In Part 1 of this article we discussed what a defined benefit pension scheme is, what the benefits could be worth and asked whether it is ever appropriate to transfer out of a defined benefit pension scheme.
In this article we explore the possible reasons to transfer out of a defined benefit pension scheme and we discuss what is involved in assessing the suitability of a transfer.
Is it right for me to transfer my defined pension benefits?
Due to the complexity of this area and the potential pitfalls of transferring the FCA requires anyone with a transfer value exceeding £30,000 to obtain specialist advice before transferring or opting out of a defined benefit pension scheme. At Springfield we offer an initial free, no obligation meeting with a client to discuss their circumstances and their objectives in relation to their defined pension benefits. Typically we would consider a client’s;
• Other sources of ‘secure’ income
• Attitude towards investment risk
• Other savings/investments/assets
• Personal circumstances (e.g. marital status, dependants’ details, health)
If discussions indicate that a transfer could be in the best interests of the client we will undertake an analysis of the transfer value, considering some of the following points;
• Multiplier – the attractiveness of the transfer value calculated as a multiple of the income provided by the scheme.
• Critical yield – the amount the fund would need to grow by in order to match the pension benefits offered by the scheme at the normal retirement age.
• Hurdle rate – the amount the fund would need to grow by in order to match the starting pension in the scheme, assuming there are no increases in payment, no spouse’s pension and no guarantee period.
• Average life expectancy – to determine the likelihood of the transfer value sustaining the required level of income over the client’s lifetime.
• Death benefits – an assessment of the amount that would be available for the client’s dependants in the event of death, relative to an individual defined contribution arrangement.
What are the benefits of transferring?
The main reasons most people consider transferring out of a defined benefit arrangement are flexibility, control and/or the level of death benefits payable.
The income from a defined benefit pension scheme is prescribed and aside from any inflationary increases is not subject to change. Whilst for many this would be an advantage, for some this lack of flexibility is undesirable. Transferring to an individual arrangement enables pension benefits to be drawn flexibly, potentially allowing individuals to retire early and extract income at nil and lower rates of tax. Transferring out of a defined benefit pension gives the member control over their income stream and over the investment of the pension fund.
Where individuals, or their spouse/civil partner, suffer poor health being able to access benefits more flexibly may be advantageous.
A defined benefit pension will typically provide a reduced pension for a spouse/dependent. However, where there is no spouse/dependent partner or children a defined benefit pension provides very little in the way of death benefits. Following the pension freedoms it is possible for funds held via defined contribution arrangements to be passed on to any nominated beneficiary including, but not limited to, the spouse/civil partner, dependent and non-dependent children. The funds can be passed on free from Inheritance Tax and where an individual has sufficient other assets and income to meet their retirement needs this can be a compelling reason to transfer.
What are the drawbacks of transferring?
There are a number of potential drawbacks to making a transfer, including;
A defined benefit pension scheme contains a high degree of guarantees. In contrast, the benefits payable from a defined contribution arrangement are not guaranteed and an individual may receive less overall than if they had they drawn retirement benefits from the scheme.
Once the benefits are transferred out of a defined benefit pension scheme it is not possible to transfer benefits back in. The loss of the guaranteed benefits provided by the scheme is therefore irrevocable.
A secure income could be provided by an annuity at a later date, however, there is no guarantee that the annuity will be greater than the scheme pension that would have been provided.
On transferring out of a defined benefit pension the responsibility for the investment risk moves from the scheme trustees to the member. Investment returns may be lower than assumed, leading to a smaller pension than anticipated.
If you are considering transferring out of a defined benefit pension scheme it is imperative that advice is sought from a suitably qualified pension specialist. Contact our Chartered Financial Planners and Pension Specialists at Springfield Financial Services Ltd on 01772 729742 for further information.