Not so long ago, everyone knew that final salary pensions were the ‘gold standard’ in pensions and life was simple. But it got complicated again when plunging UK gilt yields and the new ‘pension freedoms’ triggered a sudden boom in final salary pension transfers.
These days, the final salary (or defined benefit) pension is a rare and wonderful thing. Those lucky enough to have accrued pension benefits in such schemes enjoy an index-linked pension in retirement that’s based on a proportion of their salary at the time they left the company in question or, in some cases, an average of their salary over their years of service.
Importantly, the scheme member carries none of the investment risk that comes with building up a pension pot. The generosity of this offering when compared to personal pensions, where all the investment risk and the costs rest on the individual, couldn’t be more apparent.
Britons also learned a painful lesson about the value of final salary pensions soon after personal pensions were introduced in 1988. Back then, many thousands of final salary scheme members were lured into shiny new personal pensions which, thanks to swingeing sales commissions and poor investment returns, soon floundered.
Subsequently labelled as the ‘pensions-misselling scandal’, the decade-long battle for compensation that ensued left a strong enough taste in the mouth for Britons to learn that final salary pension transfers just weren’t worth the risks.
However, recent tectonic shifts in the pension landscape have turned such hard-earned conventional wisdom on its head and final salary pension transfers are suddenly more prevalent than at any time in their history.
So, with an estimated 10.4m Britons1 still wandering around with final salary pension benefits of one kind or another, what do you need to know to decide if a transfer is right for you?
Why final salary pension transfers are booming
A combination of factors has triggered the current boom. Chief among these is the fact that the transfer values now being offered to the 6.8m1 or so Britons with deferred final salary pensions (the rest are active members) have never been higher.
Thanks to a combination of record low yields on UK government bonds and our ever-lengthening life spans, the cost to employers of providing a final salary pension for life has hit an all-time high. This has been nothing short of a bonanza for cash equivalent transfer values (CETV) – namely the cash payments that final salary schemes offer as an alternative to drawing your pension.
Although there’s probably no such thing as an ‘average’ transfer value, in some cases they can be over 200 per cent higher than just a few years ago. Right now, we’re seeing clients who’ve enjoyed gains of 25 per cent or more in their transfer values over the last year alone.
Quite apart from the sudden eruption in transfer values, there are several other important factors that have helped to reshape this part of the pension landscape.
One is a renewed putsch by final salary schemes to remind their deferred members that they can transfer (and so get them off their books for good). Another is the recent arrival of the so-called ‘pension freedoms’.
Since April 2015, anyone over the age of 55 can access a personal pension whenever they like and take whatever level of income or cash lump sums they choose (subject to the tax rules). The new rules also abolished the 55% ‘death tax’ on pensions. Overnight this made personal pensions one of the best ways in which to pass wealth without attracting inheritance tax.
Don’t forget that a final salary pension will be lost when you, and possibly your spouse, die. So a transfer has suddenly become a way to transform your pension rights into a substantial financial asset that can provide both income and tax-efficient lump sums in retirement, and still be passed on to your loved ones, free of inheritance tax (and possibly income tax), when you die.
The last big driver of the current boom in pension transfers is fear, plain and simple. Many Britons are rightly concerned as to the security of their hard-earned final salary pensions. The recent collapse of major schemes such as British Steel and BHS highlighted how pensions can become hostages to fortune.
If your former employer fails, you could find your pension is in the hands of the Pensions Protection Fund, which will only pay out 90 per cent of your benefits subject to an overall cap of £32,761 at age 65, while future increases will also be reduced. This would be a significant loss to someone with many of years of service in a final salary scheme.
How can I tell if my transfer value is any good?
First you need to request a CETV from your scheme provider. Most will provide one free quotation a year, but beware. Valuations are only guaranteed for three months, so the clock suddenly starts ticking if you’re weighing up a possible transfer.
To work out if your valuation represents good value or not, you’ll need to find the multiple that’s been employed. Historically, the industry ‘multiple’ tended to float at around 20 meaning that a £10,000 pa pension would equate to a transfer value of around £200,000. However, multiples in the 30s, 40s and even 50s are now much more standard.
To make this process a little easier for Britons, we’ve built a Final Salary Transfer Calculator, which does all the heavy lifting for you.
You’ll find there’s little consistency between company schemes, even those in the same industry. A good example was the different multiples being offered by BT’s final salary scheme and that of Cable & Wireless at the start of 2017. While the former offered a muted multiple of 20, the latter was offering a multiple of above 50.
This means that anyone with a £10,000 pa Cable & Wireless pension could cash it in for a transfer value well in excess of £500,000!
How can I decide if a pension transfer is right for me?
The single biggest consideration is weighing up whether it’s worth turning your back on all that lovely, index-linked income and instead taking on all the investment risk yourself. Hand in hand with this is the risk that if you mismanage your subsequent withdrawals, you could exhaust your pension pot before you reach the end of your retirement. There’s no such risk with a final salary pension.
Of course, the higher the transfer value you’re offered, the lower the investment risk you take on and the better your chances of not running out of money in retirement.
That’s why you’ll need to find an adviser who can produce a ‘cashflow model’ which will illustrate just how well your new pension pot will need to perform in order to at least match the level of income you would have received from your final salary pension.
Because pension transfers are a complex and nuanced process, the ‘pension freedoms’ made it a legal requirement to seek professional financial advice (which carries a fee) on any pension transfer worth over £30,000.
So it makes sense to find a good adviser you feel you can work with before you apply for a transfer value and the clock starts ticking. Remember, both your existing scheme and your new pension provider will require evidence that you’ve received this advice before they’ll authorise a transfer.
Are some people better off staying where they are?
We think there are at least eight good reasons to consider a final salary pension transfer (see in the box inset) but it’s important to appreciate that they’re not for everyone.
There are four important things that you’ll be giving up in exchange for your transfer value. You’ll be saying good-bye to:
· Any guarantees as to the level of income you receive in retirement
· Any guaranteed inflation proofing
· Any guaranteed widow’s pension
· Any guarantee that you won’t run out of money in retirement
All this means that, if your priority is a guaranteed income or you don’t have anyone to whom you’d like to leave your pension wealth, then a transfer may offer little. Similarly, if your spouse is a lot younger than you are or if you’re still decades away from retirement age, then transferring your final salary pension probably won’t make much sense.
The same is true if you’re worried about running out of money in retirement, you don’t want to take on the investment risk, you don’t like complexity or you just don’t want to work with a financial adviser!
Meanwhile, not everyone will have seen their transfer values hit the roof. For instance, transfer values from the likes of BT and British Airways may have increased in recent times, but they’re still far from generous.
But this can change. For example, in October 2015, we advised a client against a transfer on the grounds that it was poor value. He wasn’t too thrilled but took our advice. When we reviewed the transfer for him in December 2016, we found that the same ‘little’ pension had risen by over £100,000 and suddenly a transfer made a lot more sense.
These days, the average Briton has something like a dozen jobs during the course of their working life, which means that most of us end up with multiple pensions, all of which should be reviewed to ensure we optimize our retirement.
Is a pension transfer right for you? The answer is a resounding ‘maybe’. But as it’s one of the most important and complex financial decisions you’ll ever make, it makes sense to find out. The results could, quite literally, be life changing.
1 Royal London, data correct as at March 2015. Sources: Purple Book (December) 2015 & LGPS Annual Report 2015.