Defined benefit pension schemes (sometimes called ‘final salary’ pensions) are considered to be the gold standard of pension arrangements.
Unlike defined contribution (or ‘money purchase’) schemes, investment risk is to a large extent borne by the employer rather than the scheme member.
The trend over time, for all kinds of reasons, has been for employers to replace defined benefit schemes with defined contribution arrangements which for them represent less risk and usually lower cost.
April 2015 pension changes
From April the new freedom and choice in pension rules come into force.
When a member of a deferred defined benefits scheme (a scheme they have left in the past) sees the value of their accrued pension benefits expressed as a capital sum (the cash equivalent transfer value – or CETV) for many it will represent a serious amount of money.
In some cases the CETV will be easily in excess of the value of their home.
If over 55 years old there may well be some temptation to consider a transfer from the deferred defined benefit scheme into a private arrangement such as a Self Invested Personal Pension (SIPP).
The value of the pension plan might then be taken as cash; the first 25% as tax free cash and the balance of any capital taken as taxable income.
Only transfer for good reasons
Our starting point for advising clients about what to do with their deferred defined benefits the view that they should not transfer. However there may be some circumstances where such a transfer makes real sense.
If there is a genuine Financial Planning need for a significant tax free cash payment, it may well be that the private arrangement offers a larger amount.
It may also be that the circumstances of the member – perhaps having no spouse or partner to benefit from any survivor’s pension benefits on their death – might make arranging a private pension income a better option.
Or perhaps the health position of the pension scheme member entitles them to an impaired life annuity which (after taking tax free cash) could be higher than the scheme pension offers.
Or perhaps a combination of these factors makes a transfer well worth while considering.
Financial Plan first
Before you transfer out of a defined pension scheme make sure you have in place a detailed Financial Plan; including a lifetime cash flow forecast.
Having this means you can understand the impact of the shift of risk away from defined benefits to a money purchase environment.
Make the decision based on a thorough analysis of your financial requirements, as well as the numbers being crunched.
A poor decision made now may leave you poorer later in life.
