Plans to restrict pension transfers
A recent consultation from the Department of Work and Pensions (DWP) contained proposals to stop people from transferring their defined benefit pension benefits to a defined contribution pension scheme, such as a personal pension.
The proposal is a consequence of the main proposal in the document, to stop people from contracting out of the State Second Pension (S2P) with their defined benefit (often called ‘final salary’) pension schemes.
Contracting out is set to be abolished for defined contribution pensions from 2012, so this proposal from the DWP would extend this to final salary pension schemes, saving the Treasury money in National Insurance rebates.
It is important to note that, for the vast majority of people, a transfer of defined benefits to a personal pension is a wholly inappropriate thing to do. It means giving up the promise of a (usually inflation linked) pension income in retirement for a cash equivalent transfer value that must be invested with the aim of providing an equivalent level of benefits.
There are some circumstances where a transfer can make real sense. These include where people have poor health or are unmarried and can receive a higher income from an annuity tailored to their specific circumstances.
It used to be the case that concerns about the financial security of a sponsoring employer would also be justification to move money away from a defined benefit pension scheme, but since the introduction of the Pension Protection Fund this is less of an issue.
Before a financial adviser can recommend a transfer away from a defined benefit pension, a thorough analysis must be completed to consider all of the factors and establish a ‘critical yield’; showing by how much the transfer must grow each year to stand a chance of matching the current level of pension benefits.
We will keep a close eye on this latest consultation from the DWP to find out if these transfers will be completely banned in the future or if this was simply an unintended consequence of other proposed changes.