With a final salary pension, sometimes referred to as a Defined Benefit (DB) pension, your former employer will pay you a guaranteed fixed income from the day you retire until the day you die. If your spouse survives you, they will receive a reduced pension for life.
In the UK, many employers are offering pension scheme members the option to give up their guaranteed income in exchange for a much higher lump sum that will be held within a personal pension pot – known as a Defined Contribution pension.
There are several reasons why companies are keen to move people out of DB schemes – not least the fact that the cost of providing final salary schemes has risen due to increasing life expectancy and low interest rates.
What you need to consider
Transferring a DB pension is probably the most important and potentially complicated financial decision you will ever make and should not be undertaken lightly. Because of this, the UK regulator, the Financial Conduct Authority (FCA), has made it mandatory to receive professional financial advice before transferring.
The biggest risk is that you could run out of money. When you transfer, you exchange a guaranteed income for a lump sum that you will need to provide you with an income for the rest of your life.
After transferring, your pension will usually be invested into a range of different assets – for example shares and bonds.
If these do not perform well, your lump sum may decrease at a quicker rate than your income needs can cope with. This is known as investment risk. On the other hand, if they grow faster than the rate needed to match the benefits from your Final Salary pension you could have a higher income or money to leave to your loved ones.
Some think that to avoid investment risk, all you must do is leave the money in the bank. Not quite! This leaves you open to inflation risk – meaning that over time your money can buy less.
For example, if you retire at 60 with £250,000 in the bank and take £10,000 every year, you may think that you could take £10,000 a year and still have £50,000 at the age of 80. If you want to keep the purchasing power of your money the same, you will need to withdraw more each year. For example, if inflation sits at 2 per cent, you will run out of money two years earlier than that.
Why do people transfer?
You will have to assess your own mortality, which is difficult without the help of a professional adviser. Many move to a new pension with the objective that they want to leave as much money as possible to their loved ones after they pass away, while still living on a good income in retirement.
If the final salary scheme was offering £10,000 a year but a projection showed it is likely a transfer could deliver more as a sustainable income, a transfer is likely to be suitable.
Another consideration could be the tax you will pay in retirement so, if your scheme was guaranteeing an income of £30,000, a transfer could be a way to avoid paying excess income tax by controlling the level of income you draw.
You can leave your Defined Contribution pensions to anyone, not just your spouse, and it will not incur inheritance tax.
Final salary schemes, on the other hand, usually only allow your spouse to continue to receive a guaranteed income, at a reduced rate, until their death but care is needed because some schemes will pay nothing unless you survive to retirement!
If leaving your loved ones with a large lump sum is a priority of yours, and you have enough income from other sources or don’t need all of the income from the DB scheme, transferring may well be the best way to achieve this.
So, what now?
It is important that you understand these issues and how they may affect you personally, to ensure you plan effectively for the retirement you want.
It is vital that you seek advice from a fully qualified specialist.
The specialist AAM Global Wealth Structuring team can provide you with a detailed UK Pension Audit, which will consider these issues in light of your needs, goals and circumstances and make a personal recommendation showing the right course of action for you to achieve the best retirement outcome.
Why you should have an AAM Global Wealth Structuring UK Pension Audit now
You may have taken advice in the past on your pensions, however, the AAM UK Pension Audit has evolved from a snapshot of the position at the time it is done, into a lifetime analysis of your pensions, other assets and your retirement plans. This allows you to see immediately if you ‘have enough’ and if you would be better off after a change.
Your UK Pension Audit will include:
- How much your pensions are worth and what you can expect when you retire
- Whether your pensions will allow you to take your retirement income when and how you want
- What the impact of tax will be on your retirement plans
- Whether you are on track for your perfect retirement
- If your pension will pay you for all of your life
When considering whether you should transfer your DB pension remember that:
- Every AAM UK Pension Audit is checked by Ian Black, a Chartered Financial Planner with over 25 years of experience in the provision of retirement planning advice.
- You will always receive a full recommendation on your optimum pension, whether that is the pensions(s) you already have or an alternative.
- An AAM UK Pension Audit will put you in an informed position, able to make informed choices about your optimum pension and how best to secure your perfect retirement.
If you would like to book a consultation with one of our wealth managers please email [email protected]
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