Advantages and Disadvantages of Final Salary Transfers

Transferring your Final Salary (or Defined Benefit) Scheme into Pension Drawdown involves swapping your guaranteed pension entitlement for a cash sum and investing it into a registered, or HMRC recognised, pension scheme.

It is a big decision and one we are here to help you with, in fact we have been advising clients on final salary pension transfers since 1999 and are specialists in this field.

We take our pension transfer advice very seriously. As such, all three of our pension transfer specialists have adopted the Gold Standard for pension transfers which means that we have committed to an advice process that is underpinned by adherence to nine principles. These are designed to empower you to:

  • Make an informed decision on whether a transfer of your pension benefits is appropriate for you
  • Help in understanding what good advice in this area should look like

The nine principles:

  1. Helping clients understand when advice is appropriate
  2. Ensuring advice given supports the clients overall wellbeing in the context of their stated objectives
  3. Ensuring client understanding and acceptance of all charges
  4. Ensuring the most appropriate and updated technical skills are applied
  5. Transparent management of Conflicts of Interest
  6. Helping clients understanding the cost of transferring benefits
  7. Avoiding unregulated investments and introducers*
  8. Transparency in advice processes and outcomes
  9. Promoting the Consumer Guide to the Pension Transfer Gold Standard

For further information, please see: https://www.thepfs.org/about-us/initiatives/the-pension-transfer-gold-standard/understanding-the-pension-transfer-gold-standard/

Advantages of doing a Final Salary Transfer

Flexibility: Transfers offer you complete flexibility over when and how much you draw from your pension and are in complete contrast to the typically fixed monthly pension income paid by Final Salary Schemes. It is implausible that 60-year olds retiring now with the prospect of potentially 30 years or more of retirement will have the same cash needs year in year out until they die. This flexibility extends to taking the cash as early as age 55 and deferring the taxed pension until it is needed. With a final salary pension, you are required to make a decision when you retire as to whether to exchange some of your income for a tax-free lump sum. If you take this option, you also must start taking an income from the scheme at the same time. Some people may wish to ease themselves into retirement in which case a transfer would provide greater flexibility.

The potential uses of this early cash sum are extensive, from paying down mortgages early, to investing in ISAs to generating tax-free income, or helping the next generation on to the property ladder.

Tax: The increased flexibility provided from transferring a Final Salary Scheme into Pension Drawdown facilitates efficient tax planning. In many of the cases where we have recommended a transfer, we have improved tax efficiency and tax flexibility for our client as compared to the final salary pension benefits.

A final salary benefit can be a significant family financial asset, a transfer capitalises and gives you control of this asset, which can be passed down through the generations without inheritance tax.

Concerns about the solvency of the sponsoring employer: If the employer who sponsors your final salary pension scheme is in trouble, or at risk of becoming insolvent, then there is a chance that you might not get all of the pension you were expecting. But if you transfer out of the scheme then your investment fund will be unaffected by what subsequently happens to your ex-employer’s business. There are many ways in which the Pension Protection Fund (PPF) can help in these circumstances. The terms and benefits of final salary schemes can differ when compared with others so this can be a complex area. We recommend that you see the full information about the PPF on their website - www.ppf.co.uk and how it might affect you. Please note that once the PPF become involved with a scheme, it will not be possible to subsequently transfer out.

Life expectancy/health One of the advantages of a final salary DB pension is that it lasts as long as you do.

But what about people who think – or know – that their life expectancy is likely to be on the short side? For example, if you draw a pension at 65 and die at 71 then you will not have got much out of the pension scheme compared with someone who lives well into their nineties. DB pension schemes work by pooling risk, and in effect those who live for the longest time are subsidised by those who live for the shortest time.

If you think you might be one of those whose life expectancy is below average, then you might consider taking a transfer out. The value you are offered should (broadly) reflect average life expectancy and this may be a bigger amount of money than the amount it would have cost the scheme to pay your pension if you had stayed in but died relatively young.

Disadvantages of doing a Final Salary Transfer

Certainty: One advantage of having a Final Salary Pension is that it lasts as long as you do. If you happen to live longer than average then the scheme has to find the money for this. If you decide to transfer away from the scheme then someone else has to manage the risk – either you or a financial adviser. There is a risk that if the investment does not perform that you could run out of money prematurely. Alternatively, you may be so worried of running out of money that you draw down the funds too slowly and miss out on enjoying the full benefit of your retirement savings.

Inflation: Whilst inflation currently remains low (2020), this may not always be the case. If you happen to be retired for 20-30 years, the value of having an income which has some protection against rising prices could be considerable. Many DB schemes are inflation-proofed but check your own individual scheme for precise details. Of course if you invest your DB pension proceeds successfully, you may be able to achieve an above-inflation rate of return but the protection against inflation is not guaranteed in the way that it may be with a DB scheme.

Investment risk: As a member of a DB scheme your money is invested for you and in reality it is rarely something you have to give a second thought to. The scheme has to pay your pension come what may so in effect you are insulated against the ups and downs of investments. By contrast, if you take a cash equivalent transfer and invest the money yourself, the value of your fund can, and will, go up and down. The upside of this is that your capital could grow considerably but the downside is that if your assets perform badly you will have to live on a much reduced income. A key consideration therefore is your attitude to risk. It is important to consider how you might feel and how you would cope if your investments did badly. This is something to talk through with your financial adviser.

The effect of advice charges may also erode your capital.

Provision for survivors: Since 1997, Defined Benefit pension schemes have had a legal duty to provide a pension for a surviving spouse (and children up to a certain age) if the scheme member dies after reaching a scheme pension age (this may differ and is dependent upon your scheme rules). This is a valuable benefit and should not be dismissed lightly.

Final Salary Scheme to Pension Drawdown transfers are irrevocable: You cannot change your mind a few weeks or years later if you regret having made the transfer.

Risk Warning exclamation mark icon

This guide should not be construed as individual advice to transfer out of a final salary pension scheme. Pension transfers are relatively complex and irreversible transactions and it is both imperative and a legal requirement to seek advice from a suitably qualified adviser before accepting a transfer.

Always remember the value of investments and the income they produce can fall as well as rise and you might not get back all your initial capital. This document has been produced based on our understanding of current pension rules and pension tax treatment. These do change from time to time.

The FCA think that keeping safeguarded benefits will be in the best interests of most consumers. Their current stance is that a transfer, conversion or opt-out will be unsuitable. When giving full advice, advisers should only consider a transfer, conversion or opt-out to be suitable if it can be clearly demonstrated, on contemporary evidence, that the transfer, conversion or opt-out is in the client’s best interest.

Risk Warning exclamation mark icon

This guide should not be construed as individual advice to transfer out of a final salary pension scheme. Pension transfers are relatively complex and irreversible transactions and it is both imperative and a legal requirement to seek advice from a suitably qualified adviser before accepting a transfer.

Always remember the value of investments and the income they produce can fall as well as rise and you might not get back all your initial capital. This document has been produced based on our understanding of current pension rules and pension tax treatment. These do change from time to time.

The FCA think that keeping safeguarded benefits will be in the best interests of most consumers. Their current stance is that a transfer, conversion or opt-out will be unsuitable. When giving full advice, advisers should only consider a transfer, conversion or opt-out to be suitable if it can be clearly demonstrated, on contemporary evidence, that the transfer, conversion or opt-out is in the client’s best interest.