Assessing a final salary scheme transfer
In our view it is much easier to assess a final salary transfer if you are looking at taking immediate benefits. You can see what you are giving up, and you can see what you are getting in return.
Again, another example will help understand the issues, and I have carried on the example of Mr Smith, from the transfer value
Mr Smith is 60, and his deferred pension (promised at age 65) is £20,000 plus inflation increases. If he takes this pension now, they will reduce it by 4% per year for taking it early. So, a 20% reduction. So his immediate pension is:
£16,000 per year
£72,258.06 lump sum
£10,838 per year
So, his immediate two options from the scheme are very good.
It would be quite common for final salary scheme to provide income that increases in line with inflation to some degree. So, regardless of how long he lives, he knows how much income he will get, and that it will maintain its buying power.
The pension would also be £8,000 per year for Mr Smith's spouse if he died. (It probably comes to a complete end when they both die).
Compare to CETV
The next step is to compare the benefits the final salary scheme can offer to the benefits that can be secured/provided with the transfer value. If we assume the transfer value is £449,812 (the lower of the two in the examples on the the transfer value
Remember the final salary scheme can offer:
£72,258.06 tax-free cash
£10,838 per year guaranteed
Mr Smith could take the £449,812 and put this in a flexi-access drawdown. This would allow him to take:
£112,453 tax-free cash
£337,359 remaining fund
The remaining fund could be withdrawn in its entirety! Of course that would be a more extreme use, and incur a significant amount of tax. But in simplistic terms the transfer value does give him £40,195 more tax-free cash than the final salary pension can, and almost 31 years of income upfront (31x£10,838 = £337,359).
Of course there are other uses for flexi-access drawdown, and not just stripping out the fund such as:
- To allow the pension holder to take just the tax-free lump sum and leave the rest invested
- To allow you to strip out the fund but lessen tax
- Use like a bank account, and make occasional withdrawals
- To aim to provide a long term income
- To leave the money invested to pass on inheritance tax free
For more details about flexi-access drawdown see uses of FAD
The question is does it make sense for Mr Smith in the above example to transfer his final salary scheme? In my view there is no definitive answer, and may depend on Mr Smith's circumstances and objectives.
The transfer of the final salary scheme could make sense if:
- If the Mr Smith is in poor health, and has a shortened life expectancy
- He wants to pass on as much of the value of the pension to his children - the final salary scheme offers nothing
- He is concerned that if he dies his wife will only get £8,000 per year and the asset is worth £450,000
- He has an adventurous attitude to risk and feels that he could get more if he invested the money
- He wants to make large withdrawals and spend and enjoy it (assuming he has other pensions or assets)
- He wants a higher level of income now, than the scheme can give
Of course the risk he takes with any transfer is that he lives to long or or spends it too quickly. But the risk with taking a pension with the final salary scheme is that he does not live long enough to get value from it!
Despite the excitement over the new pension rules, you should not discount an annuity out of hand. It would be possible to use the CETV of £449,812 to buy an annuity. And that should be considered too.
The interesting point here is that it would be unlikely that the £449,812 would ever purchase an income of £16,000 with inflation proofing and a 50% spouse's pension. This is the a key point to consider, that transfer values are unlikely to provide a transfer value big enough to replicate the same income through an annuity, as the final salary scheme would provide.
Again, continuing this example of Mr Smith; if Mr Smith was married, and bought an annuity that provided a joint life 50% spouses pension (his pension halves for his wife if he dies) with inflation proofing, then with a fund of £449,812, it would only generate an income of around £11,600. However, there would still be advantages of buying a different type of annuity.
(Remember, the final salary scheme provides either £16,000 per year or £72,258.06 lump sum plus £10,838 per year, and income of £8,000 per year for his wife.)
£449,812 is used to provide £112,453 as a tax-free lump sum. The remaining £337,359 can be used to buy an annuity. It could buy:
1. Joint life 100% spouses (the income staying the same if Mr Smith dies for his wife), but NOT increasing. This would give an income of £14,595.
So, it provides £40,000 or so more tax-free cash, and an income of £14,595 per year that will not increase however, it is still more that the income from the the final salary scheme (after tax-free cash) which would be just £10,838. And it would still be £14,595 if Mr Smith died, and was survived by Mrs Smith.
2. Single life annuity, and level basis (not increasing). Suppose Mr Smith is a smoker, and is taking high blood pressure tablets, he could buy an annuity with the £337,359. Suppose he is single, (or perhaps feels Mrs Smith has sufficient pension in her own right), he could buy a single life annuity. This without inflation proofing would generate a guaranteed lifetime income of £17,838. So, in this example he would have an extra £7,000 of income, and an extra £40,000 tax-free cash. BUT no inflation protection!
The key point is that the transfer value can offer greater flexibility and choice. Whether you should do it will depend on the "generosity" of the transfer value, and what benefits the transfer will provide. Your health may also play a factor in what you decide too.
There are however, a number of dangers of a final salary transfer. If you want to discuss you pension in more detail, then please contact us online
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