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What to consider before transferring a final salary pension

Is a final salary pension always best left alone?

Generally it has always been considered sensible not to transfer a final salary benefit pension from the main scheme.  On the face of it, these benefits look even more valuable as life expectancy increases and investment returns are much harder to achieve with long time low inflation.

However, with the recent changes to income limits and more importantly death benefits, many people with final salary benefit pensions are now considering whether it is still in their best interest to leave them in situ until benefits are due to be drawn.  In some cases the amount of a transfer value can be quite surprising.

Transfer values are calculated by estimating the capital cost for the scheme to provide the benefits promised which is then discounted using an assumed yield. As a result of the current low yield environment, many transfer values have been significantly increased.

This was highlighted in a recent example where a 55 year old with a preserved pension of £51,000 per annum was offered a transfer value of over £2.6 million. By dividing the transfer value by the income promise this would equate to the pension being in payment for over 50 years.

Obtaining a transfer value is only the beginning as there are many issues to consider in deciding whether a transfer is more attractive or not.

Who is affected by the changes?

Many people are now getting to grips with the government changing the lifetime allowance as one way to reduce the tax efficiency of pension funds. From 6 April 2016 the lifetime allowance will reduce to £1 million, which is significantly below its previous highest level of £1.8 million. The new protection regime is also expected to be less generous than before.

This change means that anyone retiring from April 2016 with a final salary pension of over £50,000 per annum will be effectively over the lifetime allowance and will suffer an additional tax charge!

Transfer values have no relation to how the lifetime allowance test is deployed. Therefore it is possible for individuals transferring out of final salary schemes to find themselves in a taxable environment whereas had they not transferred their entire benefits may have remained within the lifetime allowance.

How can I receive 25% of my pension tax free?

Tax free money has always been one of the key drivers when deciding how to draw pension benefits. Final salary schemes have individual commutation factors to convert how much income has to be given up in favour of tax free funds. Upon transfer, the cash is limited to the lower of 25% of the fund value or 25% of the lifetime allowance (unless previous protection has been put in place).

Commutation factors can range significantly between schemes making the difference in the amount of cash one finally receives very different. Generally schemes average commutation factors are between 12-15 although we have seen some as low as 10 which means more pension has to be given up to secure the tax free cash. When compared to the ability to draw cash at 25% of the fund value upon transfer the difference can be quite significant.

What are the death benefits that need to be considered?

Final salary schemes will also offer an element of widow’s pension in the event of the death of the member. These are paid for the life of the survivor and the amount can vary between schemes. Upon transfer, the capital value of the pension will dictate the benefits paid and for how long. For those with health conditions, the discussion over whether widow’s a benefits should be in the form of a guaranteed income or capital is a key consideration.

The major shift in how death benefits are treated is shaping whether people decide to transfer or not. For those that have other non-pension assets to fund their retirement, income transferring can allow them to leave pension capital in a very inheritance tax efficient environment which can be left to second or even third generations.  

Summary – seek professional advice

Given all of the financial issues and implications it is no longer such a clear decision to ‘leave well alone’ for those with final salary benefit pensions.  The attractions of being in a more flexible regime following a transfer are now worth looking at for people in this position.

If you are retiring from April 2016 with an expected final salary pension of £50,000 per annum or more you should make sure that any decision you make is an informed decision.  If you would like to discuss planning for your future and how you can financially protect your spouse contact us today on 0845 282 1000.

 

 

Date: 1st October, 2015
Author: Iain Muffitt - Financial Adviser

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