For those individuals who have been lucky enough to benefit from the Final Salary (Defined Benefits) pensions framework during their careers (known as “members” from here on in), there are some potentially difficult decisions to make regarding how and when they choose to access their benefits.

Susie Laws, Director & Chartered Financial Planner
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The pension freedoms introduced by George Osborne have caused many to question whether taking the guaranteed regular income offered by the DB scheme, from the scheme retirement age, is the right thing to do.

The lack of flexibility over how and when the DB pension fund is accessed means that for some members, transferring the pension from the DB scheme to a personal pension or SIPP, is an attractive option.  This is not a decision to be taken lightly and any member considering a transfer where the transfer value offered exceeds £30,000, is required to obtain financial advice from a suitably qualified financial adviser.

The desire to transfer has been intensified for some by the fact that the Cash Equivalent Transfer Values (CETVs) offered by some schemes are exceptionally high right now.  Whether they will remain high depends on many unknown factors including future interest rates.

The following sections highlight a few areas to think about for those members considering a DB transfer:

Do you want flexible access in retirement? 

DB pensions by their nature are not flexible.  As previously mentioned, they largely provide a guaranteed, inflation proofed income in retirement but a member cannot just take the tax-free cash (TFC) from a DB pension.  If a member withdraws the TFC they must start the regular income from the scheme.  Also, they might want to choose the amount of income that they draw from their pension for tax reasons and it is not possible to vary the level of income paid from a DB Scheme.  However, this flexibility is possible via a personal pension scheme.

Are you likely to want to retire earlier (or later) than the DB scheme retirement age? 

A member can generally only take the full value of the DB benefits at the scheme pension age and if they want to retire early the scheme benefits are often significantly reduced.  Personal pensions can currently be accessed from age 55 (although that age is going to rise to within 10 years of the state pension age) and the member can choose any income level that they wish until the value is exhausted.  The sustainability of income drawn from the personal pension will depend on a number of factors, the most important of which is investment performance, which is touched on later in the article.

How much tax-free cash?

The member might also want more tax-free cash than what is available under the DB Scheme. The amount of tax free cash that can be accessed from a personal pension (25% of the fund value) is generally higher than that available from a DB scheme.

How important are spouses and dependents benefits?

Under a personal pension, any funds left within the pension on death of the member can be left to any person (or charity) that the member nominates.  Under a DB scheme, the dependents benefits are limited to a spouse or other qualifying dependent.  The death benefits for a surviving spouse from a DB scheme therefore would often only constitute 50% of the income which was paid to the member.  This income would usually cease on death of the spouse and the pension has no capital value on death.

Therefore, on the death of a member who was single with no dependent children, the DB pension would cease to pay out and the DB scheme effectively retains the value of whatever was earmarked for the members pot.

A member may also feel that 50% of the income may not be sufficient for their surviving spouse.  Under a personal pension, the spouse can elect to continuing drawing the same level of income the deceased was drawing (provided there are sufficient funds left in the pot).

Do you have an inheritance tax problem?

Due to the change in the pension rules in 2015, the IHT planning opportunities using pensions have come to the forefront.  For those who have an inheritance tax problem, personal pensions can be a brilliant way of passing assets down the generations in a tax efficient manner.  Unless funds exceed the Lifetime Allowance cap, Personal pensions can be passed entirely tax free to the nominated beneficiaries if the policy holder dies before age 75.  If death occurs after 75, the beneficiaries of the pension funds will pay tax on any funds that they withdraw at their own marginal rate of tax.

Are you worried about the solvency of the sponsoring employer/scheme?

Many DB schemes are currently underfunded as the amount of capital needed to provide the guaranteed and inflation proofed benefits has soared. Although the Pension Protection Fund is designed as a safety net for failed DB schemes, the benefits paid by the PPF are subject to a cap and so for some members, may be significantly less generous than their benefits accrued under the DB scheme.

And the big one…… Risk

DB pensions offer a secure, guaranteed and largely inflation proofed income for life.  They come with built in spouse and dependents benefits and there is no investment risk for the member, as all investment risks are borne by the scheme.  They can therefore provide the member with a low risk and secure retirement, regardless of how long the member lives.

Conversely, with a personal pension all risk is carried by the member.  The income from the personal pension is not guaranteed in the same way as the income from the DB scheme (unless the member chooses to buy a guaranteed income for life via an annuity), and so anyone considering a transfer needs to ensure that they have sufficient income and assets to fall back on in the event that market conditions are not kind.

For instance, if someone choses to take the CETV of £300,000 and move the funds to a personal pension, on day one they will have £300,000 in the pension pot.  Let’s assume that they then draw an income of £10,000 a year from this, if left in cash the pension fund would broadly last 30 years.

However, it is likely that the level of income drawn would not stay static over 30 years, as inflation would reduce the purchasing power of this over time. Therefore, the withdrawals may need to be increased in future to offset this, which means that the funds would be depleted quicker.

Leaving the pension funds in cash over the long term is generally a bad idea, as the growth on the pot will not keep pace with inflation.  This leads most members to consider investing the pension funds into stock market based investments and other assets.  If the funds are invested, the member would have to ensure that these are invested at an appropriate level of risk for their needs and objectives and monitor these on an ongoing basis.  This is where most members will struggle and where we at Fiducia feel that the success (or not) of the transfer will be played out.

If the pension funds are invested correctly, in a suitably diversified and monitored portfolio of investments, the member has a much higher chance of their retirement being successful.  Incorrectly invested and the member could find that they do not have sufficient income to meet their retirement needs and in the worst-case scenario that they run out of money completely during retirement.

Susie Laws, Director & Chartered Financial Planner

If you would like to know more about how we as Financial Advisers can help you  with your Pensions and overall Retirement Planning then visit the Retirement Planning section of  our website: Retirement Planning  or send us email at: [email protected]

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