More retirees with a Final Salary pension are choosing to take their money out of schemes and transfer into a Defined Contribution (DC) scheme instead. But why are they choosing to give up an income that’s guaranteed for life?
A Final Salary pension, also known as a Defined Benefit pension, pays a pre-defined amount on retirement based on a set of criteria. Often this is how long you have been a member of a scheme and your salary when leaving. Final Salary pensions are sometimes referred to as the ‘gold standard’. They’re typically generous and the responsibility to ensure the pension is paid over your lifetime falls to the scheme trustees, rather than you.
The alternative is a DC scheme, which is now more common. If you’re a member of a DC scheme, you make contributions to your pension, which are then usually invested. This may be supplemented by employer contributions and tax relief. The amount you have when you retire will, therefore, depend on the contributions made and the performance of the underlying investments.
Growing numbers leaving Final Salary schemes
Despite the certainty of income that Final Salary pensions provide members with, more retirees are choosing to transfer out of them.
Figures released by the Financial Conduct Authority (FCA) show that between October and March 2016, 5,056 Final Salary members transferred their pension to a DC scheme. This increased sharply to 34,738 transfers during the same period in 2018; a rise of 587%.
While not all transfers are covered in the survey, the FCA estimates that it accounts for around 95% of DC contract-based pension schemes.
Why are Final Salary members transferring out?
When you’re a member of a Final Salary scheme, you essentially have two options when you reach retirement age. The first is to simply take the income the scheme provides. The second is to transfer out, taking the money offered and placing it with an alternative DC pension provider. The latter is a step you can take before retirement age, but the money transferred to a DC scheme isn’t usually accessible until you’re 55.
A few, but growing number, of Final Salary schemes, will also allow you to partially transfer. This would mean you take a lower guaranteed income and receive a lump sum transferred to a DC scheme, to compensate for the portion of income you’ve given up.
The growing number of retirees choosing to transfer can be linked to two main factors:
High values: When you approach a Final Salary pension provider to transfer, they will offer you a Cash Equivalent Value Transfer (CEVT). Operating Final Salary schemes is expensive for the pension trustees, and as life expectancy has increased, so has the cost of meeting responsibilities. As a result, many Final Salary schemes have been closed to new members and high CETVs are being offered to encourage existing members to leave. It’s now not unusual to receive a CETV that is 30 or even 40 times higher than your expected annual income. With such high sums available, it’s easy to see why some are tempted to cash out.
Pension Freedoms: In 2015, the government announced the biggest shake-up to pensions in decades with new Pension Freedoms. These changes aimed to provide more flexibility for those drawing an income from a DC pension, reflecting how retirement and lifestyles have evolved. From the age of 55, DC pension holders can now choose to access all their pension savings if they wish (although usually, only the first 25% is tax-free). They could also choose from purchasing an Annuity, providing a guaranteed income for life, or using Flexi-Access Drawdown, where money can be withdrawn from a pension as and when it’s needed.
While transferring out of a Final Salary pension does offer you more freedom with how you access your pension, as well as potential Inheritance Tax benefits for passing on your pension when you die, there are some downsides to consider:
- You’ll be giving up a guaranteed income: The impact of giving up a guaranteed income for life shouldn’t be underestimated. It gives you security throughout your retirement. You won’t have to worry about how investments perform or running out of funds in your later years. A lot of people underestimate their lifespan too, which is important to consider, as they may run out of DC pension income.
- You will need to account for inflation: The income provided by a Final Salary scheme is usually linked to inflation. This means that your spending power is maintained over time. If you choose to transfer out, you’ll need to ensure that you’ve considered how inflation will affect your income over the course of your retirement.
- You may also be giving up other valuable benefits: Depending on your personal circumstances, a Final Salary scheme may also offer other important benefits. These could include a pension paid to support a spouse, civil partner or dependent should you pass away.
- You’ll need to take responsibility for investment performance: With a Final Salary pension, the trustees are responsible for investment decisions and ensuring they can meet obligations. If you choose to transfer out, you’ll need to take on that responsibility and poor investment performance or financial decisions would impact the income available to you.
The key thing to remember when deciding whether to transfer a Final Salary pension is that it’s final. Once you’ve left a Final Salary scheme, you won’t be able to reverse your decision. It’s important to carefully weigh up your options before you move forward. If you’d like to discuss your Final Salary pension and how transferring out would affect your finances, please contact us.
Please note: A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits. The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation and regulation which are subject to change in the future.
