Defined Benefits or flexibility

Probably the most high profile and contentious issue that currently exists in the UK financial advisory world is that of Defined Benefit (DB) pension transfers. That is, the decision taken by an individual (after taking financial advice) to transfer away from an environment where at a determined point in the future they have the prospect of a known and guaranteed income, and instead walk away from this and take a Cash Equivalent Transfer Value (CETV) and invest in some form of personal pension where no such guarantees exist.

Before the introduction of the so-called ‘pension freedom’ legislation in April 2015, transfers of this type were very uncommon, but some months back, The Financial Times reported that Mercer had calculated that about £50bn has been paid to 210,000 members of DB pension plans since 2015.

According to research by Royal London, the typical value of DB pension transfers is now greater than the average price of a house. The provider found that the average transfer value lay in the range of £250,000 to £500,000. By comparison, the average UK house price was £216,000 in March 2017, it said. Typically, the cash sum offered was worth between 25 and 40 times the value of the annual pension given up.

Depending on your perspective, the current dash for pension cash is either the next high profile miss-selling scandal, or the opportunity for many to seize control of their pension wealth and flexibly shape their retirement income in a way that suits them and their families.

The Financial Conduct Authority (FCA), the regulator of financial services in the UK, is concerned about the position and issued a consultation paper (Advising on Pension Transfers) on 21st June 2017. Their current guidance is quite clear; that advisers should start from the assumption that a transfer out of a DB scheme is generally unsuitable prior to considering other factors. The consultation paper proposed a different position and recommends that; ‘An assessment of suitability should focus on whether a transaction is right for the individual and should be assessed on a case by case basis from a neutral starting position. The adviser needs to demonstrate that the transfer is in the best interests of the client."

As a firm, we have received a significant number of enquiries about transferring out of DB schemes and following the current FCA guidance, we have advised twice as many clients to remain with their current schemes than to transfer away.

So when is it right to consider such a transfer?

As you might expect, it is not straightforward and there are usually many factors that need to be considered. So, what are the main issues that motivate individuals to consider giving up the ‘gold plated’ guarantees within their company pension schemes?

Timing

The ability to control the timing of income and capital extraction is often seen as the ultimate flexibility. DB pension income commences at a fixed age (say 60 or 65) and then simply pays a rising income for life. However, income needs in retirement may not be uniform and being able to retire sooner and draw more income in the early years, then increase and decrease what is drawn at will is often seen as more attractive than having a high (and escalating) income at the latter end of retirement.

Value

Low Government gilt yields amongst other factors, mean that the level of transfer values is at an all time high and in a number of cases we have seen these transfer values rise by around 50% in the last two years. The result is that we have seen numerous transfer values in the region of £1m where the pension on offer at age 65 is in the region of £25,000 to £30,000 per annum.

Passing wealth on

The benefits of a DB scheme usually mean an income for life for the member, then a 50% pension for the surviving spouse for life, then all benefits cease – whereas any unspent funds taken in the form of a transfer value can pass on down the generations in a tax efficient manner. The sense that family wealth is being created is often a big motivating factor in considering a DB transfer.

Health

In the event of poor health and the likelihood of a reduced life expectancy, the capitalisation of benefits into a cash sum can seem a better bet than taking an income for a potentially shortened life, which may mean that only a fraction of the underlying value is paid out. A reduced life expectancy can also mean that the prospect of retiring as early as 55 and enjoying the early part of retirement can be a powerful driver. As can the thought of making sure a spouse and/or children can benefit from access to a large cash pot in the event of death early in retirement

Tax efficiency

With flexibility comes the ability to be tax efficient. In many cases where we have recommended a transfer, the ability to save tax by careful planning is often preferable to defined benefit pension benefits. These flexibilities can include a higher tax free cash sum following the transfer, the ability to limit pension income to specific income tax bands and the opportunity to defer and minimise the impact of lifetime allowance (LTA) penalty tax charges.

For many people, deciding whether to remain within a DB pension scheme or transfer away from the comfort of a lifetime guaranteed income and access the flexibilities now available will be the biggest financial decision they will ever take.

Whilst we have helped a small number of clients transfer away from their DB schemes, we take this responsibility very seriously and make sure that robust challenges are made to ensure that it is clear what is being given up compared to what is being gained, and that a coherent plan is in place to ensure that the transfer value accessed is indeed able to deliver the things that have motivated the clients to want to walk away from the security of a guaranteed pension for life in the first place.

Our view is that for many, DB schemes remain the most appropriate choice for providing their standard of living in retirement and only when it can be clearly demonstrated to be in the client’s best interests, will we consider a transfer.

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