The Benefits of a Final Salary Pension Transfer
Flexible access from 55
It is now possible, once you reach the age of 55, to use your personal pension as you wish. There is no longer any need to buy an annuity or have pension income capped at government imposed limits (although anything above 25% of the fund will be taxed at your marginal rate of income tax). You can choose how much to take out and when, so you can take more when you need it and less when you don’t.
Final salary pension schemes are more restricted. They have a fixed ‘normal retirement age’ determined by the scheme’s sponsoring employer, which usually sits between age 60 and the prevailing state pension age. Although most schemes will allow ‘early retirement’ (usually requiring trustee/employer approval), where this option is available, it is normal for your pension to be reduced and this reduction can seem significant.
You can access your pension fund from 55, before the ‘normal retirement age’ of the final salary scheme without incurring penalties, which gives you the option of early retirement. You could also opt to take a smaller amount from your pension to subsidise an alternative lifestyle choice and opt for flexible working or even part-time hours and enjoy semi-retirement from 55.
Leaving an Inheritance
Before the pensions changes introduced in 2014 and 2015, the ability to pass wealth to others efficiently via a pension was limited. Now the owner of a personal pension can nominate anyone to receive the remaining value in their pension when they die. This is called a ‘death benefit’, and is usually paid as a lump sum to the beneficiary, free from Inheritance Tax.
This favourable tax treatment means it can make sense to draw an income from alternative sources in retirement, leaving the full value of your personal pension(s) to your loved ones. So long as it remains invested, the capital within the pension can even benefit from tax-efficient growth.
This is not possible with final salary schemes, although reduced payments may be offered to spouses and young children; there is no provision for unmarried couples or adult children. In these schemes, any value remaining in the pension when you die is usually absorbed back into the scheme itself.
Income tax planning
You’ll have more control over the rate at which you pay tax. Like a final salary scheme, personal pensions can provide an income and/or a tax-free lump sum. But here the similarities stop.
A personal pension owner is able to increase, decrease or indeed stop the income from it at their discretion. The level of pension income and a lump sum is not reliant upon a formula agreed by an employer and based on service and earnings. Instead, you can take whatever level of income you feel is appropriate throughout your retirement.
This flexibility allows you to efficiently manage your tax liabilities. If you do not require the extra income, you can reduce the amount you take and save the income tax. At a later date, you can change your mind and increase it again. If you are managing multiple sources of income, this flexibility can be extremely useful.
If the pension income on offer is surplus to requirement and not essential to your retirement income needs, a transfer can offer additional flexibility (and money), which can be very attractive.
It should be remembered that a private pension does not provide a guaranteed income. If the money runs out, so does your income.
Tax-free lump sum
Personal pensions allow you to take out a tax-free lump sum (usually 25% of the value) as cash. The potential uses of this cash are extensive, from paying down a mortgage to helping the next generation onto the property ladder.
Moreover, this lump sum does not need to be taken all at once. Receiving the cash in instalments has a double advantage. Not only do you retain a larger sum within your personal pension (which is usually free from Inheritance Tax) but the instalments are not added to your other taxable income. This can keep your tax bill lower than would otherwise have been the case in future years.
Most final salary schemes allow a member to draw a one-off tax free lump sum. However, the calculation method often means you get less than 25%.
Sometimes this lump sum is offered at the cost of receiving a smaller starting pension. For other schemes, the lump sum is automatically offered in addition to your guaranteed pension income. Once you have selected your choice of pension benefits, you cannot change your mind in later years.
Control of your investments
One of the major differences between a final salary scheme and a personal pension arrangement is the responsibility for investing the money. For the former, scheme trustees receive professional guidance and pool together member and employer contributions, with a view to covering current and future pension payments. Investment performance does not affect your pension unless it is so bad that the scheme defaults.
With a personal pension, you take control over the investment selection so you can choose where your money is invested.
Pension Scheme Deficits
You won’t have to worry about possible scheme deficits once you’ve transferred out. Although there is some protection for those with pensions under the Pension Protection Fund, which will guarantee 90% of your pension value, this is capped at £33,219.36 for most people, so this may be a consideration for those with a high-value pension.
Many final salary schemes are in a precarious funding position; according to the latest PwC report, the UK’s pension deficit currently stands at £630 billion – which means only just over half (57%) of all liabilities are covered (PricewaterhouseCooper, Oct 2016).
A weak pound has exacerbated the issue since the UK’s decision to leave the EU. If recovery plans do not work, many schemes could run into financial difficulty.
‘Guaranteed benefits’ look much less attractive if the survival of the scheme itself isn’t guaranteed. The Pension Protection Fund (PPF) will secure pension benefits but only up to 90% and it’s capped, but it is not an automatic safety net.
Understanding the risks
If you have never invested before then it can be daunting to know where to start. You’ll need to be prepared to make decisions if and when there are changes in the market and it is wise to seek sound professional advice.
You’ll need investments that match your tolerance for risk and you’ll want to spread your investments so that you’re not overexposed in any one area. Only a qualified Pension Specialist is authorised to advise on Final Salary Pension Transfer and complete the transfer for you. They can also help you manage and maximise your money after the transfer.
Managing your money
Flexibility in a personal pension means you can take varying amounts year on year as well as lump sums, but you’ll also have to create a plan and manage your money wisely to make sure you don’t run out in retirement, once it’s gone, it’s gone.
As a member of a final salary scheme, you’re guaranteed to be paid each and every year until your death or the death of a qualifying financial dependent (if later). However, with a personal pension, you will need to make sure you don’t run out of money so you’ll need to consider life expectancy and plan accordingly. According to the Office for National Statistics, a 65-year-old male has an average life expectancy of 86 (21 years), while a 65-year-old female could expect to live to 89 (24 years). With one in four 65-year-olds today expected to live to 94 (men) or 96 (women), you need to make allowances for the fact you may live longer than you thought and couples need to remember that an income will be required throughout both of their lives.
Your plan should be one that will support you for as long as you need it, most likely the rest of your life, so it is reasonable to expect this to last 30+ years.
Any investment carries risk, investments can go down as well as up. In a final salary scheme you are protected from the market changes and the amount you receive stays the same regardless. However, once you transfer out, the amount you receive is dependent on growth yet to be earned, calculated by the size of the fund, when you plan to retire, how much money you plan to withdraw and when. You should also be aware of:
- Your attitude to risk – if uncertainty causes you anxiety and sleepless nights you may be better off remaining in the safety of the scheme.
- Your capacity for loss – if your final salary pension makes up a large proportion of your wealth or income in retirement then you need to consider how you would cope if the value of your investment went down: Could you still live comfortably if you had to survive on less?
Tax and the lifetime allowance
Under current tax rules, you can build up pension rights worth £1 million over your lifetime, for both final salary and private pension owners. If the Lifetime Allowance is exceeded, an additional tax bill is payable from your pension pot.
The rules relating to the Lifetime Allowance are complex and too involved for this guide, but if you are considering a transfer then it is crucial that they are checked in detail. Understanding the tax implications is part and parcel of working out whether a transfer is in your interest.
There are additional benefits that come with a Defined Benefit/Final Salary Pension, that you will be giving up if you decide to leave the scheme. These benefits may have a value (sometimes significant) to you, so it is important that you understand the implications of giving them up. Each pension scheme is different and you will need to request details of the scheme from your pension provider. The most common additional benefits are:
Final Salary Pensions have inflation protection built in, which means they go up in value every year to protect your money from being eroded by inflation. Private pensions don’t have this. With a private pension, you are reliant on your investments outperforming inflation to protect the value of your pension
If you die as a member of a final salary scheme, an ongoing (albeit, reduced) pension is provided for your surviving husband, wife, or registered civil partner. This taxable pension is payable immediately after your death for the rest of their life. If you have children under the age of 23, further temporary pensions may be payable. A one-off payment may also be made.
If there is no qualifying beneficiary, no other benefit is payable. Any surplus value remaining is retained by the scheme and used to offset future costs of the scheme.
A Pension Transfer Specialist will be able to help you understand the value of the benefits to you e.g. If you are single or divorced and have no dependent children, Family protection benefit will have no value to you.
Four key things to consider before you transfer
Here are four points you will want to be sure of before proceeding with the transfer:
The transfer value represents at least fair value and ideally is generous versus the pension benefits left behind.
Whilst the transfer value may sound like a lot of money as a lump sum, you need to look at it objectively. You’ll have to allow for the impact of inflation and account for the added risk you take on in a private pension versus the security of a final salary scheme. Investments can, and do, go down as well as up, you need to make sure that your calculations, based on the transfer amount, allow for you to meet your goals, even if there are dips in the market – and that you’ll still be able to live comfortably should this not be the case.
You are comfortable with the extra responsibility of looking after an invested fund
It helps if you have had some experience of invested savings in things like ISAs, or perhaps a Self-Invested Personal Pension (SIPP) from a different employer. Unless you are a sophisticated investor, you’ll need to work with a financial adviser to manage and maximise your money to make sure you achieve your goals. This will incur ongoing costs, and you’ll need to be fully aware of these and comfortable with them.
You can cope with a lower level of income later in life if the pension pot gets run down
Generally, individuals will spend more in early retirement and less as they get older. That said, you may need to consider care home or assisted living costs in later retirement. It is important to know how you will cope if your investments don’t grow as you’d hoped and your pension pot gets run down.
Having other savings and sources of income and capital in retirement is a good way of mitigating the investment and longevity risks of going down the transfer route. Examples of these include: –
- Other private pensions including your spouse’s pension
- State pension
- ISAs and savings
- Property – your home and any investment properties you may own
- Stocks and shares
- Premium Bonds
You can make better use of the alternative withdrawal options offered by the transfer route as compared to the scheme cash and income options.
The ability to control pension income from one year to the next can often help those with other savings and income to be more tax efficient. There are lots of ways in which individuals might want differing benefits to those offered by the scheme for example:
- It suits you and saves you tax to be able to take the cash sum early and defer the income withdrawal
- The transfer is big enough that you can preserve its capital value for the next generation whilst still having enough income in retirement
- The guaranteed income offered from the Final Salary Pension is surplus to requirement, therefore the option to move this into a pension that has a cash value is more attractive, due to the flexibility and also the ability to pass wealth onto your family and loved-ones.
- Larger transfer offers can be compelling because they often belong to people with other assets and income such that they don’t need a guaranteed income in retirement and would prefer to use the transfer value in a completely different way, for example, to preserve its value as part of the family assets.
- But smaller transfers can also make sense where there is a clear way to use the money which makes more sense to the individual than to take the life time pension, for instance clearing a mortgage.
- Ill health can be a compelling reason for some. If it’s clear your life expectancy has been shortened, then the chances are you and your family will get more cash from a transfer than staying in the scheme.
3 steps to making a successful transfer
Step 1 – Get your transfer value
The first step is to get a transfer offer in writing from your scheme by submitting a request for a transfer offer to the scheme administrator. You can do this yourself or your adviser can do it for you and get copied in with the correspondence. If you know who you are going to use for advice it makes sense to involve the adviser as early as possible as they will then be able to go to the scheme administrator directly for any information they need not included in the transfer value offer.
Transfer offers generally come with a three month guaranteed window during which the scheme will not recalculate the transfer value. This gives you three months to get the advice you need, to plan what you might do with the transfer and then make a final decision to accept it.
Please note that this may not be the case for all schemes. If in doubt you can request details of the process from your pension executor or ask your financial adviser to clarify the process.
Members are generally entitled to one free transfer offer calculation every year. If you want more than this you will likely be charged for the actuary’s time, typically a few hundred pounds.
Step 2 – Get the advice you need
For those with transfer offers of more than £30,000, it’s now a legal requirement to get advice on a transfer from a qualified Pension Transfer Specialist before it’s executed. Pension providers and schemes are effectively policing this by refusing to accept and pay transfers unless there is proof the advice has been received.
We’ve put together a handy checklist of everything that should be covered when you seek advice about a transfer here>>
N.B. The checklist is also included in the PDF download of The Definitive Guide to Final Salary Pension Transfer, which you can download here>>
Step 3 – Establish a plan for after the transfer
You will need to have a plan that takes into account:
- When will you likely make withdrawals from your pension and what will these be?
- How will the transfer money be invested?
- Who will manage your investments?
- What kind of investments will make up the fund?
Once you have decided on the above you, or your adviser on your behalf, will need to find a secure, cost-effective and properly serviced pension solution that will facilitate your plan.
- Whilst thinking about how to invest the transfer money you should also take the opportunity to review all your existing investments and use of tax wrappers such as ISAs and offshore bonds. The 2016 and 2017 budget changes have created enormous opportunity to enable those generating income in retirement to lower their tax payments.
- With the flexibility of pension drawdown and with the extra cash from the tax-free sum you should be looking to see how you can optimise:
- Your £5,000 dividend allowance (due to be reduced to £2,000 from tax year 2018/19)
- Lower Capital Gains tax rates
- A £1,000 per year Personal Savings allowance (£500 a year for higher rate taxpayers)
- Tax-free ISA income – as of April 2017 the personal allowance is £20,000
From April 2017 couples who organise their investments tax efficiently can enjoy over £50,000 per year of tax-free pension income, savings income, dividends and capital gains, plus their tax-free ISA income before paying a penny of tax.
Final salary advice checklist
If you are considering transferring your Final Salary Pension, you’ll need to assess your financial situation with a qualified Pension Transfer Specialist. Your suitability to transfer will be based on your own set of personal circumstances and financial objectives for retirement.
If you are married or in a civil partnership, it is essential to involve your spouse in the advice process as this decision will affect their financial future as well.
Here is a checklist of what should be covered in the advice you receive:
- A full explanation of the pension and cash sum benefits you would leave behind, including options for early and late retirement.
- A full explanation of the options open to you along with the governing rules and tax treatment of the personal pension fund that will be created by the transfer.
- A full explanation of the key risks associated with the transfer option as well of those of remaining in the scheme.
- A personalised critical investment return assessment which will look at what investment return is required on the transfer value to match the defined benefit pension you would leave behind.
- If you have a larger transfer value or have opted for protection against the lifetime allowance, then an explanation as to how the lifetime allowance impacts your fund and any changes to your protection caused by the transfer.
- Importantly the adviser should offer their opinion as to whether the pension transfer is a sensible transaction for you to undertake given your special circumstances and financial objectives.
- To do this they will need to:
- Understand you and your family’s financial position.
- Make sure that you and (if applicable) your spouse are comfortable and have the financial resources to tolerate the risks implicit in the transfer option.
For a list of questions that you will be asked, see our Final Salary checklist
The 2020 Final Salary Pension Transfer Process
Free Initial Call
We’ll have an initial call to discuss your situation and establish whether you have a case for transferring your pension. You’ll be asked general questions about your financial situation, whether you have a spouse, children and your reasons for wanting to discuss a pension transfer
We’ll then schedule an introductory meeting.
Fact finding and due diligence
At this stage we will
- Collect information from you about your objectives, priorities and personal circumstances.
- Contact your pension scheme to request a CETV^ (if not already available). * Please note with CAAPS (Civil Aviation Authority Pension Scheme) their process is different, if applicable we will discuss this with you
- Request specific information about the scheme benefits from your existing pension scheme
Analysis and Appraisal
Our Pension Specialists will analyse your pension scheme benefits and, taking into account your objectives, evaluate whether a transfer would be appropriate for your circumstances.
You’ll receive a full Summary Report with our recommendation and you’ll be able to see examples of how your pension pot might look in the future with your proposed monthly drawdown.
Implementation (where a transfer is recommended and you decide to proceed)
We will complete the necessary paperwork to transfer your pension to a suitable personal pension arrangement * and advise on:
- The investment strategy for your pension fund
- The level of cash and income withdrawals, if required
We will monitor and review your pension investments and recommend changes as appropriate. You’ll have regular reviews to assess your cash/income withdrawals in light of changing personal circumstances and external market conditions and you’ll receive on-going advice on the suitability of your pension arrangement. We’ll recommend changes where appropriate.
^ Please remember that your CETV is only guaranteed for a period of 3 months so it’s important to commence the advice process quickly as obtaining the necessary information can take a number of weeks. Where possible, it’s usually best to let us obtain your CETV so that we can obtain the necessary information at the same time.
*If you are an experienced investor, it may be possible to manage the on-going retirement risks yourself and request where your pension is transferred. We will still insist on completing the transfer to your chosen pension provider.