Final Salary pension may be much revered, but are you sitting on a gold mine?
Final Salary Pensions are one type of defined benefit pension; this is a pension that is defined by the benefits you received at retirement rather than the fund value you have accumulated. Typically, a final salary pension will be a promise to pay you a percentage of you leaving salary for the rest of your life. You may get other valuable benefits with it, such as a spouses pension if you die first and increases in payments on an annual basis.
The guarantees and certainty you get with these types of pension is why they are seen as so valuable to people when planning for their retirement.
You do have the option of transferring defined benefits pensions. Your scheme administrator will calculate a cash value that they will offer you to move your pension away. This is known as a Cash Equivalent Transfer Value (CETV). If you decide to do this, you can then decide how to draw an income when you retire. You could buy an annuity (a guaranteed income for life) or you could leave your pension fund invested and draw an income directly from the investment. This is not right for most clients as there is capital and market risks associated with moving your pension as well as fees and charges.
Why Review your Final Salary Pension?
The way in which your Cash Equivalent Transfer Value (CETV) is calculated depends, in part, on long term interest rates. As the Bank of England base rate has been at near-zero for a decade this has increased the CETV of these pensions. Lots of clients are surprised at the sum they could receive by transferring their pension. Care needs to be taken to evaluate the benefits you are giving up and advice should always be sought.
Potential advantages of defined benefit schemes
• You will receive a secured income for life, which is likely to rise each year in line with inflation, and your spouse/civil partner can receive an income (subject to income tax) upon your death.
• There is minimal paperwork needed to start the payment of benefits and no ongoing monitoring of the scheme is required once the first payment has been made.
• Defined benefit schemes will place no personal investment risk on you.
• Defined benefit schemes have a legal duty to provide a pension for a surviving widow/widower or dependent in the event of your death.
Potential disadvantages of defined benefit schemes
• A defined benefit scheme is rigid in its structure, you will get a set amount of money each month until you die therefore it cannot adapt if your needs change throughout retirement.
• The payments of your scheme pension must be selected before taking any benefits and cannot be changed, at a later date.
• Many defined benefit schemes have a pre-selected retirement age and taking benefits early can result in reduced pension benefits.
• Any income you receive from a defined benefit scheme will be subject to income tax at your highest marginal rate.
• Any income you receive from a defined benefit scheme may affect your entitlement to means tested state benefits.
• Only your spouse/civil partner and children under the age of 23 (unless legally defined as a dependent if older) will usually be entitled to a reduced pension on your death. This will mean you will not be able to leave your pension benefits on death to any other party.
• Any options (if offered by your scheme) to provide benefits on death must be selected at outset and will result in a lower initial pension payment.
Potential advantages of an individual pension or drawdown plan
• The tax-free pension commencement lump sum (usually referred to as Tax Free Cash) of an individual pension or drawdown plan can be greater than from a defined benefit scheme.
• You can choose how and when your benefits are taken. This offers greater flexibility and choice.
• When taking benefits there are no restrictions on the amount of money you can withdraw at any one time.
• On your death, your nominated beneficiaries will receive the remainder of your pension fund. There is no restriction on who you choose to receive these benefits.
Potential disadvantages of an individual pension or drawdown plan
• The benefits taken from a drawdown plan will need to be carefully managed to ensure it does not run out.
• THERE IS THE POSSIBILITY IF YOU NEED REGULAR INCOME THE INVESTMENT FUND MAY NOT BE SUSTAINABLE THROUGHOUT YOUR LIFETIME. THIS COULD POTENTIALLY MEAN YOU ARE NOT ABLE TO MEET CORE INCOME REQUIREMENTS IN LATER LIFE.
• The funds you invest in will be subject to fluctuation and this can result in the value of the fund reducing even when income is not being taken. Where income is being taken this will deplete the fund to a greater degree.
• The only way to obtain a secure income through an individual pension is with the purchase of an annuity. It is unlikely you would be able to replicate the same level of income payments paid by the defined benefits pension scheme.
• Any income/lump sum payments you receive from the non-tax free element of a pension fund will be subject to income tax at your highest marginal rate.
• By taking far higher levels of income (when compared to a defined benefit scheme), this may push you into a higher tax band.
• Any income/lump sum payments you receive from a pension fund may affect your entitlement to means tested state benefits.
• There will be ongoing annual charges and administration charges to pay. You will also need to monitor where the fund is invested to ensure it meets your attitude to risk and investment objectives.
Examples of where a transfer may be beneficial or harmful
• Circumstances where a transfer may be harmful
An individual would need to rely on the income from their pension to provide their core income requirements throughout retirement.
• Circumstances where a transfer may be beneficial
An individual that would not rely on their pension to provide their income throughout retirement and would like individuals to benefit on their death but who are not defined as a dependent.
Despite the advantages mentioned above, in most cases it will not be in your interest to transfer a defined benefits pension. It is important to seek advice from an independent pension specialist, like Mather & Murray Financial, before making decisions about this.