The Dash for the Cash – Exodus From Final Salary pensions
A former pensions minister and many top executives have joined a stampede of savers cashing in “gold plated” final salary company pensions after transfer offers reached record highs recently. Baroness Altmann, the pensions minister until July last year, told the Financial Times that she recently decided to cash in two of her final salary pensions after transfer quotes for both doubled over a two-year period from 2014 to 2016.
What has changed?
Millions of people with defined benefit pensions have seen their transfer values shoot up in the last year according to Royal London, a major insurance company. “The two main driving forces behind the surge in people giving up their ‘gold-plated’ pensions are the introduction of ‘Pension Freedoms’ two years ago, but more the spike in the amounts being offered by the schemes to leave” said Allan Cruse, immediate Past President of the Chartered Insurance Institute for Bournemouth and partner in multi award winning firm Strategic Solutions Chartered Financial Planners. “After the EU vote, the Bank of England quickly reduced interest rates and talked down the prospects of UK growth, leading investors to bet that interest rates would be lower, for longer. This led to the values schemes offered to let members leave shooting up”
What is a defined benefit pension?
They are often called ‘Final Salary’ pensions as schemes are either based on a worker's final salary, or on their career average earnings. Workers with defined benefit pensions know how much they will receive in retirement. The numbers of open schemes like this have reduced significantly over the past decades, as employers have tried to cap their liabilities.
Workers with defined contribution (DC) schemes however save into a pension pot, which they then use to buy a retirement income. The size of the pot depends on the performance of the assets they invest in, so can vary widely.
The quote ‘any colour, as long as it’s black’ is commonly attributed to Henry Ford, creator of the Ford Model T and there are parallels with final salary pension scheme. Defined benefit (DB) schemes provide all their members with broadly similar benefits: usually an inflation linked pension, most a reduced spouse/ civil partner pension in the event of the member dying and an option for some tax-free cash at the date of retirement. Crucially, they offer members a very attractive promise of a guaranteed income for life with no need to worry about investment returns or inflation and little need to take advice or make choices. This may be appropriate for many scheme members, but not all.
If you’re in what’s called an ‘unfunded’ public sector pension scheme, you won’t be able to transfer your pension. Examples of an unfunded public sector pension scheme are the Teachers’ Scheme, Police, Fire and the NHS scheme. So you don’t need to worry!
Drawbacks and Limitations
You get what you are given. You will have a choice to commute (reduce) the pension for a cash sum, but the benefits are ‘defined’: only not by you. The scheme decides what you receive; you are given ‘black’ even if you want another colour. This is at odds with the way we live in retirement now. Retirement is not what it used to be, where people on the whole worked lifelong for an employer until the age of 65. Modern retirement is dynamic and flexible – all the things final salary schemes aren’t. The most significant disadvantages in this new age of retirement are:
Many individuals want to retire early or spend more money in the early years of their retirement and less when they are much older. Given the choice, most would rather have more money to spend at 60 when hopefully fit and healthy than more at 90 – when it may be the case the income goes to fund care home fees?
Members may be unmarried and have no need of the widow’s pension, or have significant health issues and want their family or other beneficiaries to receive their pension money if they die early. Or, they may want more tax-free cash than the scheme is offering.
The recent demise of British Home Stores and the state of funding for many DB schemes has highlighted the frailty of the ‘pension promise’ that underpins DB guaranteed benefits. In September last year, TESCO reported a doubling of their pension scheme deficit last year, to an eye-watering £5bn!
For many, maintaining DB benefits will be best and most certainly the most secure option, but an increasing number will prefer the option to tailor their pension benefits to meet their individual requirements, allowing them to enjoy a dynamic, flexible and rewarding retirement.
Beware of pension transfer scams
Any claims that you can transfer to get cash before 55 is almost certainly a scam.
Only invest in regulated products and any firm ‘guaranteeing’ anything is one to steer clear of as a rule of thumb. If it sounds too good to be true, it probably isn’t true.
Also be wary of any adviser who offers to simply ‘sign-off’ the paperwork for you, on a nudge-nudge wink-wink type basis. They are usually passing all liability straight back to you away from themselves.
Ensure your adviser is regulated on the FCA website and is a Pension Transfer Specialist
Get a second opinion from another regulated adviser
DB pension advice is extremely complex work and requires considerable skill and expertise, so IFAs must be competent and confident to undertake such planning. It’s always a good idea to talk to more than one adviser as their costs and services might be different. However, it’s vital that you only deal with financial advisers who are regulated and authorised by the Financial Conduct Authority (the financial services regulator). A list of authorised firms can be found on https://register.fca.org.uk and look under ‘Permissions’ section to ensure they have ‘Advising on Pension Transfers and Pension Opt Outs’ specifically listed.
What to expect from a financial adviser
The adviser will discuss your personal circumstances and financial position with you, including the level of risk you feel comfortable with. The adviser should make a clear recommendation to you whether it is their professional opinion that you should move your pension or not.
They must also:
• Compare the benefits you might give up if you transfer out of your employer’s scheme
with the benefits you might get if you transfer into a new employer’s scheme or a personal/stakeholder pension.
• Explain the difference between defined benefit and defined contribution arrangements
• Give you a summary of the advantages and disadvantages of their recommendation
• Ask whether you’ve discussed your decision with your spouse or civil partner as it probably affects them too
• Check your full range of options
• Disclose all fees up front
If you do take proper regulated advice and things go wrong, you’ll be able to use the complaints and compensation schemes available.
If you then decide to transfer out of your scheme, the trustees who run the scheme convert the benefits you’ve built up into a cash sum. This is called a ‘transfer value’ (or ‘CETV’). This money would then be transferred directly into a
• Personal or stakeholder pension
• Pension scheme with another employer or
• Self-invested personal pension (SIPP)
Risks of transferring
You may get back a lot less than if you had not moved the pension, you could easily end up being worse off if things don’t go as planned.
Your pot will be affected by the investments you choose to hold. You can mitigate some by spreading the risk and diversifying, but the investment performance directly influences the amount of money you will have to live on.
Any potential advantages of transferring from a defined benefit pension scheme to a defined contribution one can be outweighed by the costs, risks and loss of benefits involved.
Your future pension income can’t be predicted with any certainty if you transfer to a defined contribution scheme, regardless of whether its run by your employer or it’s a personal or stakeholder pension run by your IFA.
With a personal or stakeholder pension, you’ll give up any benefits you had in the former employer’s scheme.
The dash for cash comes as the OECD recently warned that savers in the UK were at greater risk of running out of money in later life if they continued to turn their backs on a secure retirement income, such as an annuity.
Risks of staying in
For the majority of people, staying in is a lower risk option.
Staying in a defined benefit pension scheme is not risk-free either, but it has no investment risk for the individual.
If your employer is still in business, it usually has to make sure the scheme has enough funds to provide the full entitlement to members. But some employers sponsoring these schemes have gone bust, not leaving enough money to pay the pensions promised.
If an employer is going out of business without enough funds in its pension scheme, the Pension Protection Fund might be able provide compensation, but this might not be the full amount of the pension you’ve accumulated, unless you are already receiving the benefits.
Cruse finished with “At current super-low interest rates, the transfer value of most defined benefit pensions has increased massively. For many, it seems sensible to take a look at their situation. I have done so myself and transferred my pension as a result, as has my wife.” He went on: “Could that be the wrong decision? Yes it certainly could, but I appreciate I am in the lucky position where I am aware of all the advantages and disadvantages and for me and my family, moving our pensions was the most attractive option. But that is based on us and our situation, it is important to take individual advice. Just because your friends are making one decision, or your work colleagues or your mate ‘down the pub’ is doing something doesn’t matter; quality individual advice is the key in every situation, no two people are ever the same and it is imperative that both the individuals themselves and their Independent Financial Advisers work closely to ensure the best outcome is achieved”
For many people the first step is simply to write to the scheme and ask for the information, this information is only guaranteed for three months though, so you would need to be visiting your IFA either before or at least very soon after that, as the process is a long one and it’s very easy to run out of time. With some schemes you only get one request per annum, otherwise you may have to pay a fee for another one. Strategic Solutions have a free downloadable version of the form they send to schemes for their clients which is available at www.ssfs.co.uk for anybody wanting a template.