We are experiencing an increasing number of enquiries regarding defined benefit (DB) pensions and whether or not it is in the client’s interests to move these to an alternative arrangement.
The so called Pension Freedoms rules, which came into force in April 2015 has been a major driver in this upturn.
For some it may be better to transfer to a money purchase arrangement (like a personal pension) but certainly not all cases. There are risks in doing so and each case must be viewed in isolation to determine objectives and basically whether the client can achieve what they want where they are.
Now that the flexible access benefits from the new rules are becoming better known, this is a common reason given i.e. defined benefit pensions simply do not offer flexible access. On the other hand it provides a known and prescribed income, which increases annually, usually in line with inflation.
Some clients have commented that this is the opposite of what they want i.e. higher spending patterns in the early years then less as they get older. Also the fixed income sometimes does not suit the client's circumstances or objectives and they may need flexibility given their tax position etc.
Most DB schemes will apply a penalty affecting the pensioner’s income, should they decide to retire prior to the scheme's normal retirement age. With a money purchase scheme that doesn’t happen and if they use a new style flexi-access drawdown plan, they can take what they want, when they want.
A spouse pension is usually built into most schemes at 50% and depending on the rules, dependents pensions could be payable to children.
It very much depends on the client circumstances as to whether this is regarded as beneficial. For example, someone who is married with young children would regard this as an important benefit, but someone who is single and has children older than the allowable scheme benefit age, would not – the pension value would be lost on death.
Transferring the benefits to a money purchase arrangement would mean the whole value of the pot would be paid to the individual’s beneficiaries and this is tax free if the person dies before age 75 – a very tax-efficient way of leaving a legacy.
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 some clients consider transferring their benefits to ensure they and their family receive a definite total return from their pension fund.
Again, here is another example of why this type of advice is bespoke to the individual – it very much depends upon individual circumstances and objectives.
Reference should also be made as to how valuable the transfer value is compared to the ongoing annual income. Transfer values have typically increased over the last couple of years, due to gilt yields being so low (this is what actuaries use to calculate the transfer value). As gilt yields have fallen heavily then this has also had an impact and can indeed be a driver in the client’s decision.
There are other reasons that people may consider transferring their DB pension – for example having to leave the service of their employer to access benefits (even if they kept them in the DB scheme) and others such as repaying debt early or even helping family on to the property ladder.
Whatever the reason, it is crucial that the risks specific to the individual are made clear. The client should have sufficient information to be able to make an informed decision.
Firstly, for example, 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.
Secondly, 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. Allied to this is the fact that the DB scheme does not involve the client in investment risk, transferring does, they have to be prepared to take investment risk in return for potentially greater flexibilities.
Thirdly, pensioners will give up a guaranteed spousal income. For some, it is a crucial addition to their pension income and guarantees income for beneficiaries.
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. That adviser must have specific qualifications and permission to enable advice to be given. It is no doubt a popular topic at the moment, but the area can be very complex and the appropriate advice should be sought.
The so called Pension Freedoms rules, which came into force in April 2015 has been a major driver in this upturn.
For some it may be better to transfer to a money purchase arrangement (like a personal pension) but certainly not all cases. There are risks in doing so and each case must be viewed in isolation to determine objectives and basically whether the client can achieve what they want where they are.
Now that the flexible access benefits from the new rules are becoming better known, this is a common reason given i.e. defined benefit pensions simply do not offer flexible access. On the other hand it provides a known and prescribed income, which increases annually, usually in line with inflation.
Some clients have commented that this is the opposite of what they want i.e. higher spending patterns in the early years then less as they get older. Also the fixed income sometimes does not suit the client's circumstances or objectives and they may need flexibility given their tax position etc.
Most DB schemes will apply a penalty affecting the pensioner’s income, should they decide to retire prior to the scheme's normal retirement age. With a money purchase scheme that doesn’t happen and if they use a new style flexi-access drawdown plan, they can take what they want, when they want.
A spouse pension is usually built into most schemes at 50% and depending on the rules, dependents pensions could be payable to children.
It very much depends on the client circumstances as to whether this is regarded as beneficial. For example, someone who is married with young children would regard this as an important benefit, but someone who is single and has children older than the allowable scheme benefit age, would not – the pension value would be lost on death.
Transferring the benefits to a money purchase arrangement would mean the whole value of the pot would be paid to the individual’s beneficiaries and this is tax free if the person dies before age 75 – a very tax-efficient way of leaving a legacy.
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 some clients consider transferring their benefits to ensure they and their family receive a definite total return from their pension fund.
Again, here is another example of why this type of advice is bespoke to the individual – it very much depends upon individual circumstances and objectives.
Reference should also be made as to how valuable the transfer value is compared to the ongoing annual income. Transfer values have typically increased over the last couple of years, due to gilt yields being so low (this is what actuaries use to calculate the transfer value). As gilt yields have fallen heavily then this has also had an impact and can indeed be a driver in the client’s decision.
There are other reasons that people may consider transferring their DB pension – for example having to leave the service of their employer to access benefits (even if they kept them in the DB scheme) and others such as repaying debt early or even helping family on to the property ladder.
Whatever the reason, it is crucial that the risks specific to the individual are made clear. The client should have sufficient information to be able to make an informed decision.
Firstly, for example, 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.
Secondly, 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. Allied to this is the fact that the DB scheme does not involve the client in investment risk, transferring does, they have to be prepared to take investment risk in return for potentially greater flexibilities.
Thirdly, pensioners will give up a guaranteed spousal income. For some, it is a crucial addition to their pension income and guarantees income for beneficiaries.
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. That adviser must have specific qualifications and permission to enable advice to be given. It is no doubt a popular topic at the moment, but the area can be very complex and the appropriate advice should be sought.
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