The authorities are becoming increasingly worried about the flow of people choosing to swap ‘final salary’ style pensions for a cash sum they can invest for themselves.
These people are those transferring out of a Defined Benefit pension, where retirement income is guaranteed and worked out based on the holder’s years of service for an employer. Their schemes offer them a cash transfer value which, if they accept it, they can invest inside a Defined Contribution pension scheme such as a self-invested personal pensions (SIPP).
The flow of people doing this is turning into a flood. It was revealed in May that the cash amount transferred in 2017 was £20.8bn, up from just £7bn in 2016. As these figures cover only those transfers that were recommended by a financial adviser, the real number could be higher still.
Regulators at the Financial Conduct Authority are already on high-alert about this. Last year they reviewed a sample of cases where individuals had been advised to transfer out of a Defined Benefit pension, and found only 47% of those cases were suitable.
And this week it was revealed that The Pension Regulator has warned some Defined Benefit pension schemes that the transfer values they offer for leavers may be too generous. Its concern is that members leaving will make the schemes harder to fund in the future.
Not so long ago it was considered madness to give up a Defined Benefit pension. These are the so-called ‘gold-plated’ schemes that have tended to be far more generous to workers than most Defined Contribution pensions. The income they pay is guaranteed and often linked to inflation - qualities that are very expensive to replicate with your own pension savings. As such, the transfer values offered to members looking to leave were seldom adequate compensation for what was being given up.
More recently, however, transfer values have been driven higher by extreme pricing of the assets that typically underpin DB pensions – government bonds. Low yields on bonds mean it is becoming more expensive for schemes to meet their liabilities and, as a result, some are willing to pay members more to leave and take their liability with them.
In some cases, members have been offered 40 times their expected retirement income as a transfer value. So someone expecting a DB pension income of £20,000 could instead accept £800,000 that could potentially then be invested inside a pension.
With that sort of money to invest, many have reasoned that they can meet their income needs easily by taking only modest levels of investment risk, but with the added chance of capital gains and a larger sum to pass on after they die.
Remember though, this is an extreme example and that most transfer values are lower - 20 times expected income is more typical. At that level, the decision is not nearly as clear cut. The authorities recognise this and require anyone transferring a value of more than £30,000 from a DB pension to get financial advice first.
Advisers will trawl scheme data for relevant clauses and benefits in contracts that can be almost impossible for ordinary people to ascertain by themselves. Numbers are run through complex systems required by regulators to help determine what benefits could be worth in the future and how much income might be sustainable on transfer.
They take stock of your other personal and financial affairs – your health, other sources of income, your tax position and that of your spouse. These can all be critical to the decision of whether to transfer or not, and may mean advisers warn against transferring even when the transfer value is very high.
Conversely, advisers may recognise that a transfer is appropriate even when the valuation is lower, as long as the circumstances are right. For example to maximise the sums passed to beneficiaries after death where ample guaranteed income is already in place.
The point is that it is only after a thorough professional assessment that an informed decision to transfer or not can be taken. That’s why Fidelity Personal Investing only accepts a DB transfer into a SIPP when it comes with a positive recommendation from a financial adviser.
For more general retirement planning options, some free help is available. The Government’s Pension Wise service offers free, impartial guidance to help you understand your options at retirement. You can access the guidance online at https://www.pensionwise.gov.uk/ or over the telephone on 0800 138 3944.
Fidelity’s Retirement Service also has a team of specialists who can provide you with free guidance to help you with your decisions. They can also provide advice and help you select products though this will have a charge.
The value of investments and the income from them can go down as well as up, so you may not get back what you invest. Tax treatment depends on individual circumstances and all tax rules may change in the future. Withdrawals from a pension product will not be possible until you reach age 55. This information does not constitute investment advice and should not be used as the basis for any investment decision nor should it be treated as a recommendation for any investment. Fidelity Personal Investing does not give personal recommendations. If you are unsure about the suitability of an investment, you should speak to an authorised financial adviser.