Transferring out of a defined benefit or final salary scheme

If you’re thinking of transferring out of your defined benefit or final salary pension scheme there are many considerations to take into account.

Whatever the reason for considering giving up the valuable benefit of a guaranteed, inflation proofed lifetime income, in exchange for a more flexible pension income, it’s important to understand the pros and cons of such a move.

First of all, the Financial Conduct Authorities stance on pension transfer of this manner is that it won’t be in the best interest of the client. The reason they have this stance is that it’s near impossible to replicate the benefits offered by a defined benefit scheme after the transfer has happened.

By this they mean using the transfer value to purchase a guaranteed, inflation proofed, lifetime income with spouse’s benefits.

The main reason people look to transfer however, is that they don’t wish to accept these inflexible benefits, instead opting for more flexibility and access to capital.
The pension freedoms of 2014 have seen a massive upsurge in people wanting to move their benefits away from defined benefit schemes. These reason includes.
• Wanting to preserve the pension fund value for family members other than their spouse
• Fear that the scheme is underfunded and may collapse
• Wanting access to the capital more flexibly
• Wanting keep the fund invested in order to have the chance to grow
• Being in ill health and wanting access to a larger amount than the annual income being offered
• Not being married and therefore having no use for the spouse’s benefit

Before a pension transfer of this nature can happen, a member need to seek advice from a suitably qualified pension transfer specialist. The FCA has stipulated that financial advice has to be sought and by a company and individual who has experience and has been given the additional authorization to do so.
The process involved happens in various stages.
1. A fact find – this is for the adviser to establish the reason for a requested transfer and all personal circumstances which will help in the final recommendation after complete analysis.
2. Request for a Cash Equivalent Transfer Value (CETV) and complete pension scheme information from the individual’s occupational scheme.
3. The scheme information is then used to complete a Transfer Value Analysis (TVAS). This is compare the benefits being given up to those that could be offer by a personal scheme.
4. Research of possible solutions – If the member is looking to transfer out of a defined benefit scheme in order to take their retirement benefits, research on possible pension income solutions will be carried out. This could be to an annuity or more commonly an income drawdown arrangement.
5. Presentation of recommendations – After the analysis and research has been carried out, a recommendation, either to stay within the defined benefit scheme or transfer away will be issues to the member.

What can you transfer?

Subject to trustee approval you can transfer a private sector defined benefit scheme. Some scheme will provide an enhanced transfer value (if they are actively trying to reduce the impact of older scheme member burden on the scheme). This will involve an additional payment on top of the transfer value as an encouragement to transfer benefits away. Often these have a limited window to act.
Private sector schemes which are in deficit may also impose a reduction for those wishing to transfer out. This will be a penalty to the transfer value on transfer for the reason the scheme can’t afford to pay the full value.
Funded public sector pension schemes such as local government pensions can also be transferred.

What can’t you transfer?

Unfortunately, if you’re in what’s called an ‘unfunded’ public sector pension scheme, the government has put a ban on transferring benefits. These are Police, Fire-fighters, the NHS, Teachers, Armed Forces and Civil Service schemes.

Disadvantages of transferring

As previously stated, it’s practically impossible to replicate the benefits offered by a defined benefit scheme by moving away from one. One of the only instances is if a member has a long medical history. Defined benefit schemes don’t take into consideration the health of the member at retirement. A terminally ill member may only live for 5 years and therefore not gain sufficient benefit back during their shortened life. In this instance an enhanced annuity, which does take into consideration health, may provide more favourable income.
Generally, if a member transfers their fund scheme value away into a personal pension, it will be for more flexibility. The downside to this is that a fund will only last a finite amount of time. If the member lives into their 90’s and continue to take large amounts of income, it could run out, or sooner depending on the level of withdrawals. The big risk of transferring away is the lose therefore of a guaranteed lifetime income.