April fools prepare to throw away pension safety net

Most people are better off staying in their defined benefit scheme. Picture: Thinkstock

Most people are better off staying in their defined benefit scheme. Picture: Thinkstock

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Advisers warn of numbers seeking to transfer out of secure schemes, writes Jeff Salway

THOUSANDS of people are preparing to sacrifice gold-plated pension guarantees so they can take advantage of new pensions rules taking effect next month.

Advisers in Scotland have reported a marked increase in recent weeks in the number of inquiries from savers interested in transferring out of defined benefit (DB) schemes so they can take advantage of changes coming into force on 6 April.

But in doing so many will be walking away from benefits often far more valuable than anything they can access elsewhere. And while a switch can in some cases be beneficial, experts say the majority would be wise to sit tight.

The April shake-up, set out in last year’s Budget, gives members of defined contribution (DC) or money purchase schemes the freedom to take their whole pension as a cash lump sum, including up to 25 per cent tax-free (as now) and the remainder taxed at their marginal rate (rather than the current 55 per cent).

The pension that people in DC schemes are paid in retirement depends on the amount they pay in and the performance of their investments. In contrast, the pension that members of DB schemes (also known as final salary pensions) receive is more certain, being based on their earnings and length of service.

The latter were at first excluded from next month’s overhaul, before a government u-turn gave them the green light to take advantage of the new freedoms if they transfer to a DC scheme.

That involved lifting a ban on transfers out of public sector schemes, noted Iain Wishart, owner of Wishart Wealth Management in Edinburgh.

“The government would rather the ill, single member draws their pension for one month then dies, than pay 
out a huge transfer value where that money needs to be found from somewhere inside the limited Treasury coffers,” he said.

But the bulk of transfer-out inquiries have come from members of private sector DB schemes. Most have closed to new members in recent years and many are offering transfer-out incentives – 
also known as enhanced transfer value (ETV) deals – in a bid to reduce their pension liabilities. The imminent reforms look set to accelerate the flow out of DB schemes.

Research by Hargreaves Lansdown found that 7.8 per cent of DB scheme members intend to transfer their pension after April – more than half a million people.

The big advantage of DB schemes is the guaranteed income in retirement. The only way to secure a guaranteed income outside DB schemes is through an annuity, which in the vast majority of cases will be less generous.

DB arrangements also protect the member from investment risk. Those that do want to take some investment risk with their pensions can do so in other wrappers, such as individual savings accounts (Isas).

Anyone wanting to leave a DB scheme must take advice. However, the government’s loosening of restrictions around that means advice is now only compulsory where the transfer value of the pension being taken is above £30,000.

The complexity of the decision means advice is absolutely crucial, according to Wishart.

“This is a highly regulated area where the advisory firm and the adviser need permissions and a high level pension qualification before they can advise in this complex area,” he said. “It is essential – and indeed a regulatory requirement – that a detailed pension transfer value analysis is carried out.”

That analysis would provide an estimated investment return (or hurdle rate) that the new arrangement would need to produce to ensure the member is no worse off from transferring.

“Other areas need factoring in too – the client’s attitude to investment risk, their health, overall financial position, marital status, the size of the pension relative to other assets and so on, including the funding [financial state of health] of the final salary pension scheme,” said Wishart.

The City watchdog warned last year that many DB members were taking cash out of their schemes even after being advised not to, particularly where their employer had offered them cash incentives to transfer out.

There are some cases in which a transfer might be worth considering, however – for instance, if you don’t have anyone to pass your pension on to when you die and you have health issues likely to curtail your retirement.

You might also want to leave if you want to retire early. DB schemes can be inflexible and the charge for taking income prematurely may offset any hit for transferring out.

But the reality is that most people are better off staying in their DB scheme, according to Nathan Long at Hargreaves Lansdown.

“Whilst these changes may prompt many to take a second look, in reality the majority of members are likely to be better off keeping their final salary scheme intact,” he said.

Most people will need some sort of guaranteed income in retirement, perhaps to cover their basic living costs. A defined benefit scheme could be considered the bedrock of any retirement income and form some or all of the guaranteed income to cover basic living costs.”

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