Guide to final salary pension transfers

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.

final salary pension lump sum
The purpose of this guide is to highlight the main factors involved in assessing what your private Final Salary Pension is worth to you and how you should value it. It will help you think about whether you should enlist the help of a qualified financial adviser to take you through the analysis process so that a written recommendation can be made to either to remain in your scheme pension or to transfer out if that is an option suitable for you. 
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Remaining in your Final Salary Pension is the default option, and this is the best option for most people according to the Financial Conduct Authority’s stance. If you have limited other financial resources to call upon in retirement, then a transfer out is unlikely to be deemed suitable. 
Final Salary Pensions and Career-Average pensions promise to pay safeguarded benefits commonly referred to as Defined Benefits. This guide looks at the true value of your Defined Benefits and helps you understand the main elements that are involved with the option to transfer out analysis process. 
We also look at the option of taking your Final Salary Pension early and what you can expect when you or your adviser requests this option from your scheme. 
The value of your Defined Benefits can be the largest asset you will ever own so it makes good sense to take a thorough look at getting the most from it for you and your loved ones. 
To help our clients understand all the complexities around pensions we have developed a Final Salary Pension Guide

What are Final Salary Pensions?

Final Salary Pensions were originally designed by employers to give their employees a retirement income based on the final annual salary amount the employee achieved at a set retirement age known as the scheme’s Normal Retirement Age. In an ideal world - A job-for-life came with a guaranteed retirement pension income for life.
Final Salary Pension Goals - A happy mature couple discussing finances with an advisor
Offering membership to a Final Salary Pension Scheme was a commonly available retention attribute associated with working for a large and successful company. Many smaller organisations could not afford to offer such generous pension schemes and, before it was mandatory, some employers did not offer any pension provision at all. 

The three main factors that determine the amount of Final Salary Pension entitlement is calculated by a combination of the number of years’ service, the scheme’s accrual rate and the final year’s salary in payment at retirement or the date of leaving the scheme or, when the scheme closed for accrual. Career-Averaged schemes were introduced so that rather than using the final salary in the calculation of entitlements, the average salary is used. 

Even if you left your employer, once a member of a Final Salary Pension Scheme, you remain entitled to a scheme pension according to the scheme’s rules. Upon leaving, you became a deferred member of the employer’s Final Salary Pension Scheme, and your Defined Benefits continue to grow within the scheme. 

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. 

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.

Advantages and Disadvantages of Final Salary Pensions 

The main advantage is one of certainty. You are promised a guaranteed fixed income for life which rises each year in line with inflation. If you predecease your spouse, your spouse receives the spouse’s pension for the rest of their life.
However, there are notable disadvantages. There is no flexibility with the income which is subject to income tax. The death benefits are limited to the spouse and any dependent children. 
A person analysing financial graphs and charts for the pension decision process
The amount of tax-free lump sum is often less than what could be achieved by a transfer out. Early retirement options may be available, but the reduced income may not be attractive enough. A smaller lump-sum and a fixed income for life limits your opportunities to manage current or future liabilities. 

One advantage is that Final Salary Pension Schemes must increase the member’s pension entitlements in accordance with regulations such that certain minimums are met on an annual basis. This is probably the best monetary feature of a Final Salary Pension when compared to a defined contribution pension which has no such benefits. 

The latter has no growth guarantees and relies solely on investment performance. A Final Salary Pension is guaranteed to rise in line with a measure of inflation making the scheme’s future liabilities harder to meet during a bad economic cycle when the company’s profit may decline considerably, and the scheme’s investments have poor returns. 

Since the Pensions Freedom Act 2015, legislation enabled consumers to flexibility access their pension savings. However, they cannot do this whilst their savings are in a Final Salary Pension Scheme as Final Salary Pension Scheme rules do not allow this method of taking benefits. Pension Freedoms – your right to use your retirement savings as you see fit over the course of your retirement. This restriction, therefore, is a disadvantage. 
Pension Freedoms are really challenging Defined Benefit based schemes because people now have the potential opportunity to meet different personal needs. Defined Benefits versus Freedom to access your pension when you want it, spend your pension how you want to, manage your pension as part of your estate and manage any tax liabilities in your pension pot.

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.

Final Salary Pension Transfer Values 

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.

Final Salary Pension Goals - A happy mature man reading his paper with a cup of tea

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. 

Happy couple talking with an advisor about their final salary pension scheme

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. 

Current legislation allows you to request one free CETV per 12-month period up until the year before the scheme’s Normal Retirement Age. Some schemes do not allow more than one CETV to be produced in any event however, other schemes will allow more than one per 12-month period if you pay a fee for it in advance (commonly set at £300).

The most technically advanced and enabled schemes have online facilities where you can log into their secure portal and order a CETV at will. Some schemes offer bonuses for remaining in their schemes past Normal Retirement Age, so NRA is not necessarily the age at which you must take your benefits. However, reaching age 75 is a significant milestone for all UK pension arrangements because this is the age at which pension related tax advantages are reconciled for everyone.

CETVs are calculated as an internal affair and often take two or more weeks to produce unless there is an automated process available in which case, they can be done the same day. CETVs will vary considerably from scheme to scheme and from year to year. Transfer Values do not necessarily have to go up the following year or the year after that.

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.

Final Salary Pension Goals - A happy mature lady with a laptop thinking about her future
When a Pension Transfer Specialist (PTS) analyses your CETV the PTS will request an Appropriate Pension Transfer Analysis Report (APTA). The Financial Conduct Authority prescribe that part of this APTA report is given to you to highlight the value (or lack of value) that the cash offer (CETV) represents when used to buy an annuity (secure income – regular payments of income insured by a reputable insurance company). 

Most often, the cash value offered (CETV) will not be enough to buy an annuity of the same value as the regular pension income promised by the Final Salary Pension Scheme. So, this part of the report does the job of reinforcing how valuable the guaranteed pension income for life is.  

This can seem a bit bizarre as why would you accept a cash offer in place of a fixed income only to use the cash to buy a fixed income again? You might if the CETV offer were so generous that you could buy a higher valued annuity than the Final Salary Pension scheme offered.
More importantly, a recommendation to transfer will not be suitable unless there is enough secure income to cover the essential expenses of your retirement lifestyle. 

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:

Having some additional secure income over and above the full state pension is an ideal situation to be in before considering transfer advice. 

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.

Final Salary Pension Early Retirement

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)

Final Salary Pension Goals - A happy mature couple walking hand in hand on a sandy beach

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.

You can work out what your annual pension could be worth at retirement.

A Personal Pension

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.

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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.

A person analysing financial graphs and charts for the pension decision process

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.

How to build your Lifetime Financial Plan

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?

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“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.

If you want more than just investment advice and you feel that a holistic approach to managing your family’s money for life is a better approach, look for a Lifestyle Financial Planner you can work with to help you construct your ideal lifetime financial plan and investment strategy.

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?

To help you make the right decision for your final salary pension, we will take you through a clear, simple, transparent, and regulated four step process. 
If you would like to explore and discuss the options for your final salary pension transfer, - helping you make the right decision on your pension 
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