If you have a final salary pension, should you transfer it? In many cases it’s a bad idea, but there are times when it may make sense. Here’s a guide to the pros and cons of transferring a final salary pension.
The pros and cons of transferring a final salary pension
One of the key benefits of a final salary pension is that the amount you get at retirement doesn’t depend on how well the stock market has done. Another benefit is that your pension will rise in line with inflation. You also will normally get a pension for your husband, wife or civil partner when you die. These are valuable benefits which shouldn’t be given up lightly.
SAVVY TIP: I’ve used the phrase ‘final salary’ pension, but I’m referring to any pension that’s based on your salary. This includes a career average pension, where the amount you retire on is linked to an average of your income throughout your time with that employer. The collective term for these pensions is ‘defined benefit’.
When should you transfer a final salary pension?
The pension provider, Royal London, has produced a guide to transferring your final salary pension, and I’ve taken the information below from their guide. It says that there are five reasons why you might want to transfer your final salary pension and five reasons why it might not be a good idea.
The five pros of transferring a final salary pension are:
- Flexibility: once you’ve transferred your pension, you can take money from it whenever you want to. You don’t have to take money as a regular income (in the way that you’d be paid from your final salary pension).
- Potential for more tax-free cash: you can take up to 25% out of a pension tax-free. However, with some final salary pensions, you can take less than this. If you transfer your pension, you may be able to take more money out without paying tax on it.
- Inheritance: if you transfer your pension, any money that’s left in the pension ‘pot’ after you die can be left to your family. In some cases there may be no tax to pay. With a final salary pension, your husband, wife or civil partner may get a ‘spouse’s pension’ but this wouldn’t necessarily be the same as the amount of pension you’d built up over the years minus what you’ve been already paid.
- Health: if you’re not in good health you may be better off transferring your pension. The reason is that the amount you’d be able to transfer wouldn’t be based on how long you’d be likely to live for but how long the average person would be likely to live for. That means you should get a larger pot of money to spend.
- Worries about your employer’s financial health: with a final salary pension, if your employer goes bust you may lose out. That’s because the pensions safety net, the Pension Protection Fund would step in. However, it won’t necessarily pay the full pension that you’re entitled to.
The five cons of transferring a final salary pension are:
- Uncertainty: your final salary pension is guaranteed to be paid for as long as you live. There is no chance of running out of money if you live longer than you expected. If you transfer your pension, it may not last as long as you do!
- Lack of inflation protection: most final salary pensions increase in line with the cost of living (or a measure of the cost of living). If you transfer your money, you’d have to build that in yourself.
- Investment risk: if you’re in a final salary pension the money you retire on is linked to your salary, not how well the stock market has done. If you transfer your pension, what you have to live on will depend on what it’s invested in.
- Pension for your survivors: if you’re in a final salary scheme, it will normally pay a pension for your husband, wife or civil partner. It may pay this pension for other people – such as any children who are financially dependent on you. If you transfer your pension you’d have to buy that out of your pension pot, or make sure there was enough money ‘left over’ when you die.
- Tax if you have a large pension: This isn’t a problem for most people, but it is for those who have managed to build up a large pension pot. Under the current rules, you can build up a pension of £1 million and not have to pay tax charges on it. If you have a pension ‘pot’ type of pension, then it’s based on the value of the fund being £1 million or more. But if you have a final salary pension, the sums are rather more complicated and may work in your favour. In very basic terms, the equivalent value of the ‘fund’ for the lifetime allowance calculations is 20 times the annual pension entitlement they’ve built up plus any money they take as a tax-free cash lump sum.
Should you transfer your final salary pension?
My own view – and the view of many pension professionals – is that as a general rule, transferring a final salary pension to a pension ‘pot’ type of pension is a bad move. Indeed, this was the basis of the pensions-misselling scandal in the 1980s, when hundreds of thousands of people were lured out of their final salary pensions with the promise of fantastic returns if they invested the money in a personal pension.
The promised growth rarely materialised but sky-high charges did, and as a result those who’d transferred their final salary pension were worse off. They did get compensation but it left a very nasty taste in the mouth of those who’d been ripped off and consumer groups and others who’d seen this scandal in the making.
In the run-up to the pension ‘freedoms’ being introduced in April 2015, many rogues and scammers targeted people to transfer their final salary pensions into – frankly – non-existent, dodgy or high risk schemes. The pension freedom changes introduced rules that say you can’t transfer a public sector scheme that’s what’s called ‘unfunded’. This is where money you pay into your pension scheme today pays for today’s pensioners. However, you can transfer a final salary pension you’ve built up from a private sector employer or something like the local government pension scheme, which is ‘funded’.
Take independent advice before you transfer your pension
If you are thinking about transferring a final salary pension, you need to take advice from an independent financial adviser unless the pension is worth less than £30,000. The regulator, the FCA, has published new rules which took effect from April 2018 which say that anyone who takes independent financial advice about a pension transfer must be given a personal recommendation at the end of it. Namely, they should be told whether or not transferring their final salary pension is in their best interests.
The FCA also consulted on whether to ban fees that advisers only get paid if the pension transfer goes ahead. However, it’s decided not to ban these fees. From October 2020, people who give advice on pension transfers will also have to have a specialist investment qualification.
You can download the Royal London guide to transferring your pension via their website.
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