Last year, according to pensions
data the Financial Times
requested from the Financial Conduct Authority, the cash transferred from defined benefit (DB) or ‘final salary’ schemes and into defined contribution (DC) plans reached £20.8bn – more than doubling the 2016 total.
Spurring the surge has been the amount that providers of DB pension plans are prepared to pay holders if they opt to leave, which has risen significantly in response to the weakness of long-term government bond or ‘gilt’ yields, as these are closely linked to annuity rates.
Normally, the lower the long-term gilt yields, the lower the annuity rates
– which also raises pension transfer values. Yields have been persistently low for some time and actually reached a record low in October 2016.
Many DB schemes have also been more than happy to see members transfer out, especially deferred members (those who have already left their employer), as it reduces their liabilities, with some actively encouraging this by enhancing the transfer value.
Some transfer values have been reported at 30 to 40 times the DB annual pension the pension holder gave up.
So, is it worth transferring? Tony Watts (@tonywattswriter
) explores the options.
What are the differences between defined benefit and defined contribution pension types?
While the amount of money you can expect for your DB pension fund might sound an attractive proposition, it’s important to know what you’re giving up.
Defined benefit schemes do what they say on the tin. The provider, usually your employer or previous employer, will guarantee how much you receive in retirement depending on your salary and years of service. It can also reflect what you received in your last year of employment – why they are also called ‘final salary’ schemes.
In uncertain times, knowing what you should receive during retirement is highly reassuring. You’re immune to stock market fluctuations and protected, to an extent, against erosion by inflation.
Defined contribution schemes don’t normally provide a guaranteed pension, except in a few instances where a fixed annuity rate may be built in at retirement age. The pension you receive will depend on how much you put into the plan over time, and how good a job has been done by whoever managed your scheme’s funds. On top of that, the all-important final valuation of your pension pot is normally made when you start drawing your pension, which can vary considerably.
Can you transfer from a DC scheme to another one?
One option many people with a DC plan in place should consider is transferring to another DC scheme – especially if they are no longer contributing. If you have a number of small pension pots there can also be advantages in consolidating them, as doing so often reduces administration costs and makes it easier to track performance.
Transferring funds between DC plans is another potential route that opened up when pensions freedoms were first introduced in the 2015/16 tax year, and could be particularly attractive if an old plan is inflexible or performing poorly. But do shop around first, take expert advice and make sure that you aren’t losing out on any benefits contained in the old plan.
The upsides – and downsides – of transferring from DB to DC
'Moving out of a DB pension can be advantageous – but is not something you should do lightly,’ says Mark Soper, director of Myers Davison Ginger, who advises both corporates and individuals.
‘The principal benefit of transferring is the opportunity to move into a scheme that better fits your current situation. For instance, the DB scheme will usually include a part pension for a surviving partner or child, or a lump sum – which may be worthless to a single person.
‘A DC pension plan is flexible in that it allows a person to set withdrawals that best fit their financial circumstances – for example, taking the tax-free cash lump sum and deferring taxable income to a later date. A DC pension plan also allows the pension fund to pass down through the generations on the death of the plan holder.
‘But do weigh up the negatives: the loss of security and all the guarantees that a DB scheme provides,’ he adds. ‘Moreover, if your riskier investment strategy doesn't pay off, you may well not get the returns you’d hoped for and end up with a lower pension income… or worse still, an income that, despite careful planning, could run out in the future.’
Weighing it all up
The plus point in all of this is that pension holders really do now have more choice than previous generations, enabling you to make the most of the money you put away during your working life and ensuring that the plan you have fits around you, not vice versa. But there are caveats – not least that, without taking expert advice
, you may well end up with a plan that lands you with unexpected tax bills, or find yourself tempted to take out so much cash that you run out of money during retirement.