Should you take cash to quit your pension?

EMPLOYERS are stepping up their attempts to lure workers out of their final salary schemes as the funding of company pensions comes under growing pressure.

But the incentives offered are rarely worth accepting and often leave members at risk of lower incomes in retirement, experts have warned.

Thousands of final salary schemes have closed in recent years as employers try to cut their pension liabilities. Many companies have also reduced costs by offering members (including ex-employees) incentives to surrender the guaranteed payouts that come with their final salary pensions.

KPMG recently estimated that around 90,000 people have been offered incentives to transfer out, with around a quarter accepting cash lump sums or enhanced transfer values (ETVs). But it warned that another 750,000 people could be targeted over the next five years as firms cut costs.

And the launch of the latest round of quantitative easing (QE) is expected to accelerate the process. Company pension deficits are set to grow as a result of QE, because lower gilt yields bump up the cost of paying pensions to those in retirement, adding to the desire to reduce overheads.

Fraser Smart, Edinburgh-based managing director of Buck Consultants, said: “While the focus of many commentators has been the impact of falling equity market values, the much more dangerous and less well understood side-effect is the massive hike in liabilities as gilt yields fall in response to the government’s plans to buy more of the assets.”

The impact won’t be immediate, because of a time lag before either the end of the accounting year or the next three-yearly funding valuation, said Smart. But he warned that some firms will be forced to pull the plug on their final salary schemes.

“If market conditions are similar at the year end, there will be some horrific deficits disclosed with obvious implications for those who haven’t taken the final step. I very much hope that knee-jerk reactions aren’t made.”

ETVs are on the rise and Smart is also seeing more “pension increase exchange exercises”, where members get a higher initial income in return for giving up pension increases that are higher than the statutory ones.

The Pensions Regulator warned earlier this year that cash incentives “are likely to result in less objective decision-making”. It urged firms to ease the pressure on those being made offers and called for members to be given paid-for financial advice while mulling over the offer.

Yet there is evidence that companies are failing to heed the regulator’s warning, with Scotland on Sunday hearing tales of employees being harassed to make quick decisions, often with the threat of the offer being withdrawn.

Gary Cullen, partner and head of pensions at Maclay Murray & Spens, said firms are desperately trying to remove risk from their schemes.

“This can involve offering employees and former employee members either a cash lump sum or an ETV, to persuade members to transfer their pension pots, thereby removing long-term liability for the scheme.”

The most common approach requires members (both existing and previous employees) to switch out of final salary arrangements – where the payout is based on salary and length of service – into defined contribution schemes, where the eventual pension fund depends on contributions and investment performance.

Members are usually compensated by either a cash lump sum or an ETV, where the employer bumps up the pension being transferred.

The company’s comparison between the benefits from the final salary scheme and those from the alternative offered is likely to be stacked heavily in favour of the employer.

Alan Dick, owner of Forty Two Wealth Management in Glasgow, said: “The FSA and Pensions Regulator both assume incentivised transfers to be against members’ best interests as the default, whilst acknowledging that there may be specific cases where individuals would benefit. However they, and we, expect these cases to be in the minority, and in fact the extreme minority.”

He advises anyone offered an incentive to start by asking what’s in it for the employer. The offer may seem attractive, especially where there is a cash sum involved, but the long-term implications are harder to judge.

The investment return needed to at least match the pension benefits surrendered can be ambitious, often requiring annual growth of 6 or 7 per cent. Achieving those returns may mean taking extra investment risk, so it is vital if you do accept the offer to explore your investment options, preferably with the help of a qualified IFA.

Dick said: “From the members’ perspective, they lose all future guarantees and find themselves at the mercy of investment markets and annuity rates. It is tempting to think that investment markets have performed so badly for so long, and annuity rates have fallen to such a low, that things can only get better.

“But this is far from guaranteed and is a risk that very few members would be prepared to take if fully armed with all the relevant information to make an informed decision.”

There are instances where accepting an offer can make sense, but they are strictly on a case-by-case basis.

For instance, transferring out could enable someone in poor health to buy an enhanced annuity, which pays out a bigger income in retirement than a conventional annuity and potentially more than the final salary scheme.

“You can’t guarantee that if the member stays in the employer’s final salary scheme, they would definitely be better off than if they agree to transfer out,” said Cullen.

There may also be cases where there are doubts over the strength of the employer and the pension scheme. When an employer goes bust, the Pension Protection Fund (PPF) steps in to ensure members get most of their benefits. But the benefits paid are capped and may be much lower than those promised by the scheme.

“In this case members would have to assess just how risky the scheme may be and weigh this against the investment and annuity rate risk of transferring out,” said Dick.

It is also worth remembering that if offered a cash incentive, the money may be subject to a tax charge that could erode the value significantly.

The importance of taking time to weigh up the pros and cons of a cash incentive or an ETV can’t be overstated, said Dick.

“It is clearly not a one-size-fits-all decision and members need to think carefully about the options and the trade-offs implied. This is likely to need specialist advice but it is essential that such advice is free from any conflict of interest.”

To find a qualified IFA near you, visit www.unbiased.co.uk.