By Sam Brooks – Private Client Adviser – W1 Investment Group Qatar
There was a time when anyone with accrued benefits in a “traditional” Final Salary Pension scheme would have been considered crazy for wanting to transfer their “Gold Plated” pension into a personal pension but times have changed. Figures released by the Financial Conduct Authority in the UK reveal that £20.8bn was transferred out of these schemes in 2017, a rise from £7.9bn the previous year.
This article will look at the reasons why such a sea-change has taken place across the industry and explore the pros and cons of such a transfer.
Why the change?
In 2015 the Chancellor of the Exchequer George Osborne introduced the ‘Pension Schemes Act’. In essence this Act was designed to introduce greater flexibility and guidance for pension scheme members. These new flexibilities provided retirees in Defined Contribution (also known as Money Purchase) pension schemes with the freedom to access their pension when they wished; as cash sums, by flexible drawdown, by transfers or by purchasing an annuity.
What were the changes?
The Pension Schemes Act meant that, in the real world, pension scheme members were treated like grown ups and put in charge of how much or little they could draw from their pension pot from the age of 55 onwards.
Whilst the above changes were made to personal and occupational based Defined Contribution schemes, no changes were made to Final Salary schemes. A Final Salary scheme member would still only be able to take their benefits (without penalty) at the agreed scheme retirement age (often 65) and once they started taking an income, it was fixed (and inflation linked) for life and couldn’t be varied.
So why are people transferring now?
Before the 2015 Pension Scheme Act, a member with a Defined Contribution Scheme would have to purchase an annuity on retirement. The annuity would give the member an income for life based on the amount of money that was in the pot. As such, there really was little or no benefit to someone in a Final Salary from transferring their accrued benefits into a Defined Contribution scheme only to receive a similar style of income through an annuity.
After the changes came into effect, then for some people this increased flexibility to vary their income (to perhaps take more pension in the early years so that they may reduce their working hours or repay mortgages or to enjoy their retirement whilst they were still young and fit enough to do so) and to be able to draw on their pot from the age of 55 made a transfer more appealing.
A member of a personal or defined contribution pension scheme can also take up to 25% of their pension fund as a tax free lump sum from the age of 55.
Is that the only reason people are transferring?
Whilst earlier penalty free access and the ability to be flexible on the amount an individual was able to draw as income each year were certainly benefits, there are the other important factors that must be considered to explain the increased popularity of Final Salary pension transfers.
Firstly, when a member of a Final Salary Scheme dies, their spouse will typically receive around 50% of the accrued income as a ‘beneficiary pension’. If the member wasn’t married or their spouse had already passed away, then the pension would cease and no further payments be made to the estate or any children. This is different to a Defined Contribution Pension where the full amount of the pension fund would pass to their spouse and/or children, grandchildren or favourite niece or nephew from of any UK Inheritance Tax. As such, for scheme members that have built up significant pension benefits, this can often be a very important factor in deciding whether or not to transfer out.
Secondly, a Final Salary pension scheme trustee must attempt to guarantee the income they pay retirees by purchasing “risk free investments”, these are typically 15-year UK Government Bonds (Gilts) and the scheme actuaries use the Gilt’s annual dividend to discount the cost of providing the retirement income. However, over the past ten or so years since the 2008 Global Financial Crisis, these 15-year Gilts have seen their yields (the income they produce annually) drop from over 5.3% per year down to 1.5% at the time of writing. This has meant that it costs a pension scheme approximately 3 ½ times as much in 2018 than it did in 2008 to provide the same income to a member. As an example, if a member retired in 2008 and had accrued a guaranteed pension for life of £10,000 per year then it would have meant the Scheme Trustee would need to purchase £188,700 of UK 15-year Gilts to guarantee that level of income. In 2018, to produce that same £10,000 per year (using only 15-year Gilts), the cost to the scheme would be £666,667.
When a member of a Final Salary pension scheme requests a ‘Cash Equivalent Transfer Value’ (CETV) from their Scheme Trustee, the above calculations form a significant element of the calculation. This is why that at present, transfer values are at an historic high, often ranging from between 25 and 50 times the guaranteed annual pension amount (compared with around 5-12 times pre-2008).
Another important factor that needs to be taken into consideration is that whilst Final Salary schemes have always been considered as “Gold Plated” and “Guaranteed”, many pension schemes in the UK are either heavily in deficit (whereby they don’t have the funds to cover their liabilities) or attached to failing or failed companies such as recently happened with Carillion when the firm went into liquidation. When a pension scheme is in peril then it is forced into the UK Government Pension Protector Fund (PPF) to protect the scheme members. When this happens, there’s an immediate 10% reduction in accrued benefits and annual income is capped at £35,000 per member for those not already receiving an income.
Because of cases such as the BHS and Carillion Pension Funds being forced into the PPF, some members of Final Salary pension schemes prefer to take their retirement destiny into their own hands and transfer their Final Salary into a Personal Pension plan.
Is a transfer right for everybody?
Whilst having the option of receiving a large cash payment into a personal pension can be very tempting, it’s not right for everyone. There are a number of factors that you would need to consider when making the decision; Do you need a guaranteed income in retirement? Do you have other assets to call upon should you need them? Are death benefits important to you? And a myriad of others.
A call to action
So complex is the question of pension transfers that under the 2015 Pension Scheme Act, if you are wanting to transfer a pension with a value of over £30,000, the transfer cannot be undertaken without advice being received by an FCA qualified pension specialist in the UK.
A good starting point is to speak with a Financial Adviser and assess your current situation and it’s always beneficial to request a free annual statement of benefits (and transfer value) from your scheme trustee.
Whether you are currently receiving advice or would like some help in contacting your pension scheme, contact us at info@w1invest.com and let us guide you through the process.
