What should employees be thinking about before they transfer their pension?
The benefits of the pension freedoms have been extolled – but they are only available to those in defined contribution (DC) pension schemes. The new pension rules, however, allow employees in defined benefit (DB) schemes to transfer to a DC scheme in order to take advantage of the freedoms.
The rules prevent anyone with a DB pension value of over £30,000 from transferring without first taking regulated advice on their decision – however, there may be many thousands of people with less than £30,000 in their DB fund who want to transfer and who will not have to take regulated advice in order to do so.
Provider of financial education and employee wealth management services, WEALTH at work, have released a list of the top ten things employees should consider before transferring out of a DB scheme.
1. Is the cash really needed?
Drawing pension cash has tax implications, with only the first 25% paid out tax-free. If it is then in a bank account, the interest may be subject to savings tax. Employees must be sure they really have a purpose for the cash before they withdraw it.
2. Is the paperwork correct?
Employees need to make sure that all the information pertaining to their pension entitlement is correct – to ensure the transfer value offered is a good deal.
3. Compare transfer value against annual income
Again to ensure good value: 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.
4. Don’t forget the perks
Most DB schemes have very good benefits. Often they include 50% for a spouse’s pension, some offer increases of up to 5% on the deferred pension until the point at which benefits were taken, and then 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%.
5. Compare the value against an annuity
Employees could look at what kind of pension fund would be needed in a DC scheme to buy a similar income to those guaranteed by a DB scheme.
6. 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. The amount is said to be 'broadly equivalent' to the amount the member would have received had they not been contracted out.
7. Changing transfer values
DB transfer values can fluctuate year to year based on a range of economic and demographic factors such as investment performance and mortality rates. This can impact the underlying scheme value and lead to varying transfer calculations.
8. 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. Employees may want to consider if they want an expert to do this for them.
9. Will the scheme pay out?
Some individuals are worried whether their scheme is secure, and if it will be able to continue to pay out as promised. Transferring out may be something to consider if the scheme is in a precarious financial position, but employees shouldn’t act in haste and weigh up all their options before making any decisions.
10. Are employees 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.
Jonathan Watts-Lay, Director, WEALTH at work comments on the top tips: “In some cases, if individuals are seriously ill, or want to start a business and cash is more important than your long term income planning, it may be worth considering cashing in your DB scheme. However, in the majority of cases, employees would be better off to leave it as it is and both the FCA and The Pensions Regulator agree.”
“A structured programme of financial education delivered in the workplace can help employees understand all of their retirement income options. After all, accessing your pension is only part of the story. Then at the point of retirement, regulated advice should be offered to all employees to provide tailored information to their specific needs and would offer greater consumer protection should anything go wrong.”