Why is now the time to transfer out of your Final Salary pensions?
This article is for information only and no recommendation is being made or should be construed from the contents of the article. Always seek independent financial advice prior to taking any action.
Six million workers in the UK have a final salary pension, also known as defined benefit pension. The principle perk of these schemes is that you receive a guaranteed income for life based on your final salary or average career earnings. Following the new Pension reforms over the past few years, most of you now have the right to swap your entitlement for cash – and now with transfer values for final salary pensions at record levels, there’s never been a more tempting time to do it.
So why would you swap your final salary or “defined benefit” pension for the more flexible alternative “defined contribution” plan?
The two major benefits of the latter are that you can withdraw multiple lump sums from your pension pot at any point from your retirement and, on your death, you can pass any unused savings on to your dependents free of inheritance tax. In a final salary scheme income is typically not paid after the death of the member’s spouse.
Transferring from a final salary to a defined contribution pension means giving up a regular guaranteed income for a much larger lump sum, typically 20 times the promised annual pension.
But is there any hurry to do this? It would seem, yes – the sooner the better as, according to the experts, we could be at or near the peak of the deals being offered to members to transfer out of a final salary plan. The only way from here is down.
Schemes value their pension promises on the basis of the yields paid on government bonds or gilts. When these yields fall, pension liabilities shoot up. And events over the past few months – the election of Donald Trump and expectations of higher inflation – have had an impact making yields rise from previous historical lows.
Rising yields reduce liabilities, which in turn reduces the amount of money that needs to be set aside now to pay future pensions, which means that Pension scheme providers may be about to reduce the amount they offer to people who want to transfer.
To add to these fluctuations, the recent collapse of BHS has highlighted the exposure of final salary members to the finances of the firms that stand behind the schemes. (See our previous article Final Salary Pension Schemes) If such firms do collapse, schemes fall into the Pension Protection Fund, where incomes are capped at 90pc for people not yet retired.
Simon Munday, founder of Prosperity IFA , commented that he had seen a rise in the number of clients transferring out from their final salary schemes “With falling interest rates added to low gilt yields this means that there has been an increase in the transfer values from final salary schemes making it a good deal for some.
“However, with all good things, this will come to an end. The changing economic landscape will impact negatively on this current situation reducing the benefits of transferring out. Now could be the best time for people to cash out of final salary entitlements.”
But, as with all financial decisions, people must be aware of the down sides to moving away from these schemes.
Final salary pensions are paid out for as long as you live, whereas there’s always the risk that transferred cash will run out. Also, these schemes have in-built inflation protection, which means the value of your income will keep pace with increases in the cost of living. If you do cash in your pension you will lose this protection and will be in charge of guarding against the eroding impact of inflation.
It is vital that you seek professional Financial Advice on this as, when you sell a final salary pension, the decision is irreversible and you have to sell the entire amount.
If you would like to explore what the best move would be for you or want understand the options available, talk to one of our expert Pension Advisors on 01892 300303. For more information on how we can help you, go to our website www.prosperityifa.com.