Solve the great pension puzzle

Should you transfer or hang on to your pot?

MILLIONS of people with pensions t hey are no longer paying into are sitting on a flexible friend that could enhance their financial fitness in retirement. Such pensions are defined benefit company schemes that pay an income for life based on a mix of salary and years of service. They kick in at scheme retirement age, usually 65.

These ‘ deluxe’ plans are not available to younger workers in the private sector but as many as five million people have built significant benefits in them, often from previous employment.

A report to be published tomorrow by insurer Royal London, in conjunction with pension consultant Lane Clark & Peacock, will highlight the value of hanging on to such plans. It will call on savers to brush up on their knowledge of the perks these pensions offer.

Such schemes, it says, are more flexible than many people realise.

The report comes as many employers are tempting former workers to opt out of such plans with inflated transfer values – with the proceeds going into a personal plan. Some transfer values are now equivalent to 40 times the value of the annual pension expected at scheme retirement age.

In transferring, savers can seize control of their pension fund, finding it easier to withdraw cash when they need it or to pass money on to the next generation.

But by moving, savers lose a string of cast-iron guarantees.

Steve Webb, former Pensions Minister and now director of policy at Royal London, says savers must act early to best utilise their defined benefit pension perks. He says: ‘Company pensions are more flexible than many people realise with some plans allowing you to reshape the way income is taken.

‘Many will let you take a lower annual pension earlier, a higher pension later or perhaps offer a higher rate to tide you over between retiring and drawing a state pension.’

For example, if you are due a pension from a previous job at age 65 but wish to draw it sooner – say age 60 – you may be able to do so albeit at a reduced rate. The only draw- back is that the pension will stay at this lower level – apart from annual increases for inflation – for the rest of your life.

If you are in poor health, you may be able to take an early pension at the same level as that available at normal retirement date.

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WEBB says most schemes do not tell savers early about the options available to them at retirement. So it is vital to be proactive. The key is to find out about them well before you are due to draw your pension so you have time to plan and act accordingly. Once any decision is made, it can rarely be undone.

Webb says: ‘Such choices are usually irreversible but taking the right action could make a big difference to a person’s financial wellbeing, t heir quality of l i fe in retirement and the money that passes to their family.’

Keith Richards, chief executive of the Personal Finance Society, says there are two key reasons not to give up a defined benefit pension: the automatic index-linking of the annual pension paid and their more favourable treatment under the ‘ l i fetime allowance’ rules, which cap the size of pension people can accumulate without extra tax being charged.

Most defined benefit plans tend to increase annual pensions by inflation – as measured by the Retail Prices Index or Consumer Prices Index. The lifetime allowance is currently set at £1 million. If the value of a pension fund exceeds this amount a retirement saver pays punitive tax on the excess.

Richards says: ‘A personal pension worth £1 million would at current rates buy an index- linked pension with a widow’s pension of about £30,000.

‘But for a member of a defined benefit scheme, the lifetime allowance value attributed to a pension of £30,000 is lower – about £600,000. Turn this around and it means a defined benefit scheme member could have an annual pension of up to £50,000 without creating a lifetime allowance tax charge.’