If you’ve been paying into a Defined Benefit (DB) pension during your working life, you may be wondering if transferring out is the right option for you. The pull of greater flexibility means that more people are looking to give up the guaranteed income a DB pension offers. However, it’s crucial you seek financial advice you can have confidence in before making up your mind.
A DB pension is often considered to be the ‘gold standard’. This is because it provides you with a guaranteed income for the rest of your life that’s often linked to inflation, maintaining your spending power. In contrast, the value of a Defined Contribution (DC) pension, and therefore the income it will provide, is dependent on the performance of underlying investments. So, why are some people keen to leave a DB pension? There are two key reasons:
- Pension Freedoms: In 2015, changes to the way DC pension can be accessed provided holders with more flexibility. DC pensions can be accessed from the age of 55 through a variety of ways, including making adjustable withdrawals. Transferring out of a DB pension can provide greater flexibility because of Pension Freedoms.
- High CETVs: A CETV (cash equivalent transfer value) is the amount you’d receive to leave a DB pension. As DB pensions are expensive to operate, providers have been increasing the amount offered. Some DB pension holders have been offered a CETV that is 30 or 40 times the annual income the pension will provide.
Whilst the above two factors can make transferring out seem attractive, it’s usually not in the best interests of a DB pension holder to do so. Recently, there have also been instances of people receiving advice that is inappropriate given their circumstances. As a result, the Financial Conduct Authority (FCA) has used a video explaining what should occur during the advice process, which can be viewed here. It’s worth noting that if your CETV is more than £30,000, you must seek professional financial advice in order to transfer.
Here are nine things the FCA highlighted when outlining what your financial advisers should be doing when providing advice on transferring out of a DB pension.
1. Fully disclose the service provided and fees
First, it’s important to understand the service you’ll receive. At the top of this list is knowing if the financial adviser is independent or restricted; an independent financial adviser will be able to consider products and providers from the whole of the market, whilst a restricted adviser will be limited. You should also check the adviser has the necessary qualifications to advise on pension transfers and whether they’ll focus on your pension or be able to provide a wider financial plan.
It’s also crucial that you understand what you’ll be paying for the service. A financial adviser should tell you this clearly upfront with a cost in pounds and pence.
2. Take the time to understand your personal circumstances
If you’d like to proceed with advice, an adviser should take the time to get to know you. Transferring out of a DB pension is not usually appropriate but there are specific circumstances that mean it may be right for you. This is why it’s important for an adviser to understand you. Among the areas they should ask about are your material and family status, health, income and expenditure now and in retirement, other assets and plans for retirement. This allows a financial adviser to build a picture of how a DB pension would provide for you and what the alternatives are, with your goals in mind.
3. Question why you want to transfer out of a DB pension
Why do you want to transfer out of a pension scheme? This is a fundamental question for calculating whether it’s the right route for you.
The desire to transfer out will need to be balanced with the income needs you’ll face in retirement. When discussing why you want to transfer out of a pension scheme, it may become apparent that there are alternative solutions that are better suited to your goals and long-term plans. During the process, it’s important to look at the other options you have with a financial adviser.
4. Assess your attitude to risk
A DB pension scheme is relatively low risk. You’re guaranteed a set income throughout retirement, typically linked to inflation. Even if the pension scheme collapses, the Pension Protection Fund can often pay compensation.
In contrast, transferring to a DC will mean taking greater responsibility for savings. Usually, savings in a DC scheme are invested. As a result, the value of investments can go down and you will need to consider the level of investment risk you’re comfortable with. A financial adviser should discuss this with you, explaining how your attitude to risk could affect your pension investments.
It’s not just your attitude to risk your financial adviser should discuss with you either, but also your capacity for risk. If investments experienced volatility, would you be able to cope financially? Do you have other assets that you could fall back on?
5. What flexibility does your DB pension offer?
If it’s the inflexibility of a DB pension scheme that means you’re considering transferring out, it’s important to assess your current scheme. This is something that a financial adviser should do.
An adviser should be able to help you answer questions like, can you retire early if you choose to? Can you take a lump sum from your DB pension when you first retire? These may both be options in return for receiving a lower income annually. Depending on your plans, it may mean remaining part of a DB pension provides you with both flexibility and a reliable income. A financial adviser should explore all the ways a DB pension can be used with your retirement plans in mind.
6. Research the benefits of your DB pension
It’s not just the income a DB pension provides that should be considered. Your pension likely has other auxiliary benefits too. This could be dependent and spouse pensions that would provide your loved ones with financial stability should something happen to you. Depending on your situation, these additional benefits can be very valuable.
Your financial adviser should highlight what these benefits are and how they may be useful for you. In addition, they should explain the cost of replicating them should you decide to transfer out of your DB pension.
7. Explain the expected income should you decide to transfer
If you do decide to transfer out of a DB pension, you need to understand the income you can expect to receive. Your financial adviser should go through how you can take an income from a DC pension, what a sustainable level of income would be, where you’d place the money from transferring out and potential tax implications.
One crucial area a financial adviser should look at is the effect of inflation. A DB pension usually provides an income that’s linked to inflation, preserving your spending power throughout retirement. However, when you transfer out you’ll have to look at ways to grow pension savings to keep pace with inflation, along with the associated risks.
8. Clearly explain their findings
As you approached a financial adviser for advice, this is crucial. Your financial adviser should clearly explain their findings after speaking with you and carrying out the research. Recommendations should be personalised to you, transparent and explain why the adviser reached this decision. Recommendations should also detail both the advantages and disadvantages of the option. Importantly, a financial adviser should not provide you with a list of options; they should give a definite recommendation based on their expertise and your circumstances.
9. Highlight why transferring out often isn’t in best interests
Finally, transferring out of a DB pension often isn’t in the best interests of an individual. When you transfer out of a DB pension, you’re giving up a guaranteed income for life. This should be reiterated by your financial adviser during the process.
When seeking advice on pension transfers, keeping this list to hand can help ensure you’re working with a financial adviser that is working to the FCA’s standards. Pension transfer advice is something we can provide, and we want our clients to have complete confidence in the service provided. This is why we follow the Pension Transfer Gold Standard, a voluntary code of good practice, which you can read about here, and incorporate the above steps.
If you’d like to discuss your Defined Benefit pension and overall retirement plans, please get in touch.