Final salary pensions are workplace schemes that promise their members a post-retirement income for life. They’re often based on their final salary and usually index-linked to keep up with inflation. These plans are, however, in decline in terms of the number of active funds and, therefore, enrolled members.
Cost is the major factor — final salary pensions are expensive promises, especially as people live longer and investment returns disappoint. Financial concerns dog many funds; the yawning hole in collapsed retailer BHS’ pension fund is just one recent example.
Take time to locate your nearest exit; final salary transfer values are under your seat
Many employers have now closed their final salary schemes to new members, offering defined contribution or money purchase schemes instead. With these pensions, you build up a pot of cash and use that to fund your retirement. Your company has no liability for ongoing payments.
Another way employers are seeking to keep a lid on the spiralling cost of providing final salary pensions is by encouraging members to transfer out. This nudge towards the exit is in the form of today’s soaring final salary pension transfer values. Known in the business as cash equivalent transfer values or CETVs, it’s how much money your pension provider will offer you to leave the scheme and never look back.
Doing so does mean giving up the right to a lifelong pension income. However, in exchange you get a cash lump sum invested in a defined contribution pension. With today’s final salary transfer values so high, it’s unlikely you’ll ever see such sums on offer again.
Good deal or no deal
Of course, not every pension fund is equally generous with CETVs. Some schemes offer larger multiples of their members’ annual pension entitlement than others.
So if you’ve recently received a tempting CETV from your provider, it’s worth taking a minute to use a tool such as The Drewberry Final Salary Pension Calculator. This benchmarks the sum on offer against the industry to ensure what you’re being offered is a fair deal.
If you don’t have a pension transfer offer yet, the calculator can still provide a projection of what yours could be. That way, by barely lifting a finger, you can gauge just how much you might gain from leaving your final salary scheme.
Getting financial advice is essential if you’re considering transferring out of your final salary pension. It’s also a regulatory requirement if your scheme is worth more than £30,000. But there’s no harm in using a calculator to take a peek at what you could be entitled to.
The benefits of forfeiting benefits
As well as current favourable transfer values, there are other benefits to leaving your final salary pension scheme. One is that you get control over who gets your pension cash when you pass away.
Payments from final salary schemes usually die with you. In some schemes, they transform like Cinderella’s pumpkin coach at midnight into a reduced survivor’s pension for your spouse, which itself ceases on your spouse’s death. So retiring in poor health or dying early could see you receive little from your final salary scheme, even though you’ve been paying in for your entire career.
By swapping a final salary scheme for a defined contribution scheme in income drawdown, it’s easier to leave unspent funds to beneficiaries such as your kids on your death. And if you die before the age of 75, they can generally inherit the pot tax-free. If you’re 75+, the beneficiary is charged income tax on the inherited fund at their highest marginal rate, but in either case there’s usually no inheritance tax to pay.
Money purchase schemes are inherently more flexible than final salary schemes, including when it comes to turning your pension contributions into retirement income. It’s also easier – and requires far less paperwork – to take the 25% tax-free lump sum you’re entitled to from a pension out of a money purchase scheme than it is for a final salary scheme.
You could also benefit from greater tax-efficiency with a defined contribution pension in drawdown if you have more than one source of retirement income. That’s because, instead of receiving a fixed final salary payment, you can adjust drawdown income as you see fit, which could keep you out of a higher tax bracket.
Drawbacks to drawdown?
Of course, as with most areas of life, final salary pension transfers aren’t risk-free. It’s not a decision that should be taken lightly.
Consider that transferring out means forfeiting an income for life. Although, as mentioned, that could be beneficial if you die relatively young, perhaps at 65, it’s a different story if you reach 105. That may sound like fantasy, but it’s not according to government statistics. A man in 1967 and celebrating the big 5-0 this year has a 12% chance of living to double their current lifespan. Women fare even better; a woman turning 50 in 2017 has an 18.1% chance of hitting triple digits.
You’ll also need to actively manage your new pot of retirement wealth, even as you advance in age. Poor investment choices, spending too much or simply living longer than you thought could be disastrous. Market volatility is another major risk – and you don’t need a long memory to recall what that could look like.
There are pros and cons to leaving your final salary scheme. It’s impossible to advise someone whether or not to do so without knowing their exact circumstances. Weigh your options carefully and consider what your needs might be in terms of retirement income. Then get financial advice.
But to make informed decisions, you’ll need a cash equivalent transfer value. Then you can compare what you’ll get from leaving with what you’ll get if you stay. That’s where Drewberry’s final salary pension transfer value calculator helps you take the first step.