Should you cash in or keep final salary pensions?

Risks can make it a huge error

WORKERS are being offered bumper amounts of money to cash in final-salary pensions and give up the cast-iron guaranteed income.

A sum that’s up to 40 times the annual pension you would receive sticking with a final-salary (definedbenefit) scheme can be very tempting.

And with a constant stream of big firms going bust, workers may feel safer taking the cash when they can.

For some, it may be right for them to transfer their cash to a more flexible option, such as people with serious health issues or savers with other money sources who don’t need the regular income for everyday living.

But for most savers it could be the wrong move.

There’s a huge risk from fraudsters, for a start. They’ve already pinched £22.7million from pots since the pension freedoms began in 2015.

And savers could also end up in unsuitable newer pension schemes and run out of cash too early.

Latest industry numbers show that £34billion was transferred between pension contracts last year, with an average value of £250,000 for definedbenefit pensions.

It is estimated over six million pensions are eligible to transfer out from final-salary schemes – the gold standard for pension provision in the UK. Workers fortunate enough to have these schemes get a pension promise based on earnings and length of service with their employer.

Final salaries were common in workplaces many years ago, with companies such as Tesco, Royal Mail and BT offering them as part of the staff benefits package.

Over the past decade many have closed, or been closed to new members as employers struggled to grapple with costs. They’ve simply become too expensive for most employers to provide.

If you join a company today you will most likely be auto-enrolled into a defined-contribution pension, where you save every month and the amount you get in retirement is based on how the fund performed over its lifetime.

So why would so many people consider moving from the guarantee of an income for life to a pension where retirement income is dependent on how much you save and the performance of the stockmarket?

Andrew Tully, pensions technical director at Retirement Advantage, explains: “At first glance it would appear mad to move your pension from the safety of a defined-benefit scheme to one where you take all the risks.

“I’d say in most instances it won’t be in your best interest to move money out of a final-salary type scheme into a different type of pension. But there are situations where it can work – and that’s where proper regulated financial advice is key.

“The Financial Conduct Authority recognises this is a complex decision and insists most people speak to a pension transfer specialist.”

Life-changing sums of money can be involved, and an adviser can help you decide if a transfer is in your best interests. Steve Webb, former pensions minister and director of policy at insurer Royal London, says: “Whether or not to transfer out of a company pension is a very individual decision and depends on a wide range of factors. For some people, staying in a pension with guaranteed income that lasts as long as you live and pays out something for a widow or widower may well be the best option.

“But for others, the greater flexibility offered by a cash transfer, and the greater potential for children to inherit this money, might be attractive. The most important thing is to have an open mind when you talk to an expert adviser and listen carefully to the advice you receive.”

The Pensions Regulator warns people to take care when deciding whether to transfer a pension pot out of a secure defined-benefit scheme.

A spokesman says: “It’s really important savers seek guidance or advice before making what could be a costly mistake or even worse, falling victim to a scam. In most cases, transferring out of a DB pension scheme into a different type of pension arrangement is unlikely to be in someone’s best interests.

“If you do decide it is in your interests to transfer, it’s important to understand the scheme you transfer to, including the fees taken by all parties as these can significantly affect the final value of your pension.”

PROS AND CONS OF CASHING A DEFINED BENEFIT PENSION PROS

You may have health conditions which limit life expectancy. Transferring means you are giving up a guaranteed income for life, but you have complete control of your pension to use as you wish.

You may be single, so the automatic spouse income from the defined benefit pension simply isn’t relevant to you.

You can control when you access your money, including the income, any lump sum, and control how much tax you pay on income and tax on death.

Transfer values have been higher than usual due to economic conditions.

CONS

You are giving up a guaranteed income for life which will usually increase each year in line with the cost of living.

You must seek proper regulated financial advice which can be dear (this applies to any transfer where your pension is valued at over £30,000).

Have an open mind when you speak to an independent adviser

You leave yourself vulnerable to fraudsters who might encourage you to invest in unregulated investments.

The financial regulator and an influential working party of MPs are concerned about poor practice in the market and cases of inappropriate or poor advice. So always take your time and choose your adviser with care.

Andrew Tully says: “There are situations where transferring a finalsalary pension can make sense, but it is one of the single biggest financial decisions you can take in your lifetime. And there is no going back if you transfer and subsequently change your mind. So take your time, speak to your family, and find a good regulated financial adviser.”

OPTIONS FOR TRANSFERS

So where can you put your money if you do decide to transfer? Typically, people are moving cash into personal pensions, defined-contribution pensions or using income drawdown. For more flexibility, and to suit needs exactly, there are also hybrid products where you can combine annuities and drawdown, guaranteeing an income for life to pay the bills and also have a flexible pot to dip into as and when.

EXAMPLE OF OPTIONS

John, aged 62, is divorced with one daughter. He smokes and has diabetes. He is in a deferred finalsalary scheme and is currently considering his options.

He is thinking about retiring, but his deferred pension retirement date is set to 65, so if he takes benefits early they will be reduced.

He has been given a transfer value of £405,000 by the scheme trustees.

The final-salary scheme will pay a tax-free lump sum of £73,085 at age 65, with an annual pension of £10,962, and a spouse’s pension of 50%, all benefits rising in line with LPI (Limited Price Indexation, usually the lesser of RPI and 5%).

Option 1

Retain the finalsalary pension and take the benefits at 65, or take benefits early if the scheme allows – but with a reduction in tax-free cash and the annual pension. Option 2

Or at 62, use the transfer value to invest in drawdown, where he can withdraw as little or as much as he wants, when he wants.

Take the tax-free cash of £101,250 (25% of £405,000) and invest the rest (£303,750).

A relatively safe withdrawal rate could be about 3.5% a year, generating an income of around £10,631 but this isn’t guaranteed. Option 3

Or again at 62, use the transfer to buy an annuity and income drawdown. Take the tax-free lump sum of £101,250 and invest £271,312 in an annuity to match the starting income of the initial finalsalary scheme (note the income is not index linked but is guaranteed). Invest the balance of £29,249 in drawdown and use as he wishes.