your decision, so you should get your money’s worth by listening to what they say and asking as many questions as you can.
A number of investors I’ve spoken with complain they have struggled to find an adviser willing to take on their transfer case. This is a common issue – some advisers simply don’t have the necessary qualifications to carry out pension transfers, while others are steering clear because they are worried clients will complain in the future if things go wrong.
Unfortunately there is no easy fix to this problem, and you may need to contact several advisers before finding one to take on your case. They may also advise against the transfer – in these circumstances (known in the jargon as ‘insistent client transfers’) some pension providers will refuse to accept your money.
If you’re looking for an adviser www.unbiased.co.uk is a good place to start. You can also find more useful information through the Government’s Pension Wise guidance service at www.pensionwise.gov.uk
senior analyst, AJ Bell