If you were offered £300,000 now or an inflation-proofed £10,000 a year for the rest of your life, what would you choose?
This is a similar dilemma faced by many Britons with ‘final salary’ pensions. Often nicknamed ‘gold-plated’ pensions, these are where employers guarantee a minimum income throughout retirement, with yearly cost-of-living increases. But today many pension providers are offering non-retired members high pay-outs – ‘transfer values’ – in exchange for giving up those future rights.
While there is no right or wrong answer here, when it comes to your security in retirement, it is important to take extreme care. Start by considering some key questions.
1. What is your pension worth?
Is it enough to provide for your needs in retirement? Take an example of a final salary pension worth £15,000 a year. While this seems modest, with today’s transfer values at an all-time high of up to 40 times the income due, this could represent a pay-out of over £500,000. Properly managed, such a high sum could provide a retirement income that well exceeds the original annual payment.
However, higher value pensions risk UK lifetime pension allowance (LTA) penalties. Where combined UK pension benefits (excluding the State Pension) exceed £1 million, anything accessed over the limit attracts 55% taxation for lump sums, 25% for income.
Usually, LTA charges are triggered for final salary pensions worth £50,000+ a year. But today’s transfer values mean you could potentially breach the £1 million limit by cashing-in a pension valued at £30,000 – and lose over half the excess to the taxman.
2. Do you have other resources for retirement?
Is your transfer value high enough to outweigh the benefits of drawing a guaranteed income for life? Or will your other pensions, savings and investments provide for your future? If so, you may be more inclined to forfeit a final salary pension for a one-off reward.
However, if your pension is a large part of your retirement wealth, the certainty of a regular lifetime income will have more value. As the State Pension currently only pays a maximum of around £8,000 a year, most people need something extra to see them through retirement.
3. How long do you need it to last?
Final salary pensions provide income for as long as you live – with today’s increased life expectancy, that could be 30 years or more from retirement age. Those in good health may, therefore, benefit from the certainty of a guaranteed lifetime income. Only consider cashing-in your pension if you are confident you will not outlive your resources.
4. How stable is your pension scheme?
Final salary pensions are costly for providers – and many are failing. Recently, thousands of ex-BHS employees lost their ‘guaranteed’ pension rights when the company collapsed. Now, the British Steel Pension Scheme is diluting benefits for 130,000 members to stay afloat.
While the government’s Pension Protection Fund offers a safety net, it currently only compensates up to £34,655 a year at age 65. So, if your pension benefits are worth more than this and your scheme is vulnerable, consider transferring.
5. What will happen when you die?
Most final salary pensions will transfer half the value of the pension to your spouse on death – then go no further. By transferring your funds, however, you could unlock more flexibility in your estate planning, such as the option to pass on pension funds to other heirs, even across generations, and reduce inheritance tax liability.
6. What do you want to do with your funds?
Clearly, anyone cashing-in their pension for extravagant purchases, like a sports car or luxury property, may leave little left for retirement expenses. However, any kind of investment comes with risks.
Benefits in a final salary pension are protected – even if the value of funds goes down, the scheme provider is obliged to make the guaranteed payments. Once transferred, you gain more control over how you invest and access your funds, but they become vulnerable to unpredictable markets, no matter how they are reinvested. With historically low interest rates, even money in the bank can be eaten away as inflation outpaces returns. And without proper guidance, you risk losing everything to unregulated investments or pension scams.
Whether you should transfer a final salary pension depends on numerous factors and your unique set of circumstances and goals. Taking regulated advice is compulsory if you have benefits worth over £30,000, but it is an important step for anyone considering their pension options.
Remember, if you cash-in your pension, you cannot reverse your decision. Look beyond the temptation of large pension pay-outs and take specialist advice to fully understand the long-term implications to do what is best for your financial future.
Tax rates, scope and reliefs may change. Any statements concerning taxation are based upon our understanding of current taxation laws and practices which are subject to change. Tax information has been summarised; individuals are advised to seek personalised advice.
By Dan Henderson
Dan Henderson, Partner of Blevins Franks, is a highly experienced financial adviser, specialising in retirement, investment and succession planning. He holds the Diploma for Financial Advisers and advanced CII qualifications in pensions and investment planning.