Since the “pension freedom” reforms of July 2015 there has been an increase in people transferring away from defined benefit (final salary) pensions into new flexible pensions – but is this always the right decision? Andy James, our Head of Retirement Planning looks at why people may choose to transfer, and what they should be aware of before taking action.
With the new freedom over money held in defined contribution pensions, this increase in pension transfers shouldn't be surprising. People now have greater flexibility and more choices with what to do with their money than they did with final salary pensions.
Low interest rates are also playing their part. They have pushed the transfer values offered for final salary pensions towards all-time highs. With more money on the table, more people are tempted to take the cash and transfer.
If you think a pension transfer may be the right option, there are several considerations to take into account before making the final leap. A final salary pension comes with guarantees – so you know how much money you will get from day one. On the other hand, the amount you get from a defined contribution pension depends on how well your money is invested.
Final salary pensions also pay out an income for at least the rest of your life, regardless of how long you live. With a defined contribution pension you could run out of money in later life if you make too many early withdrawals, your investments perform badly or you live for a lot longer than expected.
This isn't to say that transferring out of a final salary pension is always the wrong thing to do. The main downside of these pensions is their lack of flexibility – you cannot vary how you take an income.
Defined contribution pensions let you make withdrawals tax-efficiently. You can spread your tax-free cash over a number of years and choose how much income to withdraw each year. You could limit the amount of Income Tax you pay and will have more money left to fund your retirement.
Another big plus for defined contribution pensions is how they are inherited by the next generation. Final salary pensions will die with you or your dependants, whereas defined contribution pensions can be passed on outside your estate.
As the pension stays outside of your estate, it won't ever be charged with Inheritance Tax. This makes defined contribution pensions a great estate planning tool. If you can fund your retirement through other savings and investments that form part of your estate, you could reduce your Inheritance Tax bill while leaving your pension to be passed on to the next generation potentially tax-free.
If you are interested in a pension transfer, you should get professional financial advice before taking any action. The decision is a big one that will affect your finances for years to come, so it pays to speak to a financial planner first to find out if a pension transfer is really in your best interest.
Before you consider transferring a pension, it is important to ask yourself: Will I lose any valuable benefits or features from my existing pension plan? Will I incur any penalties on my existing pension if I transfer? Is it an occupational final salary pension scheme? (in which case it is very unlikely to be advisable to transfer) Have I considered the charges on my current plan? (a new arrangement may be more expensive – especially if you have a stakeholder pension).