DB, or Not DB… Should You 'Cash In' Your Final Salary Pension?

Are you one of the very fortunate minority who has a ‘gold plated’ defined benefit (often termed Final Salary) pension? You would be mad to give up the guaranteed income, right?

Well, the volume of transfers is currently at a record high and, according to the Pension Regulator, 80,000 of you took a decision to transfer in the last financial year. This figure is expected to rise beyond 200,000 in the current year. So, what’s going on?

Let’s look at three key reasons why people are transferring:

1. To take income more flexibly and when you ‘want’ it

Income from your Final Salary scheme will start at a certain level (usually based on your service and final salary at retirement) and then rise each year in line with inflation. This is great, but there may come a point in retirement where you won’t spend as much money due to reduced mobility or just being more content doing less.

You can’t then reduce or turn off the income, so you will continue paying income tax on it and inevitably this builds up in cash in an environment where (unless some proactive action is taken) your estate could be subject to Inheritance Tax.

If you transfer the money to a ‘defined contribution’ pension, usually a Self Invested Personal Pension (SIPP), you have the flexibility to:

• control when and how much income you draw – perhaps spending more in the early years of retirement, doing everything you want to do while you are younger and fitter. Then reduce income to match what you need in later retirement.
• blend taxable and tax-free income (up to 25% of the initial pension value can be taken tax-free) to suit your wider position.
• access funds to help your children purchase their first homes.
• draw on funds for emergencies or unforeseen events.

2. To secure historically high transfer values

Very simply, transfer values are linked to changes in government bond (Gilt) yields. When the yields fall, it becomes more expensive for the pension scheme to pay the income to all its members, so transfer values increase.

Gilt yields are currently at historic low levels and thus transfer values have hit historic highs. Figures from pension specialists Xafinity suggest that transfer values have risen around 12% since June 2016.

Some schemes are now paying transfer values in excess of 30 times the Final Salary pension. This means that someone expecting a Final Salary pension of £30,000pa could receive a transfer value in excess of £900,000.

3. To leave an inheritance for future generations

The death benefits for Final Salary pension members are limited. Once in payment, on your death, your scheme will likely pay 50% of your income to your surviving partner (or dependent children) and then, on the death of the survivor, the income stops. For single people or those who survive their partner, this offers no benefit.

If you move the transfer value to a SIPP, any money left on your death is passed on to your nominated beneficiaries either as a lump sum of cash (subject to tax on death after age 75) or as a SIPP of their own (with access to tax-free withdrawals if death occurs pre-age 75 or taxable withdrawals on death after age 75).

This is pretty compelling for those wishing to leave an inheritance for their children.

What are the risks?

The biggest risk is that you are giving up a ‘guaranteed’ income source and taking on personal responsibility for providing and sustaining your own retirement income for life.

If you do transfer, you may be able to limit investment risk within the SIPP, depending on your income needs, but there is always a possibility the pot could run out or that you need to take an income cut to ride out falls in the stock market.

What should you do?

1. Understand – Get an up-to-date statement from your pension scheme and request a transfer value.
2. Build a plan – Think hard about how you want to spend money in retirement and what your goals are.
3. Compare – Use your plan to assess the options carefully and to help identify any relevant benefits and risks.
4. Make an informed decision – If everything in your plan can be achieved using Final Salary income, then don’t transfer, as this is the ‘least risk’ option. But, if a transfer provides life-changing value and fits better with your plan, and you have taken appropriate advice, then transfer with confidence that you are giving up the guaranteed income for sound reasons.

Need more help?

At Carbon we have a comprehensive process for helping members of Final Salary schemes build their financial plan and assess their options. If you think we may be of help to you, do get in touch for a no obligation chat over a coffee.

Stephen Rowntree is a Chartered Financial Planner at Carbon. Contact Stephen via email on stephen.rowntree@carbonfinancial.co.uk or get in touch with your local Carbon office.

The value of investments and the income derived from them can fall as well as rise. You may not get back what you invest.