As many in the industry know, there has been a lot of traction for transfers out of final salary pension schemes over the last 18 months or so.
The introduction of Pension Freedoms gave consumers unprecedented flexibility in relation to their retirement income. This has led to more and more people considering their options for retirement, rather than just settling for what they have (although, far too many still do – Retirement – Where’s the advice?).
The FCA’s original stance on these transfers was that they were essentially, in the first instance at least, the wrong thing to do. However, the recent trend has forced the regulator to revisit it’s default position; now taking a more open view on what is in a consumer’s best interest.
The choice is a simple one really – receive a guaranteed, inflation linked income for life, or gain control of your retirement? You can see why may would choose the security of a guaranteed income. After all, we spend our whole working lives making sure we can secure a regular income in order to support our family, so why not continue this trend into our retirement, without having to actually work for it anymore?
When we take a closer look at the pros and cons however, we begin to understand that actually, a final salary pension is perhaps in most cases not the best option for a client depending on their individual situation.
One of the greatest benefits of a personal pension over a final salary arrangement is the improved death benefits. Generally, members of a Defined Benefit pension scheme can expect to leave a pension to their spouse, equal to 50% of the income they were receiving at the time of their death. Beyond that though, the pension ends with the death of the surviving spouse. With a personal pension however, 100% of the residual fund can be left to the member’s beneficiaries, be it their spouse, children or anyone else they wish to nominate. The beneficiaries then have the option of how to receive these benefits to suit their personal tax situation. In fact, the whole fund can be passed down completely tax-free if the member dies before the age of 75. What’s more, the fund continues to pass down the line of inheritance until it completely runs out. For many, this represents a vast improvement to the inheritance of their family, both in terms of value and tax-efficiency.
Another reason why a personal pension is often seen as a better solution for retirees is, of course, the flexibility it provides throughout their retirement. Let’s say a member of a final salary arrangement is due to receive a scheme pension of £50,000 a year for life, but only actually needs £30,000. What you end up with is a higher tax bill for having no choice but to take income you don’t need. Instead, this extra money could remain invested for growth, in order to help offset income throughout retirement. Continuing with this example, a £50,000 a year pension could reasonably be expected to convert into a £1million fund value. You’d only need to withdraw 3% of this each year to achieve the £30,000 income – not an unreasonable net return for an investment portfolio.
Imagine having all the income you need throughout retirement, as well as being able to leave the fund you started with to your family, free of inheritance tax.
Due to a low yielding gilt market (in which pension scheme trustees invest to protect their liabilities), transfer values are at unprecedented highs at the moment; most representing excellent value versus the scheme pension available. Transferring won’t be for everyone, and final salary pensions often offer a fantastic level of security for retirement. There appears to be a trend towards control and flexibility however, and quality financial advice will be key to ensuring people retire in the best way possible.