Last month the Pensions Regulator introduced emergency measures to allow pension trustees to freeze transfers out of defined-benefit (DB) or final-salary schemes for up to three months. This news may be alarming to people who were hoping to request or complete a transfer imminently, and it could potentially lead to a write-down in the value of the money you can access. Anyone who has been considering transferring out of their DB pension scheme should think carefully about their decision and the implications it may have, especially in light of these new measures.
Final-salary schemes offer income security that no other pensions can provide, so by transferring out you are giving up a valuable benefit. In a DB scheme, the retirement income paid to you will be based on a percentage of your salary multiplied by your years of service. The managers of the pension scheme manage your investment risk, and your income is guaranteed, regardless of what happens in markets.
When is a transfer a good idea?
For most people, transferring out of a DB scheme is a bad idea. But there are circumstances in which it can be appropriate. The number of people transferring out of DB schemes into cash or self-invested personal pensions (Sipps) spiked following the introduction of pension freedoms in 2015, which made it easier to convert a DB pension into a pot of money that can be freely accessed. Many were encouraged to switch by advisers picking up lucrative fees and the Financial Conduct Authority (FCA) has subsequently implemented measures to make people think more carefully before switching out. Kay Ingram, chartered financial planner at LEBC Group, says: "For most people giving up the security of a DB pension is not suitable and is an irreversible step, so taking time to reconsider could be a good thing."
Alistair Cunningham, director at Wingate Financial Planning, says the most common reason for a transfer out of a DB scheme to be appropriate is if the person is in ill health, and they want to release capital to pay for treatment, or for inheritance purposes. Different DB schemes have different terms for spouses of deceased members. For example, a scheme might only pay a spouse 50 per cent of the value of your pension benefits, so you should check the terms carefully before making a transfer decision. Ms Ingram adds that someone who doesn’t expect to live for very long may be able to use the transfer value to buy a guaranteed income from an insurance company, which will take account of their health and expected lifespan and provide a higher level of income or a higher tax-free cash sum and the same income.
In a DB scheme you can pass on some benefits to dependents, but only if they are under the age of 21.
By transferring your DB pot into a Sipp, for example, and choosing income drawdown, on your death the value of the pot, or its benefits, can be passed on tax-free to a nominated beneficiary if you are under the age of 75 at death. If you are aged over 75 at death, benefits can be passed on but will be taxed.
To complete a transfer, by law you must get financial advice if your pension pot is valued at more than £30,000. Valuations are available from trustees on request as they have to be calculated actuarially. Once you have received your valuation, it is then valid for three months, so you have three months to go through the advice process and complete the transfer. It is worth lining up the adviser before you request a valuation as it is likely to save you time.
Tom McPhail, head of policy at Hargreaves Lansdown, says the FCA reported last year that post pension freedom, between April 2015 and September 2018, 234,951 people received advice on a DB transfer, with 162,047 being advised to proceed. “The volumes are not high but they are not insignificant,” Mr McPhail says. The average value was £352,303 so “pretty big sums of money”.
When is a transfer not a good idea?
Equity market movements do not affect the value of your DB pension scheme, so the recent fall in markets does not mean the value of your transfer will be necessarily lower following the fall in markets. Savvy pension savers may see this as an opportunity to transfer so they can move their money into a Sipp and into the stock market at significantly lower prices than at the start of the year. However, Nathan Long, senior analyst at Hargreaves Lansdown, says this is not the view investors should take. By giving up a final-salary scheme you are giving up valuable benefits of guaranteed income and recent events show how volatile markets can be, and how easy it might be to get into financial difficulty.
Mr Long says: “For most people a transfer doesn't make sense because the transfer value you are given from schemes really do quite significantly undervalue the benefit you are giving up within the scheme.” It's like having an exit penalty for moving out of the scheme. “For most schemes it will be a penalty of about 20 or 25 per cent,” he says.
Mr Cunningham adds that in his opinion having a large amount of money is not a sufficient reason to forfeit the benefits of a DB scheme. You can spend the money you get in your guaranteed income and take more investment risk with money you have elsewhere. He adds that it is also likely to be tax efficient to stay in your DB scheme if your total pensions assets are likely to breach the lifetime allowance. “A £50,000 per year pension is within your lifetime allowance under DB, but probably two to three times over your lifetime allowance if you are in a DC scheme,” he says.
DB pension members should also be aware that trustees can reject transfers if you are within 12 months of your retirement age. People already drawing from their pensions are not permitted to transfer out.
You should also be very careful that you do not fall victim to a scam. Margaret Snowdon, chair of the Pension Scams Industry Group and non-executive director of the Pensions Regulator, estimates that £170m was lost to scams where people transferred from DB schemes in 2018. Analysis from the pensions regulator last year said nearly two-thirds of people would trust someone offering pensions advice out of the blue – one of the main warning signs of a scam.
Freezing DB pension transfers is also designed to prevent people from being targeted by scammers. There has been a surge in the availability of 'buy now' pension offers in recent weeks, according to Ms Snowdon, many of which are scammers hoping to lure vulnerable pension savers into inappropriate or outright fraudulent schemes. Pension cold-calling became illegal in January 2019, so if you receive a call out of the blue you should put the phone down.
Potential implications of the three-month freeze
Deciding to transfer out of a DB scheme is a complex decision that should not be taken lightly and so any opportunity to reflect on the decision is a good thing, says Justin Corliss, senior pensions development and technical manager at Royal London. Investment markets are volatile right now and it is worth considering that if you are in a DB scheme then your pension is not going to fluctuate with the market as it would with a DC scheme.
The emergency measures to freeze transfers were introduced last month to give pension trustees more time to calculate cash equivalent transfer values, which have become more difficult to value amid the extreme market volatility of recent weeks. Those who would like to transfer out but have not yet requested a valuation are likely to have to wait. This may not be a bad thing as the value of their pension may go up, as gilt yields have fallen, making the amount required to pay their final salary higher. However, similarly, the value could also fall from current values as actuarial calculations are based on a number of assumptions. If your company goes into administration and the DB pension scheme that you are in is underfunded, your pension will be paid by the Pension Protection Fund, with a reduction of 10 per cent for those in the fund who have not yet drawn their pension. There is a cap – and it depends on your age. For a 65-year-old it is currently £41,461.07.
Mr McPhail notes that 3,492 UK pension schemes are in deficit and 1,930 in surplus. Many pension schemes may well go further into deficit and companies may struggle to fund them. The Pensions Regulator has also mandated that companies can freeze contributing to underfunded schemes for three months, so this could also have an adverse effect on the value of your transfer.
Carl Lamb, director at financial advice firm Smith & Pinching, says those who have not yet accepted current valuations may go on to have them blocked. This might happen if the valuation you were given now looks too generous as the scheme has a duty to protect all of its members. However, he has a number of schemes in the transfer process currently and they have all said they would guarantee. He also notes that it is possible the transfer freeze will be extended until the coronavirus impact is understood and actuaries are comfortable valuing pension assets.
If you need access to your money quickly, and many people do if they are requesting a transfer out due to ill health, then it may be worth speaking to your scheme trustees to explain your situation and see if they might be happy to proceed with your application. “As it currently stands [trustees of DB pensions] are not obliged to implement the delay [of transfers],” says Mr Corliss.
Another potential snag with the freeze is that if you have someone in a final-salary scheme who gets made redundant, they may be forced to start drawing down their DB scheme rather than have the option of moving into a Sipp.
