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When should you transfer a final-salary pension?

The risks of transferring out of a final-salary pension have recently been highlighted by the financial regulator, but there are instances when it might be worthwhile
February 2, 2017

The risk of transferring out of a final-salary pension has recently been highlighted by the Financial Conduct Authority (FCA), which has warned advisers that if they transfer clients out of their final-salary pensions without proper checks, they could put them at risk.

"We are aware that some firms have been advising on pension transfers or switches without considering the assets in which their clients' funds will be invested," says the FCA. "We are concerned that customers receiving this advice are at risk of transferring into unsuitable investments or - worse - being scammed."

But transferring out of your final-salary - or defined-benefit (DB) - pension is looking more appealing at present due to the soaring transfer values being offered. Low interest rates and gilt yields have pushed up transfer values by as much as 30 per cent in many cases, according to Pat Connolly, chartered financial planner at Chase de Vere, and anyone wanting to cash in a final salary-pension worth more than £30,000 must seek advice under FCA rules.

But the regulator is concerned that advisers conducting transfers into defined-contribution (DC) schemes may only be looking at their critical yields - the rate of return a DC scheme would need to generate to match the guaranteed benefits from a final-salary pension - and not looking at what assets the DC scheme invests in. So they don't take into account how likely it is that a potential DC scheme's underlying assets would deliver a return that could match that of the final-salary pension.

That could mean investors sacrifice a guaranteed income for life for an apparently hefty lump sum, but run out of cash in the long term due to a scheme's failure to generate the necessary returns.

Large cash offers to transfer out of final-salary pensions have lured in a number of investors since the end of last year. But a big transfer value is not necessarily a reason to move into a more flexible scheme.

"Transfer values have been shooting up recently because interest rates and gilt yields have been low," says Andy James, head of retirement planning at Tilney Group. "The lower the gilt yield, the more it costs to buy the income that a final-salary scheme will generate. We've been seeing transfer values offered at multiples of 30 to 40 times the projected annual pension income and these are substantial figures."

Mr Connolly adds: "We've had a big increase in clients enquiring as to whether or not they should move out of DB pensions. A lot have seen headlines talking about high transfer values and see a very large number compared to what might seem a relatively small income from their DB scheme. But bear in mind that if you transfer from a DB scheme to a DC pension or a self-invested personal pension (Sipp), you are giving up a guaranteed income which is likely to be index-linked and will last until the end of your life."

Another reason why people have transferred out in recent months is fears over high-profile pension schemes suffering deficits. "There are concerns over the security of pension schemes following headlines surrounding companies like BHS," says Mr Connolly. "But most DB schemes are likely to be very secure and the existence of the Pension Protection Fund - a state sponsored safety net for collapsed pension schemes - should put people's minds at rest."

 

Should you transfer out of your final-salary pension?

One reason to transfer out of your DB pension could be to take advantage of new flexibility afforded by pension freedom legislation, which came into force in April 2015. Retirees can now access their entire pot, take tax-free lump sums or move the pot into income drawdown while remaining invested. This might appeal if you want more control over where your cash is invested and the way in which you take benefits, rather than receiving a set amount of income as with a DB scheme.

You might also want to consolidate your workplace pensions if you are moving job, and transfer to a new scheme. It is most easy to transfer a DC pension to another DC scheme and in many cases it is worth doing this, to consolidate several workplace schemes, or benefit from more flexibility or lower costs.

But think long and hard about doing the same with a DB scheme. "Our starting point is that you should retain a DB scheme but there are a few circumstances where it might make sense [to transfer out]," says Mr Connolly.

One of those reasons could be to pass on a pension to beneficiaries, particularly if you are in ill-health. If you are in ill-health and don't expect to need many more years of income, you could pass on your pension to family instead. But this is not possible with a DB pension. "With a DB scheme, the pension dies with you unless you have a spouse who inherits it," says Mr James." You are unable to pass it on to other beneficiaries, so it could make sense to move to another scheme."

Pension freedoms abolished the punitive 'death tax' on DC pensions, meaning they can be passed on to beneficiaries free of tax. Previously anyone inheriting a pension would have to pay 55 per cent tax on it, but now if an individual dies before the age of 75 and has not yet touched the pot it can be inherited free of tax. If the individual dies after 75 and has started taking benefits, the beneficiary pays income tax on any income taken from the pot.

Mr James says: "We have clients with other money to spend who do not want to see their pension disappear with them when they die. In this case they might want to transfer it into a Sipp or another DC scheme."

He says there has been a tenfold increase in demand from people wanting to transfer out of DB schemes, particularly from clients with very large pots, and other savings and resources to draw upon in retirement.

"In most cases we are talking about very large sums, for example a pension worth £7.5m being moved into a Sipp, and often these clients have large sums of money elsewhere too," says Mr James. "I would not consider moving anything less than £100,000 because the charges of moving the pot would eat into the value."

DIY Sipp platforms or DC schemes may charge a flat fee to move your pension into them, and you will also pay ongoing fund charges and transaction fees when you move assets into a new or existing pot. You could also be charged to leave your current scheme.

Pension exit fees have been the subject of controversy and last year the government capped charges on these at 1 per cent following complaints that some savers faced losing up to a fifth of their pot when transferring to another scheme.

Some insurers have gone further, scrapping all exit fees for workplace pensions. These include Scottish Widows, which removed all exit fees on its workplace pensions in March 2016 and last week said it would remove early exit fees on personal pensions, too.

However, exit fees are just one of the charges to consider when transferring pensions. "You really need to understand what you are giving up when you move and what you could be paying to a broker or platform to do so," says Mr Connolly.

If you are keen to make the most of pension freedoms elsewhere, one solution could be to move part of your pension to a DC scheme and leave some invested, meaning you still have an index-linked income to fall back on if your flexible pot performs badly.

Transfers are generally irreversible so if you change your mind your old scheme could refuse to take you back, although pension transfers usually offer a 30-day cancellation period.

And some pension providers offer bonuses or reduced charges if you stay with them for a long time, which you could miss out on if you leave.

 

Beware high DIY Sipp charges for freedom

Retirees have accessed funds worth £9.2bn since pension freedom legislation came in, according to HM Revenue & Customs (HMRC). The number of pensioners accessing their pots hit an all-time high in the last quarter of 2016, with 162,000 people taking payments from their pot, up from 67,000 in the same period in 2015.

Jon Greer, pensions expert at Old Mutual Wealth, says the HMRC figures show that retirees are getting to grips with the new system. "They are withdrawing less per payment and increasing the frequency of the withdrawals they make," he explains. "We expect these trends to continue, with withdrawal sizes per payment continuing to fall and the frequency of withdrawals by individuals continuing to increase."

Between April and June 2015, 121,000 payments were made to 84,000 people taking an average sum of £18,571 each. Between October and December 2016, the average person took £9,630 but the average number of payments had increased from 1.4 to 2.4.

However those taking flexible sums from their Sipps face a wide variety of costs from brokers and platforms. If you take benefits, make sure you have worked out how much it will cost. You could face a cost difference per year of as much as £180 just to go into income drawdown, depending on which platform you use.

The costs of taking cash-free lump sums, meanwhile, vary by as much as £300 depending on which platform you use.

 

Costs of drawing down from DIY Sipps

Drawdown set-up costsOther income drawdown fees (+ VAT)*UFPLS charges (for one-off payments (all + VAT)) Transfer in from DB scheme 
Alliance Trust SavingsNil£23.75£40 for one-off UFPLS lump sum£150+VAT 
AJ Bell YouinvestNil£100 pa£25 for one-off paymentNil
Barclays Stockbrokers £75£100 pa£75Nil
Charles Stanley Direct£150£50 pa£25Nil
BestinvestNil£100 for portfolios over £100k, no charge belowNil
Fidelity Personal Investing NilNilNilNil
Interactive Investor Nil£170 pa£40£50 per transfer, max £300
Halifax Share DealingNil£180 pa£90£60 per plan, max £300
Hargreaves Lansdown NilNilNilNil
TD Direct ????
The Share Centre Nil£195NilNil
iWebNil£180 pa£90£60 per plan, max £300

Source: Product providers

*Uncrystallised funds pension lump sum