Further reading on Final Salary Transfers
We will help you to navigate your final salary transfer from start to finish, but just incase you want to do some more research here is some further reading for you
- > Pension Drawdown 4 Bankers Top Tips
- > Three steps to making a successful transfer
- > Things to look out for when receiving transfer advice
- > Historic views on Final Salary Transfers
- > Reasons Not to do Final Salary Transfers
- > More info on what are Final Salary Transfer are about
- > Examples of final salary transfer values
Pension Drawdown 4 Bankers Top Tips
- As more people seek to transfer out of schemes we expect more schemes in deficit to reduce transfer offers irrespective of market rates.
- 2015 saw one of the UK’s largest banks reduce transfer values by around 10% and another FTSE 100 company announce planned reductions to transfer values in 2016, irrespective of market conditions and purely down to the increased outflow of funds through transfers. According to the Pension Protection Fund as of January 2015 private sector schemes had a combined deficit of £370bn against total liabilities of £1.64trn. 5,175 were in deficit and 882 ran a surplus. Six FTSE 100 companies had deficits bigger than their market capital values, two of these have reduced current transfer values (March 2017).
- Under the final salary scheme your tax free cash lump sum and taxed pension income in retirement are fixed and guaranteed by the scheme and old employer assuming they both still exist. In some cases scheme liabilities have been sold on to an insurance company who then take on the responsibility for the guarantees. The guarantees extend to increases each year to protect your pension against inflation (usually up to certain limits) and paying your pension for life, no matter how long you live. The longer you or your spouse live the more you will receive from the scheme.
- Once you accept the transfer value and have an invested fund in a personal pension the lump sums and income withdrawals you will be able to make will entirely depend on how you invest your fund and what investment returns are actually achieved. If the fund does well you may end up with more net cash from the transfer value, if the fund does badly you could have significantly less and of course if you end up living a long time you may have to cut your pension income to keep the fund from running out.
- If you accept a transfer value you will be ‘discharged’ from the pension scheme. This means the sum has been paid in lieu of benefits and you have no further claim on the scheme. The transaction is irreversible. You can’t buy your way back into the final salary scheme. Not surprisingly then it’s a transaction which needs very careful consideration before acting on.
- Be sure to continue to benefit from sound ongoing financial advice. Experience shows that a one-off financial plan is not enough by itself to achieve long term financial freedom. An ongoing relationship, benefiting from regular reviews with your financial advisor is critical to giving you the best possible chance of achieving your long and short term financial goals and making sure your finance stay on track.
Three steps to making a successful transfer
Step 1 – Get Your Transfer Value
The first step is to get a transfer offer in writing from your scheme by submitting a request for a cash equivalent transfer offer to the scheme administrator. You can do this yourself or your adviser can do it for you and get copied in with the correspondence. If you know who you are going to use for advice it makes sense to involve the adviser as early as possible as they will then be able to go ask for any additional information they might need to avoid delays.
Transfer offers generally come with a three month guaranteed window during which the scheme will not recalculate the transfer value. This gives you three months to get the advice you need, to plan what you might do with the transfer and then make a final decision to accept it. Members are generally entitled to one free transfer offer calculation every year. If you want more than this you will likely be charged for the actuary’s time, typically a few hundred pounds.
Step 2 – Get the Advice You Will Need
For those with transfer offers of more than £30,000 it’s now a legal requirement to get properly qualified advice on a transfer before it’s executed. Pension providers and schemes are effectively policing this by refusing to accept and pay transfers unless there is proof the advice has been received.
Here below is a checklist of what should be covered in the advice you receive:
|A full explanation of the pension and cash sum benefits you would leave behind, including options for early and late retirement.|
|A full explanation of the options open to you along with the governing rules and tax treatment of the personal pension fund that will be created by the transfer|
|A full explanation of the key risks associated with the transfer option as well of those of remaining in the scheme.|
|A personalised critical investment return assessment which will look at what investment return is required on the transfer value to match the final salary pension you would leave behind.|
|If you have a larger transfer value or have opted for protection against the lifetime allowance, then an explanation as to how the lifetime allowance impacts your fund and any changes to your protection caused by the transfer.|
|Importantly the adviser should offer their opinion as to whether the pension transfer is a sensible transaction for you to undertake given your specific circumstances and financial objectives.|
To do this they will need to:
- Understand you and your family’s financial position.
- Make sure you are both comfortable and have the financial resources to tolerate the risks implicit in the transfer option.
Step 3 – Establish a Plan for After the Transfer
The key elements to this will be the answers to:
- Consider whether or not to take your (up to 25%) tax free Pension Commencement Lump sum
- When will you likely make withdrawals from your pension and what will these be? This does not have to be set in stone but having a most likely scenario will help you with the next two elements.
- How will the transfer money be invested, who will manage it and what kind of investments will make up the fund?
Once these first few points have been worked out then you, or your adviser on your behalf, will need to find a secure, low cost yet properly serviced pension solution that will facilitate your plan.
Whilst thinking about how to invest the transfer money you should also take the opportunity to review all your existing investments and use of tax wrappers such as ISAs.
The 2016 budget changes create enormous planning opportunity to enable those generating income in retirement to lower their tax payments. With the flexibility of pension drawdown and with the extra cash from the tax free sum you should be looking to see how you can optimise:
- The new £5,000 dividend allowance
- Lower Capital Gains tax rates
- A £5,000 per year saving income allowance
- Tax free ISA income From April 2016 couples who organise their investments tax efficiently could enjoy over £60,000 per year of tax free pension income, savings income, dividends and capital gains, plus their tax free ISA income before paying a penny of tax.
As you go through these three steps here are three things to look out for.
1. Misleading TVAS Reports
Many advisers use an externally produced and semi-automated report based on a Transfer Value Analysis System (TVAS). These reports include a number of graphs and factors including;
- The critical investment return calculations at normal retirement age and early retirement
- Projections for the personal pension cash sum and income based on a range of returns which don’t take account of inflation
These reports use a methodology and set of assumptions that ignore recent pensions rule changes and the preference by the vast majority to use flexible drawdown in retirement rather than buy an annuity. This is particularly perplexing given that a final salary pension holder already has an annuity, such that if this is the form of retirement benefit they want, the best option in the vast majority of situations will be to stay in the scheme. The TVAS calculations assume that following the transfer the individual will use their transfer fund to buy an annuity at the normal retirement date of the scheme. They make an assumption as to the cost of this annuity in years to come and then work back to an investment return needed on the transfer value to get to a fund big enough to buy this forecast annuity.
The Financial Conduct Authority (FCA) has from time to time critiqued the assumptions used in these calculations and set guidelines as to what these should be. They have also recently warned of advisers over relying on the output from these reports and not considering other suitability issues. However to date there has been no alternative methodology put forward by FCA and there is still a tendency by advisers to rely heavily on the critical yields generated by TVAS reports to decide whether to recommend a transfer or not.
As already discussed in this guide if you are attracted to an annuity style guaranteed income in retirement, unless you have a life threatening illness or are concerned over the long term security of your scheme then you will most likely be best served by staying in your scheme. A TVAS calculation is most likely simply going to emphasise this assertion. In a scenario where you dismiss annuities and consider drawdown as the way to invest a transfer value then the critical investment return can be much more simply calculated as on page 8, with only one assumption, that of the inflationary increases on the final salary scheme pension and one judgement call, which is to speculate how long you, or in the case of a couple we, might live.
Watch out for misleading TVAS reports:
TVAS reports can throw up misleading critical yield calculations. As you approach normal retirement the time to make up the gap between the transfer value and the forecast annuity cost can lead to high critical yields. These can be further distorted when the projected fund crosses the lifetime allowance. The TVAS critical yield is not the return you must make on your pension fund post transfer to match the benefits you have left behind, unless you intend to do this by buying an annuity.
Pension projections can be much simpler too if they use a real investment return after inflation and allow the individual to select the end date for the income they would like to plan. By using these two more simplified and appropriate calculations, with significantly fewer forward looking assumptions, individuals can get a real sense of investment return challenges and the outcome possibilities.
2. Excessive Investment Risk
Having secured a generous transfer offer the next objective is not to lose it. Here a few things to watch out for:
- Unregulated investment schemes - often referred to as UCIS schemes (not to be confused with highly regulated UCITS funds). These will often be based around esoteric investments like car parks, timber or foreign property and often promise very high returns. There have been a number of high profile collapses of such schemes in recent years with investors losing most of their money or taking many years to get back a lot less than they originally invested. Those running these schemes choose to do them outside of the reach of the regulator for a reason and they are best given a very wide berth.
- Being a forced seller of investments at a loss to fund income – it’s important to make sure your investments are planned with your anticipated withdrawals in mind to ensure a long enough investment time horizon. Volatile investments, whose values move around significantly in the short term often produce higher longer term returns. However, they can be a disaster for someone needing to make regular withdrawals who ends up being forced to sell them when values are depressed. This can be avoided if they can be segregated from the withdrawal funding and can be left to recover
- Pure capital growth investments – income producing investments tend to be less volatile in value than pure growth investments as the prospect of future income payments helps stabilise their price. Additionally once you have removed your tax free cash sum from your pension all further withdrawals, be they by you, your spouse, or ultimately by your children will be taxed as income. Capital gains tax rates have been and continue to be lower than income tax rates, so if you have the option to hold growth investments personally outside of the pension wrapper this will likely reduce the tax on profits in the future.
3. Excessive Fees
Different advisers charge differing amounts for initial advice and intermediary services and ongoing services. However it’s not just the adviser’s fees you need to concern yourself with, it’s important to keep a track of all your costs as you transfer out and on an ongoing basis. These may include:
- Advice fees
- Platform Charges
- Fees for administering withdrawals
- Fees for switching funds
- Investment fees and fund charges
There is no right or wrong answer to what these should all add up to but as a general rule initial fees should be no more than 3% of the transfer value. It’s impossible to invest outside of straightforward deposit accounts without incurring some ongoing costs. The key point to ensure is that all additional ongoing costs need to bring added value such that your prospective after costs investment returns are better than a deposit account with as much certainty as possible. Excessive ongoing costs are potentially more damaging to the long term success of a transfer than a high initial fee and can turn what could be a relatively low risk investment strategy with a low target return into a high risk exercise just to overcome the cost hurdle.
The historic view is that “it’s always wrong to come out of a final salary defined benefit (DB) pension scheme”. This is still the case but depending on your circumstances, there may be good reasons to consider the transfer option:
- A final salary benefit can be a significant family financial asset, a transfer capitalises and gives you control of this asset, which can be passed down through the generations without inheritance tax.
- Transfer values are at record highs (March 2019) and on most transfer values a 2% real investment return, after fees and inflation, will provide the same level of pension plus potential for residual value to be passed on.
- Transfers offer you complete flexibility over when and how much you draw on your pension account and are in complete contrast to a fixed monthly pension income. It’s inconceivable that 60 year olds retiring now with the prospect of potentially 30 years or more of retirement will have the same cash needs year in year out until they die.
- This flexibility extends to taking the cash as early as age 55 and deferring the taxed pension until it’s needed. The potential uses of this early cash sum are extensive, from paying down mortgages early, to investing in ISAs to generating tax free income, or helping the next generation on to the property ladder.
- A final salary transfer takes away the life expectancy gamble implicit in a lifetime income. It capitalises the benefit once and for all based on normal life expectancy, irrespective of your personal health now and in the future.
- With flexibility comes the ability to be tax efficient. In virtually all the cases where we have recommended a transfer there has been the ability to save tax as compared to the rigid final salary pension benefits.
These can include:
- A higher tax free cash sum following the transfer
- The ability to limit pension income to specific income tax bands
- The opportunity to defer and minimise the impact of lifetime allowance (LTA) penalty tax charges
In the interests of fairness and balance, here are some reasons NOT to do a final salary transfer:
- Certainty – One advantage of having a Final Salary Pension is that it lasts as long as you do. If you happen to live longer than average then the scheme has to find the money for this. If you decide to transfer away from the scheme then someone else has to manage the risk – either you or a financial adviser. There is a risk that if the investment does not perform that you could run out of money prematurely. Alternatively, you may be so worried of running out of money that you draw down the funds too slowly and miss out on enjoying the full benefit of your retirement savings.
- Inflation – Inflation is running at around 2% (2019) following years of virtually no inflation, to 2-3%. If you happen to be retired for 20-30 years the value of having an income which has some protection against rising prices could be considerable. Many DB schemes are inflation-proofed but check your own individual scheme for precise details. Of course if you invest your DB pension proceeds successfully, you may be able to achieve an above-inflation rate of return but the protection against inflation is not guaranteed in the way that it is with a DB scheme.
- Investment risk – As a member of a DB scheme your money is invested for you and in reality it is rarely something to have to give a second thought to. The scheme has to pay your pension come what may so in effect you are insulated against the ups and downs of investment. By contrast, if you take a cash equivalent transfer and invest the money yourself, the value of your fund can, and will, go up and down. The upside of this is that your capital could grow considerably but the downside is that if your assets perform badly you will have to live on a much reduced income. A key consideration therefore is your attitude to risk. It is important to consider how you might feel and how you would cope if your investments did badly. This is something to talk through with your financial adviser.
- Provision for survivors – since 1997, DB pension schemes have had a legal duty to provide a pension for a surviving spouse if the scheme member dies after reaching a scheme pension age (this may differ and is dependent upon your scheme rules). This is a valuable benefit and should not be dismissed lightly.
- DB to Drawdown transfers are irrevocable – you cannot change your mind a few weeks or years later if you regret having made the transfer.
A final salary transfer allows you to swap a future pension entitlement in a final salary, or defined pension scheme for a cash sum that must in the first instance be put into a registered, or HMRC recognised pension scheme.
Final salary transfers are usually available to what are known as ‘deferred scheme members’ i.e. those who have left the employer who sponsored the scheme but have yet to draw their pension or cash sum. They can also be offered to employees at retirement or as part of an early retirement or redundancy package.
The cash sum value is the ‘cash equivalent ’ of the pension income you leave behind, or put another way the amount of money today that would be notionally set aside in the scheme to meet your specific pension liabilities as they fall due. In practice the process of calculating a transfer value is done by the scheme actuary based on laid down guidelines.
How much could I expect to receive?
This depends on:
- How far away from retirement you are
- The level of pension you were entitled to when you left the employer
- The scheme rules dictating how pensions increase between leaving the scheme and when you retire and in retirement and such things as widow’s benefits and guaranteed periods
- How long you might live
- Future investment returns that can be expected on funds set aside to meet your pension liabilities
Importantly, the calculation uses standard assumptions about how long you will live and whether you are married rather than reflecting your own personal situation and state of health. Both the life expectancy factor and the investment return factors are changed from time to time to keep them up to date.
If you are in your 50’s and the scheme retirement date is age 65 you are likely to be offered a transfer value of around 20 times the current value of your deferred pension. If you are in your 50’s and the pension scheme retirement date is age 60 you will likely offered a transfer value of 25 times the pension you might expect in today’s values.
As a general principle the closer you are to normal retirement the higher your value will be as there is less time for the transfer value to grow before benefits would normally be paid.
A couple of key words used in the examples:
Might be - Firstly transfer values do vary quite considerably depending on a range of factors so age 65 schemes might be in the range of 18 to 23 times the current deferred pension and age 60 schemes 23 to 30. A lot depends on how generous the annual increases are to the deferred pension and will be on the pension in payment. Secondly if schemes are badly under-funded and it’s clear the employer does not have the means to make up the deficit, then the trustees have a right to scale back any transfer values they get asked for in line with the scheme deficit, so as to be fair to all members.
Today’s values – it’s important to get the right pension number before you multiply it up. Different schemes send out differing notices to members up dating them on their benefits. Some only give the pension on leaving, some revalue this to the date of the statement. Some show the projected pension at normal retirement date. The factors quoted above hold true for the pension expressed in today’s money i.e. re-valued up from the date of leaving, but not projected forwards to the normal retirement date. Some actually show the transfer value on the statement, then it’s easy and you don’t have to speculate.
Examples of final salary transfer values
If a 55 year old is entitled to a pension in today’s values of £30,000 per year starting from age 65, the transfer value might be around £600,000. If the same 55 year old is entitled to a pension of £30,000 per year in today’s values starting at age 60, the transfer value offered might be around £750,000
In our recent experience most people are pleasantly suprised to see how much their pensions are worth. In some cases there might be benefits which are quite small and may have been almost forgotten but still produce a few hundred thousand pounds of value. In larger cases where people had their benefits valued for A –Day in 2006, it can come as a surprise that the value has roughly doubled in the last 8 years and this through a period of financial crisis and when stock markets have largely gone sideways.