Beware dangers of dash for the exit door

Cashing in a final salary pension would be a huge mistake for most employees. But there are a few small groups of people for whom the rewards of these gold-plated pensions are less black and white.

From January 2012, the government plans to stop members transferring out of their company defined benefit scheme. It has drawn up draft regulations, as part of a wider reform of National Insurance "contracting out" arrangements.

Standard Life head of pensions, John Lawson, said that insurance companies had already begun gearing up for a "last chance saloon" push to win transfer business.

He said: "2011 will be the year of pension transfers, with 'buy now while stocks last' type campaigns. Transfers are big business for us, so, of course, we will go all out to attract any transfer money that is around. Transfers tend to be very significant lump sums, as higher earners have the biggest incentives to move."

Final salary pensions can be very valuable, providing, as they do, a guaranteed income, inflation-proofing, and security for spouses and other dependants. As the top end, a 30,000 annual pension might be valued for transfer purposes at around 750,000, with a 40,000 pension worth 1 million.

Actuaries believe some employers, with a weather eye on the gap between their pension liabilities and assets, will also make a dash to beat the deadline. They will want to cash in on the last opportunity to encourage staff to leave their schemes, thus cutting costs for the firm. Accordingly, they will ask their advisers to draw up programmes of "sweeteners" such as cash bribes and enhanced transfer values.

David Cule, a principal at actuarial adviser Punter Southall, said: "Some employers will see this deadline as a last chance by which to get an exercise of enhanced transfers completed."

However, some pensions professionals, not least Tom McPhail at Hargreaves Lansdown, is calling for an eleventh hour change of heart by the government.

He said: "Our concern is that the total removal of the right to transfer your pension elsewhere could lead to severe financial penalties for a minority. The timing couldn't be worse, as schemes are switching over from Retail Price Index to the lower Consumer Price Index uprating, effectively cutting the value of many pensions. It might be worthwhile some transferring out before the switch takes place."

Employees have always been permitted to transfer a so-called gold-plated salary-linked pension into a personal pension or other cash-based, investment-style arrangement. The employer literally pays you a lump sum to buy you out of the scheme. However, this is rarely recommended, because most employees would be worse off. Firstly they would lose the guarantees and other security provided by the company scheme, but also because transfer quotations will not necessarily reflect the true value of the underlying pension that is lost.

For example, Cule estimates you need to guarantee an annual return of between 8 and 10 per cent, over 30 years, on your transfer value, to be confident of not losing out.

He said: "While this was possible during the 1970s and 1980s, it certainly hasn't been easily achievable over the past decade."

McPhail agrees: "If the government proceeds with this change, for most employees it will make no difference at all. They will keep their money in their final salary scheme, where it should be."

Nevertheless, it can make sense for some individuals to take a transfer. If you are single as you approach retirement, you'll set little store by a widow's pension. If you take a transfer of the whole value of your package, this will allow you personally to enjoy in retirement cash otherwise set aside to pay a spouse's pension that you are unlikely to ever use.

High earners, concerned about the robustness of their company pension scheme, may prefer to transfer out, rather than end up in the Pension Protection Fund, where compensation is capped at a maximum entitlement of 29,748, but reduced according to age and service.

It can sometimes pay other staff, fearful that an employer is contemplating reducing the value of benefits, by, for example, raising the pension age, to exit before he acts. This way, the original value of their pension can be protected.

There may be opportunities for some employees to escape a retirement on lower annual increases, following a pegging of their pension to CPI rather than RPI, by taking a transfer before the move is under way.

Elsewhere, someone in very poor health may prefer to take their money out and access it earlier, as they may not live to enjoy the full benefit. Alternatively, they may do better by transferring into an "enhanced" annuity, which pays more to those with shortened life expectancy.

Executives expecting significant pensions may prefer to switch their pensions out as a purely protective measure, in case they die shortly after retirement, and much of their investment dies with them.

If they transfer their pension out, then more of it could be passed on to their beneficiaries, potentially leaving a widow better provided for than under the scheme arrangements.

Finally, it can occasionally make sense for those in dire financial or personal circumstances to access their pension savings early, to get them through a time of extreme difficulty.

The last Labour government wanted to end "contracting out" pension arrangements, because they were proving too costly for the Exchequer, and leaving some individuals with inadequate income in retirement. But employees in final salary schemes were permitted to continue paying reduced contributions.

But Labour's new arrangements opened up a loophole whereby an employee with a spouse's pension could transfer from a final salary scheme into a personal pension, but not use that money to replicate the widow's pension which had been sacrificed.

Primarily to protect widows and other dependants, the Department for Work and Pensions decided to close the loophole, by blocking any future transfers from final salary schemes.

The DWP has finished consulting on the draft regulations with new rules expected to be published before the New Year.

McPhail is also concerned that setting a deadline in this way could lead to mis-selling. "People may be panicked into taking the wrong decision."