This guide is for you if you are one of the many thousands of people who are members of one or more UK Final Salary Pension Schemes and/or Career-Averaged Schemes.
If you belong to a publicly funded pension scheme such as the NHS or Teacher’s Pension Scheme, then a cash transfer to a personal arrangement is not an option. However, if you belong to one of the approximately 1,000 private pension schemes in the UK, a Final Salary Pension Transfer might be a suitable option for you.
The set retirement age is typically between 60 & 65 years old, but it is possible to take your benefits early.
It is not uncommon for people to be deferred members of more than one Final Salary Pension Scheme and so it is possible that it may be in a member’s best interest to transfer out of one of the schemes and remain in the other(s) for the secure income element.
It is not unreasonable for schemes to seek to better manage their future liabilities by offering members a generous Cash Equivalent Transfer Value (CETV) in return for giving up their safeguarded pension benefits.
In simple terms, a Final Salary Pension is designed to pay a fraction of the employee’s salary as an annual pension based on the accrual rate of the scheme, the number of years of service and the final salary paid to the employee. In addition, scheme rules allow for a certain amount of tax-free lump sum at commencement of the scheme pension.
The employer’s Final Salary Pension Scheme, generically referred to as an occupational scheme, would have been originally funded by the employer’s business and employee salary-deducted contributions. Most schemes are now closed to new members and further accrual however, investments are still managed to meet the scheme’s future liabilities i.e., providing its members with the promised future defined benefits.
Nowadays, even the most successful companies cannot afford to run such schemes as originally intended. The main reason being that people are living longer than the schemes were designed for. Meeting the future liabilities of members’ pensions for a higher proportion of its members for thirty to forty years becomes unaffordable if the investment returns cannot keep up with what is required.
A significant proportion of a scheme’s investment funds are held in A-rated government bonds which are regarded as low-risk investments however, with low-risk comes low returns making reaching fully funded status more difficult in a low interest environment.
To flexibly access your pension savings in the modern sense, they must be in a modern pension policy that is ‘Pension Freedoms aware’ and not solely allowed to offer annuities in retirement. Even pre-2015 policies may not offer the full flexibility some people will want to take advantage of in retirement.
The economic force acting against Final Salary Pension Schemes is affordability – will the scheme get into trouble and need rescuing by the Pension Protection Fund? Final Salary Schemes are required to contribute to the Pension Protection Fund (PPF) so that they are effectively insured to meet the majority of all their future liabilities.
Those already receiving a pension are 100% covered but those members of pre-pension age are covered on a sliding scale with the youngest members having the most to lose should the PPF step in. It would be a disadvantage if you were to receive less pension than you had been promised. It is not uncommon for a Final Salary Pension Scheme to be under-funded and specific information on its funded status is made generally available via a specific report on an annual basis.
If you are building up benefits in a Final Salary Pension Scheme it would be good to have a regular benefits statement however, they might not be automatically sending out periodic statements so you may need to ask for one. In addition, it is a good idea to keep an eye on the funding position of your Final Salary Pension Scheme and any relevant company financial statements they make public.
On paper, a Final Salary Pension scheme has a higher chance of paying you more taxable income than an equivalent money purchase pension over a ‘normal lifetime’ because of its payment escalation feature but as with everything in life, there are catches.
You may prefer to manage your income level such that you stay in the lowest possible income tax bracket and not have a fixed pension income with tax automatically deducted by the scheme especially if you don’t need that level of regular fixed income.
You might be fortunate enough to have significant other savings and not require all the taxable fixed income pension in retirement. In which case you might want to pass on some or all the money to your loved ones (your chosen beneficiaries).
Final Salary Pensions were not designed with this mind as their core purpose is to provide safeguarded regular income and not to provide a capital value on death in later life. Depending on your personal circumstances, affordability, and your goals, it may be better to remain in the scheme and take out life insurance cover to provide a capital sum on death to pass onto your loved ones.
A Final Salary Pension Scheme promises Defined Benefits to the member based on its scheme rules and generic details can be found in your member’s handbook.
You can request a Cash Equivalent Transfer Value from your scheme, or you can ask your adviser to do this for you under a Letter of Authority.
Your adviser will also ask the scheme for all relevant information to assess the suitability of a transfer.
As there is a limited amount of time (3 months) from the date of the production of the valuation (offer) to when the guaranteed amount offered will expire, it is prudent to instruct your adviser to initiate the process.
If the Cash Equivalent Transfer Value (CETV) is under £30,000 then independent advice is not a regulated requirement and a transfer can be requested by the member directly. If the value is between £30,000 and £100,000 then it may be more challenging to find a firm willing to provide advice due to their charging structure.
How is my Final Salary Pension Transfer Value calculated and what does it represent? The actual Cash Equivalent Transfer Value (CETV) is an offer made by your Final Salary Pension Scheme in return for you giving up your safeguarded benefits. By paying you a transferrable cash sum, the scheme is reducing their future liabilities.
The CETV is a point-in-time offer that is a guaranteed cash amount that can be transferred to another HMRC recognised pension scheme, but it has a limited time to be accepted, also known as the expiry date. This will be 3 months from the date the CETV was produced by the Final Salary Pension Scheme actuaries.
In recent times Final Salary Pension Transfer values have skyrocketed due the way they are calculated. In simplistic terms, the lower the Bank of England Gilt yields, the higher the CETV calculated will be. Since the surprise result of the Brexit election, Gilt yields plummeted and have not yet recovered to pre-Brexit levels. If they do go back up, then Final Salary Pension Transfer Values would be expected to come down on a comparative basis.
It should be noted that firms can decline to advise and that members cannot transfer out simply because they believe it is right for them to do so. Ultimately, someone (in a firm) must be on-the-hook for the advice taken to transfer. Legal costs and compensation for claims of bad advice can run into the hundreds of thousands of pounds. Hence the need for firms providing this advice to be adequately covered by professional indemnity insurance.
Since October 2020, the Financial Conduct Authority have banned the provision of contingent advice meaning that an advice fee must be charged irrespective of the outcome of the advice. Previously, an advice firm would typically only charge if the transfer went ahead, usually by taking the fee from the funds transferred. Now the advice fee must be for the value of the advice given and not the implementation of the transfer.
Firms that have FCA permissions to advise on Final Salary Pension Transfers employ Pension Transfer Specialists to analyse a member’s specific financial circumstances. There are currently hundreds of Final Salary Pension Schemes in the UK all with their own bespoke scheme nuances.
The basic structure is the same but each one determines its own features such as Normal Retirement Date, Spouse’s pension entitlement percentage, Accrual Rate and discretionary decisions the scheme may need to make on things like how much to pay out on the diagnosis of terminal illness of a member.
It is crucially important to ensure there is enough safeguarded income to meet essential expenditure in retirement. The full state pension for those claiming it now at age 66 in 2021 is £9,339 per year. Knowing your state pension entitlements and the cost of your retirement lifestyle is at the heart of the decision-making process as to whether a transfer can be deemed suitable or not.
If you have an online personal tax account with HMRC, you can check your state pension forecast here:
Your essential household expenditure which includes things such as food, utilities, insurance, and council tax should all be notionally covered by some form of guaranteed income such as the state pension. The essential expenditure for a typical household in retirement ex-mortgage or ex-rent does not vary that much across the UK.
A couple living in their own home with no mortgage and two full state pensions may very well have sufficient secure income to cover all their essential expenditure with the surplus income going towards discretionary spending and perhaps even some luxuries. Other savings such as cash at the bank are very important in case of emergencies such as a fixing a leaking roof or replacing essential household items when they are not covered by insurance.
Taking benefits before the scheme’s Normal Retirement Age would require the scheme to produce an Early Retirement Quote (ERQ) to establish the member’s Tax-free Lump Sum amount and the annual pension payment entitlements.
The amount a Final Salary Pension promises to pay out as a tax-free lump sum is scheme specific and is not set at 25% of the Cash Equivalent Transfer Value (CETV).
Indeed, a CETV is only produced for purposes of undergoing a transfer analysis to establish whether a transfer is suitable. If the funds are transferred to a defined contribution pension scheme, then the standard 25% tax-free lump sum is available on a flexible access basis.
A Final Salary Pension Scheme will pay the tax-free lump sum in one payment, and it is a fixed amount. In contrast, because a defined contribution pension scheme allows for flexible access, delaying taking the 25% tax-free amount may result in a much greater tax-free amount than taking it earlier but this does depend on positive investment returns which are not guaranteed.
The current age for access to a defined contribution pension scheme funds is 55 rising to 57 by 2028. To take benefits from a Final Salary Pension Scheme from age 55, either the Normal Retirement Age must be 55 or the scheme has granted the commencement of benefits due to extenuating circumstances such as terminal illness.
Transferring your pension from a Final Salary Pension Scheme to a defined contribution arrangement means your funds go from a group defined benefits arrangement to either a personal pension wrapper or an existing workplace scheme you may have.
However, there are some defined contribution arrangements that cannot accept funds from Final Salary Pension Schemes and if relevant, will be covered by the Pension Transfer Specialist in the analysis process.
Depending on the firm you use to implement the transfer this will typically determine the new home for your retirement savings. If you use True Potential Wealth Management for example and they recommend your funds are transferred to a personal pension, then they will only transfer into one of their managed personal pensions using their investment portfolios.
The reason for this is because it is an insured process, and they are not insured to transfer Final Salary Pension Scheme funds anywhere else. Once the funds have been transferred however, they are then in a less restrictive environment so it would be possible to transfer your funds on again depending on the receiving scheme’s acceptance criteria.
When there is a recommendation to transfer out of a Final Salary Pension Scheme, the pension transfer specialist must give a personal recommendation and justification for the new pension arrangement in their suitability report. The advice process is insured against bad advice meaning that the firm must transfer the funds to an arrangement they have full confidence in.
To fully understand your financial position now and how it will evolve over the rest of your life requires some serious number crunching unless your life is so simple and straightforward that every day is predictable, and that every financial scenario is perfectly catered for. How many people do you know that have all their finances so well planned, balanced, and organised?
“Life happens” as they say and being prepared for some of the most likely life events that may happen to you makes good practical sense. Using Lifetime Financial Planning techniques, a planner such as myself will help you construct what if scenarios based on
a) how you would like your financial lifestyle to be and
b) what if bad things happen to your plans.
Nobody likes to think about bad scenarios, but we all should know that is what protection insurance policies are designed for. Creating your ideal lifetime financial plan will include working out exactly how much protection your plan requires in the event of catastrophe. Having the correct type and level of protection cover is the cornerstone of a robustly created lifetime financial plan.
‘What if…’ scenarios are modelled using a software tool to visualise the financial impact of changes on your financial lifestyle as they unfold. Lifestyle Financial Planning takes a holistic approach, so it looks at all your financial goals working together simultaneously. It is a superior approach than just looking at one goal-based plan at a time because people’s lives generally have competing demands on their finances.
Software modelling is dynamic so you can adjust several parts of your plan at once to see the future outcomes. This will guide your decision-making process to help you commit financial resources to the areas of your life that need it the most. It can help you work out whether you can retire early or how much you can afford to gift to your loved ones or charity without worrying about going short yourself.
Once you have a Lifetime Financial Plan you can use it to answer the specific question: How much pension do I need? And more broadly: When you are evaluating more than just pension assets. You may want to downsize your home releasing cash for retirement spending or cash-in other investments over time. How much money do you need to retire?