Final salary pensions - gold standard
 
There is a lot of information warning people of the dangers of transferring a final salary (or any other form of defined benefit) pension scheme but are they as safe as they are made out to be? Could it actually be in your favour to transfer your pension or are you best off leaving it where it is? To determine the best course of action you should weigh up the following considerations to allow you to make an informed decision;

There is not a simple universal yes or no answer to this question. On the one hand, the Pensions Regulator is concerned that people are not sufficiently informed to make a suitable decision. This has led them to demand that proper financial advice is sought where final salary pension transfers are concerned. They also said “it is unlikely that the application of best estimate assumptions used to calculate the transfer value would provide benefits equal to those given up”. Further to this, due to fears of new mis-selling scandals financial advisors can tend to start from a position that a transfer is not in your interests rather than beginning from a point of neutrality.
 
On the flip side, there are multiple reasons why it may be in someone’s interest to transfer their final salary scheme including increased flexibility, a reduction in tax, high transfer values and security

Reasons to keep your final salary scheme

This is the single greatest reason to keep your defined benefit plan. In these circumstances the level of contributions made on your behalf by your employer are substantial in comparison to the alternative, a defined contribution scheme. As such, any transfers should only occur for frozen schemes, i.e. when you are no longer an active member and your benefits are known, or otherwise in very rare and specific circumstances
This is for when you require the security of knowing how much income you will receive for the rest of your life. Even in these circumstances the transfer value offered may mean moving your pension is still in your interests

Reasons to transfer your final salary pension plan

A defined benefit pension will set out strict rules governing the level of income due and the payment term. There is a one time offer to take a tax free lump sum (any amount not taken will increase the taxable income received). Payments will then be made regularly and cease after death of the member and any dependant (which is also strictly defined i.e. usually a spouse, civil partner, or dependant child up to 23)
A final salary scheme has a normal retirement age (NRA) which is usually years above the minimum retirement age allowed by law. Accessing the pension beforehand tends to be met with a penalty, typically a 5% reduction in benefits per year. Also, delaying payments until after the NRA may not raise the level of benefits received
There are different calculations used to determine the level of tax free pension commencement lump sum (PCLS) that is payable depending on the scheme rules. By contrast, a money purchase scheme, such as SIPPS (Self Invested Personal Pension Schemes), allows a tax free lump sum of 25%. This is enhanced for expatriates who transfer their pension abroad into a QROPS because they can receive up to 30% tax free + 100% of all investment growth since the switch
One of the determining factors for calculating the current value of a defined benefit scheme is the anticipated yield (interest) on government bonds. These are at historic lows which, by contrast, means that prices are at historic highs. The result of which is that CETVs are also at historic highs. When rates normalise in the future, all else being equal, the cash transfer values of defined benefit schemes offered will fall

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When a final salary pension scheme holder dies their dependants will typically receive only a proportion of the income previously received (50% is common). A defined contribution scheme, such as a SIPPS, can pass any remaining funds to a nominated beneficiary of their choosing. The same applies to expatriates with QROPS though they may be able to avoid death tax, which is otherwise due
Expats can either receive all income gross if they live outside the UK or receive a 10% deduction on their taxed income if they return to the UK. Also, because they can choose the timing and level of income withdrawn they can manage their tax affairs efficiently – this is applicable to any defined contribution scheme as well. Funds can therefore be left within the tax efficient pension structure when not required
You will be able to invest according to your risk profile and requirements. This could allow you to benefit from any gains that exceed the return required to match the provisions given up. Of course, on the contrary, you run the risk that your investment returns disappoint. Generally, if you hold a QROPS you will have a greater choice of investment opportunities compared to UK based schemes such as SIPPS. Final salary schemes by contrast do not provide any chance to benefit from their investment strategy
Expats can transfer into a QROPS which creates a one off assessment against the lifetime allowance (LTA). All future growth and/or any reduction in the rate will not lead to any further charges even on return to the UK. This only applies to QROPS
Should the final salary scheme be closed due to insufficient funding it will be covered by the Pension Protection Fund. This, however, only covers 90% up to a pre-defined limit, provides limited inflation cover, and is not government backed. According to the Pension Protection Fund’s June update of pension funding levels, out of the 6,057 schemes monitored there is an aggregate funding deficit of £241.3 billion with only 1,249 schemes being in surplus
Expatriates can move their pension scheme between jurisdictions to capitalise on on the most suitable rules for their requirements thereby increasing tax efficiency & flexibility further
The cash equivalent transfer value (CEVT) offered will, in most cases, determine whether transferring your final salary scheme is in your interests or not. Please bear in mind that if you are currently a contributing member then it is extremely unlikely that it will be in your interests.
 
There is no fixed rule on how the CEVT is calculated which means some providers are far more generous than others. It can be difficult to calculate the true value of future benefits which is why there is such a discrepancy. This provides an opportunity for you to capitalise.
 
Before transferring you should always get an independent matching yield analysis report done. In it’s most basic form this provides an investment return figure that has to be generated to match the guarantees given up. For example, if the matching yield is 5% then so long as you receive an average annual return on your investments in excess of 5% then you will be deemed to be in a better financial position than if you remained in your final salary scheme and vice versa. Therefore, the more risk averse you are the lower the figure you willl demand for the transfer to be worthwhile
To determine whether you should transfer your defined benefit pension scheme you should first weigh up all the guarantees relinquished against the benefits that pertain to you. From this, determine what level of return you would be willing to aim for. The more additional benefits you obtain from transferring the higher the annualised investment return and vice versa. There should always be a figure because even the most risk adverse person who is not interested in any of the advantages mentioned would be better off if the transfer value offered was sufficient to buy government backed index linked bonds which provided a higher income offered compared to their final salary pension after all costs

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Are final salary pensions’ gold standard misleading? written by Liberty Wealth average rating 3.6/5 - 12 user ratings