Should I reinvest my deferred defined benefit pension, my final salary pension, in a private pension?
If you have a deferred defined benefit (DB) pension, or final salary pension, which you’re no longer paying into, you may be offered the option of reinvesting it (ie transferring it) into a personal pension under your own control. This is a big decision and an irreversible one, so it’s important to understand exactly what this means, and the advantages and disadvantages.
What is a deferred benefit pension or final salary pension?
A deferred defined benefit Pension (also known as a final salary pension) is a special type of workplace pension. Instead of building up a pension fund over time, it provides you with a guaranteed annual income for life. This income is based on your average salary during your final years with that employer and how long you’ve worked for them.
Defined Benefit pensions are often seen as generous, because they would take an above-averaged defined contribution (DC) personal pension fund to be able to receive a similar annuity. A defined contribution (DC) pension scheme provides benefits purely based on the investment value of the fund you and your employer have built up over the years.
If my deferred defined benefit pension is so good, why transfer it into a private pension?
Despite the guarantees the defined benefit pension offers, it is not as flexible as a personal pension fund.
You can’t vary the income you take from it, nor draw out larger lump sums (apart from the tax-free lump sum usually offered when you start taking the income). Defined benefit pensions cannot be inherited by your beneficiaries but there are valuable death benefits for your spouse and children.
Your pension’s ‘transfer value’ is the size of the pension fund you would receive in exchange for giving up your rights to your existing deferred defined benefit pension. Some providers will offer generous transfer values, and this may be a strong incentive to transfer.
The choice is between having a guaranteed inflation proof income for the rest of your life with the defined benefit pension, or the ability to vary the income and access the capital through a personal pension. This flexibility also carries some risks for you including running out of money before you die and investment performance not meeting expectaions.
Often the reasons you have been offered an attractive transfer value is because the pension scheme trustees are trying to reduce their long term liabilities. We are now living longer which means that we are drawing an income from the scheme for many more years than expected.
Are all defined benefit pensions transferrable?
Not every defined benefit pension is transferrable. Private sector schemes, and some public sector ones will be ‘funded schemes’ – that is, supported by a central fund. This is the only kind from which you can transfer.
Other public-sector schemes such as the NHS and Civil Service are ‘unfunded’ meaning there is no fund to provide the benefits when employees retire. Instead they are supported directly by future taxpayers in the same way as State Pensions are funded. You can’t transfer out of these kind of pension schemes.
What are the possible benefits of transferring?
Transferring your DB pension to a DC pension pot means you can access your pension flexibly, and also pass on any unspent pension to your loved ones when you die.
For smaller DB pensions with transfer value of just a few thousand pounds, there may be a stronger argument for transferring them – as in such cases the guaranteed annual income may not be very much and paying off debt such as mortgages may be more beneficial for you.
What are the risks?
If you transfer your pension you won’t be able to transfer it back, so tread carefully and do your sums before making your decision. You will expose yourself to the risk of your pension running out one day, or of failing to achieve as high an income as you would have received from the original scheme.
Your advice processes
Having money to spend now may be very appealing, especially if there is a pressing demand for it. However, if your pension’s transfer value is over £30,000, the law requires you to seek financial advice before the transfer can be made.
At Torphin, we have a three stage process when providing defined benefit transfer advice. These are to make sure you fully understand what is involved, what guarantees you are giving up and if it is in your best interest and right for you. Our process is as follows:
- Stage 1: Initial Research. This will establish whether or not to provide you with defined benefit pension transfer advice to you. If it is worth your while receiving advice, we will move to stage 2.
- Stage 2: Advice Report. This will determine the advice to transfer or stay in the existing scheme.
- Stage 3: Implementation. If the Advice Report recommendation is to transfer from the existing defined benefits scheme, Torphin will implement this for you.
Please contact us for a free meeting to discuss the options for your Defined Benefit Pension or Final Salary Pension.