Although the current ‘bonanza’ in final salary pension transfer values has become one of the biggest stories in the pension industry for a generation, there are probably still millions of Britons who’ll be better off keeping their old company pension where it is.
For decades, the best advice for Britons with generous final salary pensions has always been to leave them exactly where they are. The promise of an index-linked pension for life that’s based on a percentage of your final salary with an old employer is something to be coveted. Not least because it’s your old employer, not you, that has to pick up the tab.
But a sudden shift in the wind has meant that the old rules have suddenly changed. This has triggered a boom in the number of pension transfers that are now taking place in the UK and the relatively few advisers that are still qualified to transact such business are now inundated with queries on potential transfers.
There are three simple reasons why record numbers of Britons are now choosing to cash in their ‘gold-plated’ final salary pensions into more risky personal pensions. The record transfer values now on offer; the new pension freedoms; and the fear that an old employer might just fold and leave your treasured pension in the hands of the Pension Protection Fund.
But as Neil Adams, Head of Pension Planning at Drewberry Wealth Management, observes, “The biggest driver for the transfer clients we’re now seeing is understandably the sudden jump in the transfer values being offered to scheme members. Every scheme is different,” he says, “but in the last few years we’ve seen the standard industry multiple of 20 jump to 30, 40 or even 50 times annual pension entitlement. This means that a £10,000 a year pension promise that a few years ago would have been worth a £200,000 transfer value [using a multiple of 20] could now be worth over £500,000 if the multiple being offered has jumped to 50 or more.
“The change in transfer values has been driven by the record low in government gilt yields,” he explains, “this means that it’s never been more expensive for a company to provide a lifelong pension to its old employees and this is being reflected in the current transfer values on offer. Employers are desperate to get these liabilities off their balance sheets once and for all,” he says, “and a great many are actively writing to their old scheme members encouraging them to take advantage of the generous transfer values on offer.”
Where do you stand?
Although the pension landscape may be changing, a transfer still won’t be in everyone’s best interests. As Neil Adams explains, “You need to be very conscious of just what you’ll be giving up and the risk you’re taking on. If you cash in your final salary pension, you’ll lose any guarantees as to the level of income you’ll receive in retirement; the index-linking that usually comes with it; any guaranteed widow’s pension and, ultimately,” he says, “any guarantee that you won’t run out of money in retirement”.
“You’ll be taking on the investment risk yourself,” he says, “and there’s no going back if you should change your mind”. This means investing your pot in a range of different ‘risk assets’ such as equities, property and bonds. Hand in hand with this investment risk is the risk that you fail to manage your pension withdrawals conservatively enough to last throughout your retirement.
“There’s a very real risk that you exhaust your pension pot while still in retirement,” says Adams. “There’s no such risk with a final salary arrangement”.
Timing is also an issue. There’s no question that during the ‘accumulation’ years for a pension pot – when you’re not taking the pension benefits – it’s far better to be in final salary scheme. It’s very difficult to match the investment performance and indexing that these schemes offer without taking significant risks. It’s only when you come to the ‘decumulation’ stage – namely taking your pension benefits in the most convenient and tax-efficient way – that the pendulum suddenly swings back in favour of a personal pension arrangement.
Timing also plays a part in other ways. As Adams explains, “At some point down the retirement path you might want to buy a fixed income in the form of annuity. There’s often little point in ‘cashing in’ a generous final salary pension if you’re only going to covert it to annuity at some point in the foreseeable future. The income from the former will normally always be far greater than a standard annuity.
“You’ll also have to accept that if you have a smaller transfer value or if the scheme benefits in question represent one of the largest parts of your total pension portfolio then it just may not be in your best interests – not unless you’re in a poor state of health where if you passed away early the full pension entitlement would die with you.”
Making the call
With so many factors to consider, pension transfers are a complex and nuanced area. Whether a transfer will make sense for you will depend on a whole host of factors from your age and attitude to risk to the size of your other retirement savings and just what your old employer may be offering as a transfer value.
Deciding whether to cash in your pension will be one of the most important financial decisions you ever make. So it’s not one that should be rushed. Even so, it’s a complex problem – especially given the three-month guarantee that accompanies any pension scheme transfer value. This free to use calculator by Drewberry Wealth is a useful tool to help you to work out if your scheme is offering a high or low transfer value relative to other schemes.
As Neil Adams explains, “Whether a pension transfer is right for you will depend on your circumstances, but with record transfer values and new pension freedoms on offer, it makes good sense to find out. This is one of those times when making the wrong decision could have life changing consequences. So it pays to do your research and to find an adviser you feel confident with before taking the plunge.”