DB pensions transfers – look before you leap

Since the “pension freedom” reforms came into being, there has been a marked increase in individuals looking to transfer away from defined benefit (final salary) pension schemes into new flexible arrangements. But is this always the right decision? Andy James, head of retirement planning at Tilney looks at why people may choose to transfer, and what people need to be aware of.

“It is unsurprising that we have seen an increase in individuals transferring away from DB pensions. The new pension freedoms available with defined contribution (money purchase) pensions offer greater flexibility than was previously available, therefore opening up more opportunities for benefits in transferring away from a defined benefit arrangement

“Additionally, the current low interest rate environment has had a knock on effect with the transfer values being offered for defined benefit schemes at or near all time highs meaning that more people are being tempted by what is on the table.

“Whilst a transfer may well be the right decision there are a number of considerations to take into account before making the final leap:

• A defined benefit scheme comes with guarantees where you will know what you and any dependants will get from day one onwards. Such guarantees are not available with a defined contribution arrangement where, in the long run, how much you get will depend on how well your money is invested.
• A defined benefit scheme will pay out to you and your dependants for the whole of your lives. This means that you will never run out of income. A defined contribution pension could leave you running out of money if you withdraw too much too early or if your investment performs poorly.
• A knock on effect of the fact that a defined benefit scheme will continue to make payments throughout retirement is that it takes away the problem of working out how long you are likely to live. No birth certificate is released with an expiry date and this makes retirement planning very tricky. If you expect to live to say age 90 but are still around at age 95 a defined contribution plan will need to fund your income for 5 years longer than planned which can again lead to problems with running out of funds.
• A defined benefit pension will have set increases in payments each year which are designed to offset inflation and maintain your purchasing power throughout retirement. Any increases in income from a defined contribution plan will have to be funded by investment returns – and those are inherently uncertain.
• Having your money invested in a defined contribution plan means that you have to continue to monitor investments for many years. This may be fine in the earlier years of your retirement but as we age there tends to be less appetite to continue to review plans and to take investment risk. Even with assistance, when our mental faculties start to let us down, this can be a problem.

“However, this is not to say that transferring out of a DB scheme is always the wrong thing to do. The downside of a DB scheme is the lack of flexibility. The availability of those guarantees means that you cannot vary your income. This may not be an issue but the flexibility can offer:

• The ability to be tax efficient with income and tax free cash withdrawals thus limiting the amount of income tax paid and therefore leaving a greater sum for your own use
• The ability to reduce income taken from pensions where you have other income/capital resources which may be a better option for your retirement funding

“The big plus for defined contribution arrangements over defined benefit schemes is the inheritability of the plans. A defined benefit scheme will die with you or your dependants. A defined contribution pension can be passed onto beneficiaries outside of your estate. This makes such a plan a highly tax efficient estate planning tool where you may prefer to use income and/or capital from assets within your estate to reduce inheritance tax charges whilst leaving the pension alone.

“Whatever your situation, the decision on whether or not to transfer out of your DB pension is not one that should be taken lightly, and you should always seek sound financial planning before making a such an important financial decision.”

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