Defined Benefit pensions: Is it appropriate to transfer out?
Please note: Transferring out of a Final Salary scheme is unlikely to be in the best interests of most people.
Do you have a Defined Benefit (DB) pension? If you’ve seen the sums you could receive by transferring out, you might just be tempted. However, it’s not the right choice for everyone and it’s crucial to consider the long-term impact.
Receiving a lump sum that’s probably many times the annual value of your pension might seem like a dream come true. Plans of jetting off on holiday, making a lavish purchase or helping loved ones might already be filling your head. But you’ll still need to fund your retirement for the rest of your life. So, whilst transferring out might sound like a fantastic idea, to begin with, it’s not always appropriate.
Why are people opting out of Defined Benefit pensions?
First, let’s take a quick look at what a DB pension is.
A DB pension provides you with a guaranteed income throughout retirement, rising in line with inflation to maintain spending power. Members pay in a portion of their salary and how retirement income is calculated is defined from the outset. Typically, it’s linked to the number of years paying in and final salary. For this reason, a DB pension is also commonly referred to as a Final Salary pension.
The option of a guaranteed income in retirement is certainly attractive. But according to XPS Pensions Group between 50,000 and 70,000 DB members are leaving their scheme every year.
There are two key factors driving this trend.
The first factor is the Cash Equivalent Transfer Values (CETV) being offered. This is the amount members receive as a lump sum to transfer into. As the responsibility of meeting retirement income falls to DB pension trustees, many are keen to reduce the number of members they have given improving longevity. As a result, CETVs have increased in recent years. It’s not uncommon to be offered a CETV that is 30 or 40 times your projected annual retirement income. In April, the average transfer value was £242,300.
The second reason is down to the flexibility offered with Defined Contribution (DC) pensions. Four years ago, Pension Freedoms were introduced, and DC pension holders can now often access their pension from the age of 55 flexibly, including taking a 25% tax-free lump sum. For some DB pension holders transferring out is attractive due to the increased number of options they’d have. However, with a DC pension, it’s important to note the individual takes responsibility for creating an income and it may be exposed to investment volatility.
What would you be giving up?
Before you even start to think about whether you should leave a DB pension scheme, it’s important to understand what you’ll be giving up; it’s a decision that can’t be reversed.
A DB pension provides you with a level of security throughout retirement. You’ll know that you have a reliable source of income that will continue until you die. The only other way to achieve a guaranteed retirement income is through purchasing an Annuity, which would be unlikely to deliver the same level of benefits. For many DB pension holders, the drawbacks of giving this up outweigh the benefits of leaving their scheme.
Many DB pensions also come with other benefits, some of which may be valuable to you. Depending on your situation, for instance, a spouse or civil partner pension may give you peace of mind.
Is leaving a Defined Benefit pension scheme appropriate for you?
After thinking about what you’d be giving up by leaving a DB pension, you might still be interested in leaving. If you are, it’s important to weigh up whether it’s appropriate for you. There isn’t a single answer to the above question. It will depend on a range of factors.
Answering these questions below can act as a starting point for exploring whether leaving a DB pension is the right option for you. However, we’d always recommend that you seek professional advice. One thing to note here is that should a CETV be £30,000 or more, you must take financial advice from a regulated professional. Leaving a DB pension will have an impact on your income for the rest of your life and isn’t a decision that should be made lightly.
- What are your reasons? First, take a look at the reasons why you’re considering leaving a DB pension scheme. Is it because you’re tempted by the CETV or want flexibility? Going back to the reasons why you’re interested is crucial for understanding if there are alternative solutions available.
- How will you create an income? Without a DB pension, you’ll need to take control of how you’ll build an income that will last throughout retirement. Looking at how decisions relating to how you take an income will affect your finances now and in the future, as well as taking the time to understand the risks of each option. You should also consider longevity and how you’ll ensure the income lasts a lifetime here too.
- What is your risk profile? A DB pension provides you with a secure income throughout your retirement, whilst leaving will mean you’re likely to be exposed to risks. This could include the risk of spending too much too soon, investment values falling or inflation affecting your savings. If your overall attitude to risk is to avoid it, leaving a DB pension may not be the best option.
- What are the alternatives? Often, there are alternatives to leaving a DB pension. If, for instance, you wanted to benefit from a lump sum to kick-start your retirement plans, could you do this by taking money out of savings or investments? Of course, it’s equally as important to understand how any alternatives would affect your wealth in the short and long term too, this is an area financial planning can help with.
If you have a DB pension and would like to discuss your options, including the financial impact of leaving the scheme, please contact us.
Please note: The decision to transfer out of a Defined Benefit pension cannot be reversed. The merits or otherwise of transferring out will depend on individual circumstances. Legislation and regulation are subject to change in the future.
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