21 June 2017
Good news: Regulator wakes up to new landscape for pension transfers
- Advisers encouraged to recognise that transferring out of a final salary scheme could be the right thing to do
- Pension freedoms have radically improved attractions of Defined Contribution pensions
- Vital to understand both risks and benefits, rather than assume transfers always wrong
The new world of pension freedom and choice paves the way for fresh thinking on transferring out of Defined Benefit pension schemes. Here’s a summary.
Strong reasons not to transfer will include:
- If you are frightened that this decision is irreversible and you might regret it
- If the DB scheme is your only pension
- If you value the peace of mind of a guaranteed regular income
- If you are concerned about inflation and have an inflation-linked DB pension
- If you do not want to take investment risk
- If you don’t want to pay someone to manage a pension fund for you
- If you might exceed the Lifetime Allowance and face a hefty tax charge
- If you might lose enhanced protection
And there are some strong reasons why DB transfers make sense:
- If you have several DB pensions, could transfer some and still retain guaranteed income
- If you’re in poor health and fear dying young
- If you are single and have no use for spouse pension
- If you want to pass any unused pension fund on tax-free to anyone you choose free of inheritance tax (and free of all tax if you die before age 75)
- If you are happy to take some risk and want the chance to benefit from future tax-free investment returns
- If you are comfortable with managing money or finding someone to do that for you
- If you want a fund to help pay for care if needed (£20 a week DB pension could be worth £30,000-£40,000
- In some cases, if you have large debts, the money could help you to pay them off
FCA recognises case against DB transfers has radically changed: The FCA has just launched a consultation which could change the way people wanting to transfer out of a final salary-type (DB) pension schemes are treated. https://www.fca.org.uk/news/press-releases/fca-proposes-changes-advice-pension-transfers Two years after the pension freedoms were introduced, making Defined Contribution (DC) pension schemes far more user-friendly, the Regulator is rightly recognising that the case against transferring out of guaranteed employer schemes has radically changed. Each case should be considered individually to assess the benefits and risks for that person.
Can be strong reasons to transfer out but must understand risks first: In the new pensions world, there are some compelling arguments in favour of DB transfers but the decision must not be taken lightly, particularly because it is irrevocable. Anyone whose transfer is worth over £30,000 must get independent financial advice.
Advisers have been under regulatory pressure to assume transferring out is wrong: In the old regime, the regulators rightly warned strongly against advising anyone to transfer. Indeed, financial advisers often refused to do the transfer for clients still wanting to after being advised against it. But the pension freedom reforms mean this attitude is outdated.
DC much more attractive now: Defined Contribution pensions, which build up your own individual pot of money for your retirement, are much more user-friendly now.
End of mandatory mass-annuitisation: In the past, someone who wanted to take their tax-free cash from a DC pension would usually have to buy an annuity with the rest, unless it was a very large fund. These annuities were inflexible and might not suit their needs. Now you can take out some money if you want to and leave the rest invested for later life. Some people can even get more tax free cash from a DC scheme than from DB.
No 55% death tax, can pass on IHT-free: People can now pass their pensions on in full to loved ones free of inheritance tax, whereas in the past they would face a 55% death tax charge on their unused fund. A DB scheme will only provide a fraction of the pension income for a partner and perhaps nothing for other relatives.
Those in poor health could benefit from transferring: Someone in poor health, who dies relatively young, will not have had much money from the scheme, but could pass on a fund to their loved ones instead. If they are single, the partner’s pension in their employer DB scheme will have no value to them.
Transfer values have risen enormously as interest rates have plummeted: Low interest rates have increased transfer values, which makes them more attractive. Capital sums worth 30 to 40 times the annual pension could provide good alternative financial security for some. There are those who think the period of low interest rates will end soon and, therefore, feel today’s transfer values are likely to fall in future, so want to take the money now. There is no certainty that rates will rise, but there are other reasons to consider transferring.
Some people have large debts: If you have no other way to pay off debts, it may be worth considering transferring a small pension to help you out. It is vital to get advice, perhaps from PensionWise first though.
Many have several DB pensions – could transfer some and keep others: Many people have a few past pensions from previous employers, often some small deferred pensions of only a few pounds a week. But these could be worth thousands of pounds. A £10 a week DB pension could be worth £15,000 – £20,000. People with a good base of guaranteed pension income from other past schemes could cash-in some while retaining others.
Could use DC transfer to provide money for care: People could also use the funds from a transfer to provide a pot of money for long-term care. A £20 a week pension would not pay for care, but £30,000 – £40,000 in a DC pension could help enormously. This alone is a powerful reason for those with several pensions to consider transferring, as nobody has set money aside to cover care costs. In fact, the Government should think about allowing tax-free DC withdrawals if used for care.
But beware of Lifetime Allowance rules: Given the sharp rise in transfer values, people need to be careful of hitting the lifetime allowance, or losing enhanced protection. DB pensions are treated much more favourably than DC under the illogical Lifetime Limit rules. The DB lifetime allowance test of 20 times starting pension means a £40,000 DB income is worth well below £1m but could generate a £1.5m transfer value with a hefty tax charge.
Of course, many people will still be best-advised to stay with their employer’s guaranteed pension: Especially if they have no other pension, the certainty of the employer promise (even with the risk of reduction in the PPF) is very valuable. Those who value guaranteed income with inflation and partner protection, and do not want to worry about investment risk, should not transfer. The decision is irrevocable, so it is vital to get good advice first.
FCA recognises that DC pensions are more attractive now: Transferring out will not be right for everyone, but there are now some compelling arguments in favour of DB to DC transfers and the Regulator is recognising this reality with its consultation. That’s welcome news.