On Wednesday the Financial Conduct Authority (FCA) announced they are concerned at the amount of Defined Benefit (DB) transfers that are being recommended. There have been lots of stories of pension transfer values of forty times annual income, but recent research also found that savers actually could lose out on over 50% of their final salary pension in transfer values.
To help individuals to understand what is at stake, WEALTH at work, a specialist provider of financial education and guidance in the workplace supported by regulated advice for individuals, has updated its checklist of the top 10 things to consider when deciding whether to transfer from a defined benefit to a defined contribution (DC) pension scheme;
Jonathan Watts-Lay, Director, WEALTH at work said, “When the transfer values offered seem generous, it can be extremely tempting for individuals, but it can be difficult to know whether they are as good as they seem, and need to be carefully considered.
“Transferring from a DB pension scheme can mean that valuable guaranteed benefits are given up and many could find themselves worse off. It is very important that individuals understand what they are giving up when they choose to leave a DB scheme, which is not an easy task.”
WEALTH at work, have created a checklist of the top 10 things to consider when deciding whether to transfer from a DB to a DC pension scheme:
- Compare transfer value against annual income. The first step is to find out how many years of annual income you would need to match the transfer value offered. This can be achieved by carrying out a calculation which compares the ‘cash equivalent transfer value’ (the lump sum the pension scheme will offer you in exchange for you giving up any future claims to a pension from the scheme) against the ‘current’ annual pension entitlement payable at the scheme’s normal retirement date. For example, if a DB annual income guarantee is £5,000 and the transfer value is £100,000, then the conversion factor would be twenty times (100,000/5,000). There have been some very ‘high’ reported values with reports of forty times the annual income, or even higher. However, it doesn’t mean the transfer value equates to a good deal, as by transferring out the member takes on all of the future risk associated with managing the investment and there are other perks, benefits and tax implications to consider.
- Is the cash really needed? If you are considering transferring to a DC pension to take all of the pension fund as cash, make sure you understand the tax implications; usually the first 25% of what you take out of a DC pension is tax-free but the remainder is taxed at your ‘marginal’ rate, the rate of income tax you pay when you add all of your sources of income together. If you take the money and simply put it in a bank account, it will be subject to inflation risk as the cost of living is likely to increase.
- Don’t forget the benefits. Most DB schemes have very good benefits. Often they include 50% for a spouse’s/partner’s pension (upon death, either before or after your retirement date), children’s pensions and some offer increases of up to 5% on the deferred pension until the point at which benefits were taken (to help keep the values in-line with inflation), and then provide inflation proofing once in payment. Others also have an element of death benefits in payment if the scheme member passes away within five years of receiving benefits. Some DB scheme members may also be entitled to ‘scheme protected tax-free cash’ higher than the standard 25%. These benefits would be lost in most circumstances if transferred into a DC pension.
- How generous is the transfer value really? To help individuals understand whether they are getting a good deal or not, the FCA has made it a requirement for advisers to provide a ‘transfer value comparator’ (TVC) when advising on DB transfers. The TVC is an estimate of the cost of replacing the DB pension income by purchasing an annuity. When looked at closely, the transfer value on offer may not be as good as initially thought. For example, research** shows that people who are 10-years away from retirement may only get on average 57% of the real value of the DB pension, whilst those one year away will get around 73%.
- Is a partial transfer available? Some schemes have started to offer partial transfers to their members. This means that individuals are able to transfer part of their DB pension into a DC pension so that they can access the money flexibly, whilst having the security of keeping the remainder of it in the DB scheme. Partial transfers could be a good option and middle ground for those torn between sticking with a guaranteed income and transferring all of their benefits. It isn’t common yet, but you should check with your scheme to see if they allow it.
- Have you ever contracted-out? Employees who were contracted out of the ‘State Earnings-Related Pension Scheme’ (SERPS) between 6 April 1978 and 5 April 1997 should check the Guaranteed Minimum Pension (GMP) value (the minimum pension value which an occupational pension scheme has to provide) if they are considering a pension transfer. The amount is said to be ‘broadly equivalent’ to the amount the member would have received had they not been contracted out. Make sure you understand the current value of the income being offered as often it will be quoted at the date you left the scheme and not the uprated value you would get at the scheme retirement date .
- Will the scheme pay out? Some individuals are worried whether their scheme is secure, and if it will be able to continue to pay out as promised. After all, the scheme is only as good as the company behind it. The PPF (Pension Protection Fund) will generally pay up to 90% of a pension value if the scheme fails, but there is an annual cap of £34,655 (when the 90% level is applied) which may be less than expected.
- Beware of pension transfer scams. Unfortunately, members of DB schemes can be an easy target for fraudsters. They often pressure individuals into transferring their DB pensions to them by offering what appear to be legitimate investment opportunities, which turn out to be non-existent or extremely high risk investments with low returns. Tell-tale signs include offering access to your pension before the age of 55 (‘pension liberation’) or investments which sound too good to be true. Before making any decisions, visit the FCA’s ScamSmart website which includes a warning list of companies operating without authorisation or running scams www.scamsmart.fca.org.uk.
- Are you equipped to understand your options without regulated advice? If your DB pension scheme has a transfer value of £30,000 or more, you’ll be required to take regulated advice and your Adviser will make a recommendation for you to consider. But if it’s less than this, would you really want to go it alone? Advisers that specialise in this are required to have specific qualifications and also rely on specialist systems and tools to work out whether they believe a transfer is in your best interest, as well as making sure that the new pension you will be transferring into and the proposed investment strategy meets your needs. In fact, it’s such a complex area that the FCA has raised the qualification levels for pension transfer specialists (PTSs) to require them to obtain the same investment qualification as an investment financial adviser alongside their PTS qualification. The value of specialist advice should not be underestimated.
- Do you have a plan for your ongoing income needs in retirement? Even though regulated advice must be sought to transfer a DB pension if its value is £30,000 or above, there is no requirement to take ongoing advice once the transfer has been made. By transferring out, individuals will be taking on all of the future risk associated with managing the pension such as longevity, inflation, tax and investment risk and there are no guarantees that future income needs will be met. To mitigate these risks it’s important that the transferred money is managed well, yet few people have the expertise to do this. Ongoing regulated advice may be needed if the retirement savings are going to be managed effectively over what may be 30 years or more.
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