To transfer your pension pot…or not
Each week we’re contacted by people with a burning financial question; should I transfer my defined benefits pension plan, or not? It’s a tough one to answer and shows the importance of professional independent advice.
Chances are that they have received a statement from the administrators of an ex-employer’s pension scheme, in which they used to be an active member, telling them about the value of their benefits in that scheme.
Or they may have read in the press that the current values available, if they were to transfer away, are at an all-time high. Transferring out of a defined benefits scheme (a pension scheme where the benefits are calculated by reference to earnings and length of employment) is a hot topic at the moment.
Deciding whether to transfer, or not, is an important and complex decision. The government decided some years ago that anyone wishing to do this, who had a value of £30,000 or more, needed to take independent advice before they transferred away from such a pension scheme.
Advising on this subject is a highly specialist advice service requiring the adviser to hold specific qualifications and permissions from the financial regulator, the Financial Conduct Authority.
The challenge for the consumer is to consider two very different numbers. A lifetime flow of retirement income at some point in the future or a significant capital sum today (to be transferred into a personal pension plan).
The numbers can be truly mind-boggling. A current value deferred defined benefits pension of say £12,000 per year might have a capital value (called a cash equivalent transfer value) of anything up to £420,000.
Human nature being what it is, our eyes are attracted to the large capital sum – it’s almost lottery winning territory. Surely having £420,000 in my pension plan now is better than having £12,000 a year payable from age 65? Well the answer to that question is, it depends.
Key to good decision making is not to be seduced by the high capital value to the point where the value of the guaranteed income for life is ignored.
And there are both advantages and disadvantages to keeping or transferring from such a scheme. So what are the important points to note?
In favour of keeping the defined benefits pension;
• First of all, people tend to underestimate their life expectancy. The pension income payable from a defined benefits pension scheme is payable for life and usually increases in value each year.
We have to be a little careful if we call it “guaranteed” income, because there are some circumstances where it might actually not be guaranteed;
• It usually provides a lifetime income for a surviving spouse or civil partner as well, so both people should be involved in the decision making process if they do decide to transfer;
• The financial risk of the “guaranteed” pension income rests with the previous employer who sponsors the scheme;
Factors in favour of transferring might include;
• A more flexible access to pension benefits to fit in with the other retirement income a person might have;
• Potentially greater lump sum death benefits that might be passed on down a generation;
• In some instances a greater entitlement to a tax free cash lump sum to spend, invest or pay off debt
The state of health of the pension benefit owner is also a material fact for consideration. A person with a shortened life expectancy due to a pre-existing medical condition might well feel they will get better value from a pension pot on transfer than a flow of future income.
However, taking the cash equivalent transfer value is a transfer of risk away from the previous employer and into the hands of the person who transfers. The key risk is that the money in the personal pension plan may not last as long as you do!
Once transferred the pension plan might provide what is known as “flexible access drawdown” this means that the pension plan owner sets the level of retirement income they receive.
If the invested pension fund is not robust enough to support this rate of withdrawal then the owner may have to reduce their level of income later in life and in the worst case have no money left at all.
This is why, when we advise on this subject, we produce multiple lifetime cash flow forecasts and ensure that those clients who do transfer are those who can afford to take such risks and whose income in retirement is robust enough to mitigate the risks involved.
For the majority of people the right answer is to retain the defined benefit pension and not take any investment risk at all.
It may well be, for example, that the “guaranteed” pension income is enough to pay all of their committed post retirement bills.
For some people there are meaningful reasons to transfer but anyone who does must be fully aware of the risks that they are taking.
This article first appeared in the September 2018 edition of Informed magazine