Final Salary Transfers – the good, the bad and the ugly

FINAL Salary (or Defined Benefit) transfers have been in the news again over the last few months, with more negative stories of failing companies, lost guarantees, poor advice, Financial Conduct Authority (FCA) rumblings and soapboxing MPs.

Whilst it is fair to say the majority of the headlines have been dominated by the British Steel saga, it is not the only story to have been doing the rounds of late.  So why all the fuss about someone wishing to exchange their guaranteed Final Salary pension for a pot of money transferred to a Self-Invested Personal Pension?  To answer that we need to look at the differences between the two benefit types.

Final Salary pensions are a guarantee from the Scheme to the individual member that, upon reaching their normal retirement date, they will pay them an income for life.  The member will usually also have the option to take an amount of Tax Free Lump Sum and a lower amount of guaranteed pension income.

The Trustees take on the investment risk of the entire scheme’s pooled fund and are duty-bound to report on the scheme’s overall funding.  This means the individual does not take on any investment decisions or risk themselves.

The rates of increase both before and whilst taking income benefits are linked to a set of rules and are guaranteed.  This guarantee is valuable and can protect the individual’s income from inflation.  In some cases these “escalation” rates are extremely generous and the rate of income can rarely be matched by purchasing an annuity contract after transferring away from a Final Salary scheme.

A Final Salary pension income will also have a provision for paying a spouse or civil partner a guaranteed income for their life should the member pre-decease them.  This level of income is usually between 50-67% of the member’s original guaranteed income and generally ceases on the second death.  If there is no spouse/civil partner the income would normally cease on the member’s death, subject to any guarantee periods.

The alternative to taking benefits from this type of scheme would be to accept the Cash Equivalent Transfer Value offered by the Scheme Trustees and invest these monies into a Personal Pension or Self-Invested Personal Pension (SIPP).

With these types of plans the member takes on the investment risk; choosing the funds/assets to invest in and level of risk to take.  This can be a burden for some, particularly without a trusted financial adviser.  At present, due to economic conditions, Final Salary Transfer Values are often quite generous, which can make investing these larger sums of money worrying for an individual who has not previously had to add money “into the markets”.

Rather than the Final Salary scheme’s guaranteed income for life, a SIPP member may enter Income Drawdown (currently from age 55), allowing the individual to choose how much Tax Free Cash or Income they take and how frequently.  Although this flexibility can be seen as an advantage, without proper monitoring the fund could potentially run out during retirement.  The SIPP has fees attached to it, which can also reduce the fund value.  The individual in a Final Salary scheme does not have to worry about this as their income levels are set by the schemes rules and the charges are covered within the scheme’s assets and monitored by the Trustees.

Tax Free Cash equal to 25% of a SIPP’s fund value can be taken.  This is normally in excess of the amount that can be taken from a Final Salary pension.  The death benefits of the SIPP are also seen as a major advantage.  I explained above the normal treatment on the Final Salary scheme once in payment, this is very different from a SIPP which will usually offer the individual’s beneficiaries either a one-off lump sum or their own Drawdown contract.  The beneficiaries can be almost anyone and multiple people can be nominated.  Following the government’s recent rule changes, the plan’s value can be passed down through successive generations.  There are also both Inheritance Tax and Income Tax advantages of using a SIPP for this purpose, depending on the age of the deceased.

Clearly there are advantages and disadvantages to both types of benefits.  The complexity does not stop there as I have not mentioned Lifetime Allowance, Annual Allowance, ill health, divorce or the Payment Protection Fund, to name but a few other considerations.

The reality is that, generally as a rule, the certainty a Final Salary Pension affords, along with its guarantees, means a Transfer is not usually in the best interest of the individual.  However, there are individuals and circumstances that it may suit and that can only be assessed on a case-by-case basis.  It should also be noted that “unfunded” Public Sector Final Salary Schemes are not eligible for Transfer.

If you have one, or a number, of these types of benefits then the only way to know if transferring is in your interests is to speak to a Pension Transfer Specialist.  That is a Financial Adviser or Planner who has the relevant qualifications and has experience of advising on the subject.  They should perform a thorough assessment of your needs, objectives, attitude to risk and circumstances before making any recommendations on suitability.

DHM Wynchwood LLP has two Pension Transfer Specialists and, should you wish to discuss Final Salary transfers, or any other financial planning needs, please do not hesitate to contact us to book a without obligation initial meeting.