Reader Question:
I have always been led to believe that remaining in a final salary pension scheme is always in my best interests. But I have recently been reading articles that suggest that it may be beneficial to transfer my final salary pension particularly as I'd like to take advantage of the new pension freedom rules. Should I consider a final salary pension transfer? Or should I leave it? If I do move it should I transfer my final salary pension into a personal pension or a SIPP (self invested personal pension)?
Thanks in advance,
S Waller
Damien's response:
Transferring a final salary scheme into a defined-contribution pension (such as a SIPP) needs a lot of careful consideration. In addition there are a number of rules and regulations in place to protect members, which I will also cover in this response. However, for the benefit of others and for completeness, I will cover in detail what a final salary pension is before moving on to the pros and cons of transferring a final salary pension and what to consider.
If you are reading this article and want to quickly gauge whether you should take the transfer value offered by your final salary scheme and move it into a personal pension then use this link to jump to the Final Salary Pension Calculator section below. This will help you decide whether the transfer value you have been quoted represents good value based upon historical benchmarks. However, do make sure you also read this article in full.
What is a final salary pension and how do they work?
A final salary pension scheme (also known as a defined-benefit scheme) is a pension scheme provided by an employer where the pension benefits are based on the final salary of the employee at retirement. The exact definition of the final salary varies from scheme to scheme. But as an example, a final salary may be defined as equal to the member's salary in the year prior to retiring. In some final salary schemes the 'final salary' is calculated as an average salary over the last few years prior to retirement to reduce the impact of their actual salary falling just prior to retirement.
Final salary pension benefits are calculated as a percentage of the defined final salary for every year the employee has worked. Final salary pension rules allow these benefits to be calculated at an accrual rate (such as 1/60th or 1/80th) of final salary for each year the employee has been in the scheme. The maximum pension benefits allowed under the final salary schemes is the equivalent to 40 years worked or 2/3rds of final salary. There are very few schemes that offer such generous retirement benefits and that are still accepting new members.
It is possible to take a tax-free lump sum and many schemes have a final salary pension lump sum option. In theory, it is possible to take 25% of your accumulated pension as a lump sum but as there is no actual 'pension pot' owned by the employee it is difficult to calculate this figure. Each individual final salary pension scheme will have a set of rules that indicate how this final salary pension lump sum is actually calculated. In addition, many final salary pension scheme benefits increase in payment to counteract the effects of inflation.
All final salary pension schemes will have a defined retirement age but early retirement is usually possible from age 55, often with a discount applied to the retirement benefits.
Who can transfer out of a final salary pension scheme?
Interestingly not everyone who is member of a final salary pension scheme can have a final salary pension transfer. You are not allowed to transfer out of your final salary pension scheme if it is an unfunded public sector scheme. So that includes the armed forces, the NHS, the police force and teachers but also many other schemes. You are also not allowed to transfer a final salary pension once it is in payment.
Advantages of transferring out of a final salary pension
Transferring from a final salary pension scheme has looked more appealing recently due to soaring transfer values being offered by final salary scheme administrators as well as the advent of the new pension freedom rules. Low interest rates and gilt yields have pushed up transfer values by as much as 30%. Add to this the incentives offered by some final salary schemes to encourage individuals to transfer their pension and you can see why the demand for a final salary pension is growing.
One of the main advantages of transferring out of a final salary scheme is the flexibility offered by pension-freedom legislation which came into force in April 2015. This new flexibility can offer retirees larger cash sums and greater choice when it comes to where their pension pot is invested rather than the fixed amount of cash and income offered by a final salary pension. It may also be beneficial, if you have a number of pension pots with different employers, to transfer these to one provider for ease of management.
Another reason to consider transferring a final salary pension is to pass on benefits to the beneficiaries of your estate on death. In the event of death any final salary benefits die with the employee unless a dependent pension is provided for in the rules of the scheme. Under the new pension-freedom legislation it is possible to pass on the proceeds of a pension tax free if the individual dies before age 75 and is not taking a pension. If the individual dies after 75 and is taking an income the beneficiary will pay tax on the income.
It may well make sense to consider transferring a final salary pension if the individual is in poor health which is likely to affect his/her life expectancy. The benefits in a final salary pension are not dependent on your health at retirement but purely dependent on length of service and final salary. If an individual transfers their final salary pension benefits then they will have more flexibility with what they can do with their pension transfer pot. A transferred pension pot can provide a larger lump sum or, if an annuity is required, an individual can obtain an enhanced annuity due to their impaired health.
Disadvantages of transferring out of a final salary pension
Final salary schemes provide a guaranteed income that will not only rise as your income rises during your career (with the same employer) but also rise in retirement due to index linking. Other benefits available with final salary schemes can be dependent pensions and life insurance cover.
Transferring away these benefits is a difficult and complicated decision and if your pension transfer value is £30,000 or more, then you are required to take financial advice before transferring. If a final salary pension scheme is transferred into a personal pension or a SIPP then a decision will have to be made regarding where to invest the pension pot and the investment risks involved. These investment decisions can have a dramatic effect on the final pension an individual will receive. This could be more or less than would have been received if they remained in the original final salary scheme. The financial regulator, the FCA, has reiterated its stance that anyone advising on final salary transfers should start from the assumption that a final salary pension transfer will be unsuitable for a client.
What are your options if you wish to transfer your pension?
If you wish to transfer from a final salary pension scheme then are a few options to consider:
- Transfer into a personal pension - a personal pension is an individual pension arrangement where the final benefits are dictated by the level of contributions. Group personal pensions offered by employers often have restricted investment choices.
- Transfer into a SIPP - a SIPP is a form of personal pension with more flexibility over investment choices.
- Transfer to another company pension scheme - only possible if an existing company scheme allows transfers into the scheme.
How to work out if transferring your pension is the right decision for you
The first thing to do when considering final salary transfers is to understand the company pension scheme rules. A copy of the rules will be available from your employer and will give you the full details of your benefits under your current scheme. Once you have a better understanding of your current scheme you know what benefits you will be losing if you transfer your pension.
The next step would be to speak to an independent financial adviser that specialises in final salary pension transfers (see the last section for more details). An independent financial adviser will give a clear understanding of the pros and cons of transferring your final salary pension. Once you have a clear picture then you can make an educated decision about transferring your final salary pension. But as stated above, the starting position should be that a final salary pension transfer is not suitable unless shown to be otherwise.
How much is my final salary pension worth?
Once you have the full details of your current final salary pension scheme you can calculate what your pension income would be if you were to retire today. You can then do another calculation which would estimate your possible pension at a future retirement date using the years in the scheme and your estimated salary at retirement. In each case, you multiply the final salary by the number of years in the scheme and then multiply it by the accrual rate.
Calculating your final salary transfer value
Calculating a final salary pension scheme transfer value of a final salary pension scheme is far more complicated as there is no actual 'pension pot' as in a personal pension or a SIPP. You can request that your pension-scheme administrator calculates a figure known as the 'final salary cash equivalent transfer value' (CETV). The CETV is the amount of cash required to buy the final salary scheme benefits if invested at the date of the calculation. This final salary cash equivalent transfer value will be guaranteed for 3 months from the date of calculation. This CETV is the amount that you could transfer into a SIPP for example.
Final Salary Pension Calculator
If you don't have a CETV to hand or you want to check whether the CETV (transfer value) your final salary scheme has quoted represents good value or not then use this free cash equivalent transfer value calculator. This final salary pension calculator calculates the value of your final salary pension and compares that against historical benchmarks.
Get professional final salary transfer advice
If you are thinking about transferring a final salary pension then I strongly suggest that you take advantage of a free pension check* with a qualified adviser. We have secured a limited number of these FREE 30 minute phone consultations to ensure that people receive the right advice when considering transferring a final salary pension. There is no obligation on your part.
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