With transfer values at high levels, could moving your pension out of a final salary scheme be the right option for you?
Deferred members of final salary pension schemes who are thinking about leaving their pension scheme and reinvesting their funds elsewhere have seen a significant rise in the transfer values being offered when they leave.
According to Scottish Widows, there has been a 246% increase in the number of new customers requesting a transfer from a final salary scheme. Transfer values relative to future pension entitlements are higher than ever before, thanks to a number of economic factors.
New pensions freedoms
Final salary schemes, also known as defined benefit (DB) schemes, are usually more generous than other types of private or employer pensions and tend to guarantee payments based on years worked and salary earned. They provide guarantees and protections that other schemes do not and scheme members are usually advised not to leave.
However, DB schemes can be inflexible and don’t allow the scheme member to change or increase the amount of income paid out. They are governed by their own rules on when and how much money can be withdrawn.
The introduction of new pensions freedoms in 2015 gave people much more control over when and how they drew cash or income from their funds.
From age 55, anyone in a qualifying scheme is allowed to take all or some of their pension fund. There is no obligation to buy an annuity, as there was in the past.
The freedoms apply only to defined contribution (DC) pension schemes, sometimes referred to as “money purchase” schemes, and not to those in final salary schemes.
Yet retirement provision is changing. More people are using income withdrawal to fund their retirement and fewer are choosing to purchase an annuity. As a result, there has been a surge in the number of people looking to transfer out of DB schemes, thanks to lifestyle changes and demands for more flexibility.
How are transfer values calculated?
If you are a member of a Defined Benefit pension scheme, you are allowed to transfer out of the scheme and receive a ‘transfer value’.
This is known as a Cash Equivalent Transfer Value (CETV) and is based on an actuarial calculation of how much it would cost a person to buy the same income provided by the DB scheme if they had to purchase an annuity on the open market.
The primary economic factor driving CETVs is UK Gilt yields, which sunk to record lows last year, driving transfer values up.
When you combine this with the fact that people are living longer than ever before and that inflation is starting to increase, it creates an environment where deferred members of DB schemes might consider that this would be a good time to transfer.
The table below shows the change in gilt yields over the past ten years.
15-year gilt yields - last 10 years
Based on figures for March 2017
Source: Sharing Pensions
Transferring out of a DB pension is not necessarily right for everyone, and it depends on your personal circumstances, the size of your fund and the composition of their entitlement within the DB scheme as a whole. For instance, those with a cautious attitude to risk or who prefer the security of a guaranteed, index linked income stream, may be better off remaining in the scheme,
For this reason, it is very important to take financial advice before proceeding. It’s also worth considering your own needs – do you require flexibility? Will your retirement be gradual? Will you need more income just after retirement and less when you pass the age of 70 and are less active? Do you need cash to pay off a mortgage or other debts? Are you planning to retire overseas? Are you in good health?
Before you go ahead, you should seek specialist advice from a regulated financial adviser – in some circumstances this may be a legal requirement.
Check whether your scheme is eligible. Some public sector pension schemes like the Teachers Scheme and the NHS do not allow transfers.
Why are transfer values high?
The fall in interest rates and in gilt yields have enhanced the transfer value of a DB scheme quite significantly over a relatively short period of time.
Pension transfer values as measured by the Xafinity Transfer Value Index ended 2016 up 15%. The Index increased from around £203,000 at 31 December 2015 to just over £234,000 as at 31 December 2016.
Source: Xafinity Transfer Value Index
The “Xafinity Transfer Value Index” tracks the transfer value that would be provided by an example DB scheme to a member aged 64 who is currently entitled to a pension of £10,000 each year starting at age 65 (and which increases each year in line with inflation).
Different schemes calculate transfer values in different ways. A given individual may therefore receive a transfer value from their scheme that is significantly different from that quoted by the Xafinity Transfer Value Index.
Looking for more flexibility?
Consumers are increasingly attracted to the flexibility of drawdown plans. Many people want access to the funds during ‘the golden decade’ of their retirement, between the aged of 60 and 70 when their mobility still allows for an active lifestyle and holidays of a lifetime.
They will take greater income during this period and then reduce their income requirements in later life. A DB pension is the opposite of this with a fixed income which will be at its greatest the day that member dies.
Another major attraction is around the death benefits. You might choose to exchange income for wealth and use a drawdown plan to take flexible income, taking into account generational wealth planning.
Finally, for those living overseas, transferring away from a DB scheme allows an individual to remove currency exposure from their retirement plans by holding the funds in the same currency as their expenditure.
Transfers will not be for everyone, and there are certainly many attractions to defined benefit schemes. It is important to take advice specific to your personal circumstances, tax position, income requirements and future anticipated lifestyle needs. We would recommend that now is an opportune time for deferred members of these schemes to review their options.