Since the pension rules changes, increasing numbers of my clients are reviewing their defined benefit pensions and assessing their options. For some, transferring to a money purchase arrangement is better, but there are risks and pitfalls.
This is the reason my clients give most often. Their defined benefits scheme just doesn’t offer an income that suits their spending habits throughout retirement. With a typical DB scheme, income increases annually, usually in line with inflation, and therefore increasing in later years.
Many clients tell me this is the wrong way round. They have big plans in their 60s and 70s but know that in their 80s and beyond their spending will reduce.
Most DB schemes will not allow early access without applying an actuarial reduction which affects a pensioner’s future income. That is why many clients say they prefer flexibility. A money purchase arrangement will not penalise them for early access.
A spousal income is built into most defined benefit schemes. Typically a spouse would inherit 50 per cent of the member’s income. Some DB schemes also offer a legacy income to dependent children. For some this is a valuable option but could potentially be a poor return compared to inheriting a lump sum from a money purchase scheme – a tax efficient way of leaving a legacy.
The death benefits of a DB scheme are extremely rigid and if a client is not married and has no financially dependent children, the fund may die with them. If they want someone else to inherit their fund, I usually advise them to move it into a money purchase scheme.
My clients often want to work out how valuable the transfer value of their DB pension is compared to the ongoing annual income. In other words, how many years would they have to live to receive the same income as they could generate by taking the whole transfer value offered by their scheme and move it into another pension arrangement?
For someone in good health they could expect to receive a higher total capital return by staying in their DB scheme. But for anyone concerned about their life expectancy it may be that the scheme would offer a poor total capital return. That’s why I advise some clients to consider transferring their benefits to ensure they and their family receive a definite total return from their pension fund.
These are the most common reasons I hear for moving a DB pension but there are others too.
Repaying debt is one or helping children onto the property ladder. But whatever the reason, I always explain the risks involved.
First, they are giving up a guaranteed, inflation proof, income, which is payable for life and beyond that will be payable to a spouse. For many this guaranteed income is essential because they do not have other resources to rely on in retirement.
Second, capacity for loss is an important consideration. If a client has other assets to help generate retirement income, they may be less dependent on their defined benefit income. They may be willing and able to take on the risk of transferring their benefits.
Third, pensioners will give up a guaranteed spousal income. For some, it is a crucial addition to their pension income and guarantees income for beneficiaries. A money purchase scheme guarantees neither income nor lump sum for beneficiaries.
Advising in this area is a complex topic and anyone advising clients in this area must pass the Advanced Pension Planning exam. In further recognition of the risks and complexities, the government insists that anyone with a fund of more than £30,000, must seek advice from a qualified adviser before transferring their pension.