30 Jan 2019
Of all the issues around pensions currently being debated, one which has caught the imagination is that of Defined Benefit (DB) pension schemes, and more specifically, the discussion around transfer values.
In broad terms, a DB pension, also known as a final salary scheme, is a promise by an employer to pay an employee a certain percentage of their final salary once they reach the contracted pensionable age, based on a range of factors including the number of years employed. The pension is payable until the member of the scheme, or in some cases a dependant, dies. This is regardless of how well the company has performed or how the company’s wider pension fund investment performance has fared.
These types of pensions contrast with Defined Contribution schemes, which is where the employee knows how much they are putting in, but does not receive a guarantee of what the final pension will be.
DB pensions have tended to be offered by larger organisations, and are often described as gold plated, for good reason.
Thousands of workers across Scotland breaking into their 50s will be members of a DB Scheme, many of whom may not have appreciated their good fortune back in the 80s’ when they signed up.
Some of these schemes are, by today’s standards, incredible. Banks offered some of the best, an example being RBS, who offered a non-contributory, final salary scheme. Ooft, as the younger generation might say.
There are far fewer schemes available, and for those companies that offered them in the past, they are extremely expensive. For this reason, in the last few years companies have been offering scheme members a premium on the value of their fund, to transfer the pension to another provider.
For the company, there is one clear benefit of encouraging, through the premium paid, a member to transfer. Simply, they discharge any future financial liability.
For members, there are of course both potential benefits and drawbacks.
The benefit of staying within the scheme is that you receive the guaranteed amount until you die. In addition, you can take a tax free lump sum at the beginning. This would of course reduce the amount of annual pension. In some schemes, once you die, if you have a spouse or partner, it will pay a percentage of the pension to them. When your partner dies, the pension dies with them.
By transferring out of the scheme, the biggest benefits are both the potential premium you might receive, and the flexibility of no longer being in the scheme. Also, once your fund has been withdrawn and invested with another savings or investment institution, it is yours to do with what you wish.
In addition to all of this, if you and your partner were both to die prior to exhausting the fund, whatever is left can pass to a nominated beneficiary, potentially tax free depending on the size of the fund and what age you are when you die.
The most obvious downside of transferring the fund is that you no longer benefit from the security of guaranteed monthly income payments, and in most cases will be investing in assets which carry risk.
The losses across global stock markets near the end of 2018 is a recent example of this volatility, with pension funds undoubtedly affected.
There is also the risk that once the fund has been exhausted, something which cannot happen by remaining in the final salary scheme, you would then require other forms of income to maintain your lifestyle.
There will also be costs to transfer out and manage the investments, both of which may impact your fund, as well as the costs of obtaining advice from an Independent Financial Adviser, who must be specifically authorised to provide this service.
Don’t be seduced by a large transfer value, or influenced by what your workmate is doing. It is potentially the biggest financial decision you will make and there are good reasons why the law requires you to take financial advice where your fund is over £30,000. Make your retirement the best it can be, you’ve earned it.