‘I’m confused about DB pension transfers’
Bill from Devon
‘I’m thinking about transferring out of my defined benefit pension scheme but struggling to decide if it’s the right thing to do. I’ve been offered a £230,000 transfer value and have a meeting with an adviser to discuss it.
‘I understand there are risks involved but I’m confident I can get better value by investing the money myself. Are there any other things I should be thinking about?’
Swapping the security of a guaranteed defined benefit (DB) income for the flexibility of defined contribution (DC) plans such as SIPPs has become increasingly common in recent years.
You are right to think carefully before making the leap because this could be one of the biggest financial decisions you ever make. In most cases, it’s likely you’ll be better off sticking with the scheme you already have.
That said, there are a number of perfectly legitimate reasons to consider transferring. One of the most common is to increase the amount of money you can pass on after you die.
In most DB schemes you will get two valuable guarantees: inflation protection and a guaranteed spouse’s pension worth at least 50% of your pension income.
Although transferring to a DC scheme will mean you lose both of those benefits, you have the potential to pass on any funds you haven’t yet withdrawn. What’s more, you can usually pass them on to anyone you want to, not just your spouse.
It’s worth noting that DC funds can also be passed on tax-free if you die before age 75. If you die after 75 income tax will be payable at your beneficiaries’ marginal rate.
You can read more about pension death benefits rules here.
Another major factor influencing DB transfers has been fears over the solvency of the employer ultimately responsible for paying the pension.
If this is your primary concern, remember that the Pension Protection Fund (PPF) provides a valuable insurance policy so that, even in the worst circumstances, you should get at least 90% of your promised retirement income.
You can read more about how the PPF works in this article from 2017.
When it comes to investing your fund, the ‘critical yield’ shows the returns you’ll need to achieve (after charges) to match what you would have received from your DB scheme. If your critical yield is higher, your investments will have to work harder to equal your previous benefits.
You’ll also need to think about all sorts of other potential risks, primarily managing your income withdrawals in a sustainable way.
Your financial adviser should be able to talk you through this, although as a very rough rule of thumb if a 65 year old makes annual withdrawals of more than 4% of the initial value of their fund they are at serious risk of exhausting their retirement pot early.