an estimated 100,000 people have left Final Salary Pension Schemes Since April 2017. Withdrawing pension values totalling £14.3bn. These gold-plated pensions are highly sought after for their guaranteed benefits, so why are so many people transferring out?here has been much talk in the press about final salary pensions and new rules that could affect you if you have one. According to the pensions regulator,
In April 2015 sweeping changes to the pension industry have made the idea of transferring out of a Final Salary Pension Scheme much more attractive. The most radical changes to private pensions for a generation were brought into force, meaning that those with private pensions had much more freedom and choice in how they accessed their pension.
Final Salary Pensions & New Rules
Many, but not all, of the changes to pension rules, are linked to the 2015 pension freedoms. Knowledge and understanding of the impact of these changes is still limited across most of the population. We examine these new rules and how they could affect Final Salary Pension holders…
1. Access your Pension From 55
Without a doubt, one of the biggest changes to the pension industry is the new rule allowing anyone with a private pension access to their pension pot from 55. The changes opened the door to the prospect of early retirement for thousands of people across the UK. For those with a private pension, you can take just some or your whole pot in one go.
N.B. It is important to note that withdrawing more than 25% of your pension fund will result in you being taxed at your marginal rate of income tax.
Individuals with a Final Salary Pension still need to wait until their scheme’s pensionable age before they can access their pension. In some cases, early retirement may be considered by your pension scheme administrator but your benefits will be adjusted and you may receive considerably less than you had previously been forecasted.
For those with a Final Salary pension considering early retirement, the new rules could make transferring to a private pension a more attractive prospect to give them early access to their pension savings.
Changes for those with a private pension mean you can take just some or your whole pot in one go from 55
2. Tax-Free Lump Sum Rules
The pension changes brought in in 2015 allow private pension holders access to a 25% tax-free lump sum from 55. Individuals can access this lump sum without needing to draw the rest of their pension. So, if you have a private pension you can take your tax-free lump sum at 55 and leave the rest of your pension invested until you retire. Private pension holders don’t need to take all of their tax-free cash in one go. You can take your tax-free cash in chunks over time.
Tax-free lump sum for Final Salary Pension Holders
Most final salary schemes also allow pension holders to draw a one-off tax-free lump sum but you cannot take it in chunks, you need to take your lump sum all at once and normally the scheme pension must be taken at the same time.
It is worth noting that this lump sum is often offered at the cost of receiving a smaller starting pension. Sometimes, this lump sum is automatically offered in addition to your guaranteed pension income, but, it’s important to note that the calculation method used to determine how much you would receive often results in you receiving less than 25% of your pension pot. So check first and make sure you understand the cost of taking this tax-free lump sum because once you have selected your choice of pension benefits, you will not be able to change your mind in later years.
3. Drawdown Limits Removed
From 6 April 2015, the limits on how much or how little you could take from your drawdown fund (see our drawdown calculator) each year were scrapped. Previously the amount you could take as income was capped at 150% of the income a healthy person of the same age could get from a lifetime annuity. Now, however, you are allowed unlimited withdrawals.
For higher earners the option of a flexible income offers them the opportunity to manage their income in a tax-efficient manner, taking less when they don’t need it and more when required. They can balance their income requirement with their tax-liability.
For individuals with a Final Salary Pension that takes them into the higher-rate tax bracket, the ability to access their money in a more flexible way may be advantageous for tax planning purposes.
4. Changes to the Lifetime Allowance
The Lifetime Allowance is a limit on the amount you can take from your pension without triggering an extra tax charge.
The Lifetime allowance was reduced from £1.25m down to £1m in April 2016 but in 2020/2021 it will increase to £1.073 million from the current level of £1.055 million.
Current taxable rate over the LTA
- 55% if you get it as a lump sum
- 25% if you get it any other way, for example, pension payments or cash withdrawals
Example of Lump sum withdrawal over the lifetime allowance per £1000
You’ll pay a flat-rate 55% tax on any lump sum you take from your pension once you are over the lifetime allowance. So for every £1000 you take over the lifetime allowance, you’ll receive £450.
Example of income withdrawal over lifetime allowance per £1000
If you take your pension as regular income withdrawals you’ll pay a 25% tax surcharge once you go over the lifetime allowance. So for every £1000 of income, you’ll pay £250 in lifetime allowance surcharge and then 40% tax on the remaining amount. After tax, you’ll receive £450.
For defined benefit pension schemes, your pension scheme administrator should pay the 25% tax to HMRC out of your pension pot, leaving you with the remaining 75% to use towards your retirement income. This will be collected at source by the pension scheme from day one of the pension payments.
Those with private pensions valued at more than £1.03m (or higher with protection) can defer the impact of the lifetime allowance to age 75.
This can be achieved by keeping withdrawals within the lifetime allowance limits up to age 75, thus gaining the benefit of a largely tax-exempt investment account until that date, when the surcharge tax will become due on the excess value of the fund – 55% if taken as a lump sum or 25% tax if taken as income. Read more here
5. Changes to Inheritance Rules for Private Pensions
Changes to Inheritance tax rules in October 2014 brought greater flexibility over who can inherit your pension. Private Pensions in drawdown can now be left as a legacy to any beneficiary that you nominate. They do not have to be your spouse or civil partner, opening up the doors to leave a tax-free legacy to adult children, siblings or grandchildren.
Your beneficiaries could receive either a lump sum on your death or they can inherit your drawdown plan as their own pension pot.
‘Inherited drawdown’ allows your beneficiaries to take out as much or as little as they need, when they need it, without having to wait until they retire.
If you die before the age of 75 and your beneficiary takes the money within 2 years the money is tax-free. If you die over the age of 75, your pension provider will deduct income tax from anything they take.
If you have taken some or all of your savings out of your pension – e.g. to put into a bank account or another type of investment– that money then becomes part of your estate and could be subject to inheritance tax. This includes anything left unspent from your pension tax-free lump sum.
Your private pension could now provide a tax-free inheritance for your loved ones
How Do These Inheritance Rule Changes Affect Final Salary Pension Holders?
The rules are different for those with Final Salary Pensions. When you die your scheme may pay a reduced pension to your spouse but you are not able to pass on the full value of your pension. They will not normally be able to take the money as a lump sum and you normally cannot nominate an adult child or another beneficiary.
If you are unmarried, it is important to know that when you die your Final Salary Pension is absorbed back into the scheme for the remaining members. You cannot pass the money on.
It is this change that has made many consider transferring out of their Final Salary Pension. Although, it is important to remember that there are often ways to retain the benefits of a Final Salary Pension, i.e. remain within the scheme, and to implement plans to pass on wealth in other ways i.e. you could consider a life insurance policy.
N.B. Death benefits vary from scheme to scheme, always check with your pension scheme provider for details of the rules applying to your scheme.
6. Pension Protection Fund Limits
The Pension Protection Fund has been highlighted in the press with the collapse of BHS and the British Steel Final Salary Pension fund. There is much fear-mongering surround the collapse of Final Salary Pension Schemes with people wrongly assuming that they could lose all of their pension savings. The reality is that you need to have a pension pot of over £2million before you start missing out significantly.
The PPF was set up in April 2005 to protect those with Final Salary Pension if their employer goes bust and its pension scheme can no longer afford to pay their promised pension.
As of 1 April 2018, if your Final Salary Scheme goes bust and if covered by the Pension Protection Fund, they will pay 90% of the value of your pension up to a maximum of £39,006.18 (this equates to £35,105.56 when the 90 per cent level is applied) per year. The payments will rise in line with inflation (up to a maximum of 2.5% per year).
If you have already retired and are claiming your pension, and/or you were/are over the scheme’s normal retirement age at the time the scheme went bust the Pension Protection Fund will generally pay 100 per cent of what your pension scheme was paying you. The payments will also rise in line with inflation (2.5% maximum applies here too).
7. You Must Seek Regulated Advice if Your Transfer Value is Over £30,000
If you are considering a Final Salary Pension Transfer and your pension pot is worth more than £30,000 you must seek professional advice from a regulated financial adviser, they also need to be a qualified pension transfer specialist. Pension Transfer Specialists have in-depth and up-to-date knowledge of final salary pensions and new rules affecting them, they’ll be able to explain your options to you as well as any risks or benefits involved.
Your scheme provider will not transfer your funds without proof that you have obtained this advice.
Pension Transfer Specialists have in-depth and up-to-date knowledge of final salary pensions and new rules affecting them
There is a good reason for this requirement. The decision whether or not to transfer out of a Final Salary Pension Scheme is not one that should be taken lightly. Final Salary Pension Schemes are extremely valuable and many people do not understand the true value of the asset they have. A guaranteed, inflation-protected, income for life, especially with people living for longer, is not something to be sniffed at and is often worth much more than people realise.
Beyond the cash equivalent transfer value, there are often other benefits – like a protected retirement age or death benefits that also need to be considered.
And then there’s the element of Risk. Moving from a Final Salary Pension scheme to a private pension brings with it an element of risk and added responsibility. Your pension is no longer managed and invested by your pension scheme administrators and benefits are no longer guaranteed. You’ll need to invest your pension fund to provide yourself with a future income.
A full pension transfer analysis is incredibly in-depth and will take many hours of work by a qualified specialist. You will need to pay for this advice. Please note that fees vary from firm to firm.
For full details of what you should be thinking about before you transfer, we recommend reading 4 key things to consider before you transfer your Final Salary Pension .
8. Personal Recommendation to Transfer
Following a lengthy consultation the Financial Conduct Authority have updated guidance on pension transfers and now require all advice to be a personal recommendation, which means the advisor is responsible for the advice they give you. If you feel you have mis-advised you will have recourse through the Financial Ombudsman.
This means a financial advisor needs to carry out full analysis before recommending any transfer – whilst this should have always have been the case, some firms were simply not being thorough enough in their approach.
9. Self Managed Investments after Final Salary Pension Transfer
Another of the big concerns raised by the FCA during their Defined Benefit Pension consultation was the sheer number of individuals being advised to transfer their pension without being given any advice on how to invest the money afterwards to protect the value of their pension fund.
For this reason, a growing number of insurance firms are refusing to cover Final Salary Pension Transfers unless the firm recommending the transfer is also managing the fund after the transfer. So, if you are seeking to transfer your fund you may find fewer firms willing to recommend a transfer if you are wanting to self-manage your private pension afterwards.
With a growing number of insurers moving out of this area of the market many Financial Advice firms have already been forced to stop offering this service and you may find far fewer firms offering this as an option in the future.
Final Salary Pensions and New Rules: Summary
The changing landscape for pensions has opened up many possibilities for those considering a Final Salary Pension Transfer, but it is essential to get the right advice based on your personal circumstances and to consider the benefits and risks as they apply to you.
About the Author
Simon Garber DIP PFS is an Independent Financial Advisor and Qualified Pension Transfer Specialist. He is the Managing Director and Founder of 2020 Financial, based in Southampton, Hampshire. Simon specialises in Pensions and Retirement planning and is a later life planning specialist. He also holds qualifications in investment and life insurance and is a member of the Personal Finance Society and Chartered Insurance Institute.
Simon is passionate about providing the highest standards of customer care and transparency. 2020 Financial were awarded the Pension Gold Standard in 2019. You can find out more about Simon here.
GOT A QUESTION? TALK TO A SPECIALIST
Sometimes it’s just nice to talk to a human. Especially when that person is a Qualified Pension Transfer Specialist with experience of Final Salary Pension Transfers. We offer a free, no obligation, 20-minute call with one of our specialists. Pick our brains, get your questions answered and find out how to get started or arrange an introductory meeting to get the ball rolling.
This guide does not constitute personal advice, nor should it be treated as such. It is provided for general information and it is vital (and in most cases a regulatory requirement) that you contact a Qualified Pension Transfer Specialist for personal financial advice and obtain a recommendation to transfer before opting out.
- If you are a member of a pension scheme with safeguarded benefits, it is likely it would be in your best interests to retain the safeguarded benefits.
- Make sure you understand all the risks before investing.
- The value of investments and the income they produce can fall as well as rise and you may not get back your original investment. Once you transfer, you will become responsible for the management of your investments.
- Any information contained within this website should not be deemed to constitute investment advice and should not be relied upon as the basis for a decision to enter into a transaction, or as the basis for any financial or investment decision. Investors should always seek professional advice in regard to the suitability of any investment.