Attractive transfer values combined with the pension freedoms introduced in 2015 are leading to increasing numbers of people considering transferring their defined benefit pensions.
In this article we will discuss what a defined benefit pension scheme is and what the benefits could be worth to you.
Should I transfer my Defined Benefit pension to an Individual Pension Arrangement?
This is a question that the advisers at Springfield Financial Services Ltd are being asked on an increasingly regular basis.
The Financial Conduct Authority (FCA) which regulates the financial services industry states that an adviser’s starting point should always be to assume that transferring defined pension benefits is not suitable and a transfer to a ‘defined contribution’ arrangement should only be recommended where it is very clearly in the best interests of the client.
In the majority of cases retaining a defined benefit pension provides the best outcome for the client. However, there can be instances where a transfer is suitable and this will provide a better outcome for the client based on their particular circumstances.
What is a defined benefit pension scheme?
A defined benefit pension scheme, otherwise known as a final salary pension scheme, provides a pension in retirement which is calculated based on an individual’s pensionable years of service with an employer and their pensionable salary. This is in contrast to a ‘defined contribution’ pension scheme, where benefits depend on contributions paid by both the employee and employer and the investment returns achieved.
With a defined benefit pension scheme, all of the investment decisions are made by the Trustees of the scheme, in conjunction with their advisers. The benefits are calculated and paid in accordance with the scheme rules, without individual reference to personal circumstances, investment returns or annuity rates. If the Trustees make poor investment decisions, this does not directly impact on the benefits payable. The Trustees must try to recover the losses through more profitable investments or they may need to seek further funds from the sponsoring employer. The main risk to the individual is therefore the ongoing viability of the sponsoring employer.
In the event that the sponsoring employer becomes insolvent the Pension Protection Fund (PPF) would normally step in to provide benefits which would generally be 90% of the pension accrued prior to scheme’s normal retirement age (subject to a payment cap of £34,655) or 100% of any benefits in payment post normal retirement age.
Defined benefits will normally be made up of different parts, accrued at different times and may contain a ‘contracted out’ element where the scheme has contracted out of the earnings related element of the State Pension (SERPS, State Second Pension).
Where individuals are deferred members of defined benefit pension arrangements, meaning that they have left service but retained benefits within the pension scheme, these are usually revalued at least in line with inflation.
When pension benefits are taken it is usually possible to take an element of ‘tax-free cash’ and an annual income which also usually increases, at least in part, in line with inflation.
In the event of death pre/post retirement there will usually be a widow/widower’s pension which is typically 50% of the pension that would have been payable to the member before the payment of any tax-free lump sum.
What is my defined benefit pension worth?
Defined benefit pension schemes provide an income for life which to most is extremely valuable. However, defined benefit pensions have a ‘Cash Equivalent Transfer Value’ (CETV) calculated by the scheme actuaries which is the amount that would be available if the member was to transfer out of the scheme.
At present, most schemes will only allow a full transfer of benefits. However, some schemes will allow a partial transfer out. Where the member has left service the transfer value will normally be guaranteed for a period of 3 months from the date of calculation. Members are normally able to request a valuation of their scheme benefits annually without charge.
If you would like to learn more about the value of your defined benefit pension and the options available to you please contact one of Springfield Financial Services Ltd’s Chartered Financial Planners and Pension Specialists on 01772 729742.