Top 10 things to consider when deciding whether to transfer a pension.

15th February 2016

Jonathan Watts-Lay discusses the pros and cons of transferring from a Defined Benefit to a Defined Contribution pension scheme.

The new pension rules which came into force in April 2015 allow people to transfer their Defined Benefit (DB) scheme to a Defined Contribution (DC) scheme to take advantage of the new found freedoms, which includes taking the pension value as cash.
The rules stipulate that those with a DB pension value of over £30,000 need to take regulated advice before transferring to a DC scheme. The Financial Conduct Authority (FCA) has estimated that 35,000 people a year will fall into this category.
However, there are likely to be thousands more with a DB pension pot of less than £30,000 who want to transfer out without taking advice. But will these individuals be able to get a good deal?

These are the top 10 things to consider before transferring out of a DB scheme:

• Is the cash really needed? – Drawing on pensions has tax implications. Usually the first 25 per cent is tax-free but the remainder is taxed at your marginal rate and if it sits in a bank account the interest may be subject to savings tax. However, transferring out may be appropriate for someone who does not require dependent benefits, is in significant ill health, or requires a large cash sum to start a business or pay off debts which are creating life pressures. But even these are not certain reasons for doing so.
• Is the paperwork correct? –We have heard of many transfer value statements arriving with confusing pension income figures, this is because they tend to quote the pension entitlement at the date the member left the scheme. This could have been many years ago and with deferred pensions benefiting from annual inflationary increases, the actual pension entitlement at the date of the statement could in fact be a lot higher. This obviously makes a big difference when making a decision whether or not the transfer value offered looks a good deal.
• Compare transfer value against annual income – A simple calculation is to compare the cash equivalent transfer value against the ‘current’ annual pension entitlement, not the pension at the date of leaving the scheme, to find out how many years annual income would need to be received before reaching the transfer value offered. For example, if a DB annual income guarantee is £1,355.58 and the transfer value is £27,384, then the conversion factor would be twenty times (27,384/1,355.58 = 20.20). However, it should be noted that this is not an accurate definition of ‘value’; the annual pension usually increases each year to maintain its purchasing power (indexation). The tax implications also need to be considered.
• Don’t forget the perks – Most DB schemes have very good benefits. Often they include 50 per cent survivor spouse’s pension, and possibly pensions for dependent children. Some offer increases of up to 5 per cent on the deferred pension until benefits are taken, and provide inflation proofing once in payment. Others also have an element of death benefits in payment if the policy holder passes away within five years of receiving benefits. Some DB scheme members may also be entitled to ‘scheme protected tax free cash’ higher than the standard 25 per cent, a benefit likely to be lost if transferred into a DC arrangement.
• Compare the value against an annuity – What kind of pension fund would be needed in a DC scheme to buy a similar income to those guaranteed by a DB scheme.
• Check the Guaranteed Minimum Pension (GMP) value – The GMP is the minimum pension value which an occupational pension scheme has to provide for those employees who were contracted out of the State Earnings-Related Pension Scheme (SERPS) between 6 April 1978 and 5 April 1997. Check the current value carefully as some of these compound at high fixed rates of up to 8.5% before retirement.
• Changing transfer values – DB transfer values can fluctuate year to year based on a range of factors such as investment performance and mortality rates. This can impact the underlying scheme value and lead to varying transfer calculations.
• Transfer Value Analysis Systems (TVAs) – Calculating accurate transfer values is incredibly complicated and even financial advisers turn to their TVAs for guidance on how to value a DB pension. Individuals may want to consider if they want an expert to do this for them.
• Will the scheme pay out? – Some individuals are worried whether their scheme is secure. Transferring out may be something to consider if the company is in a precarious financial position, but don’t act in haste and weigh up all options before making any decisions. Although there is the PPF (Pension Protection Fund) which will pay up to 90 per cent of your pension value, there is presently an annual cap of £32,761.07 (when the 90% level is applied).
• Are you equipped to understand your options without advice – Pension transfer documents are often unclear, full of jargon, and it is hard to understand the value of the actual benefits that will be given up. Taking independent professional advice could be money well spent.