The new Pension Freedom rules allow members of final salary pension schemes, or defined benefit (DB), to switch into defined contribution (DC) arrangements and take advantage of the changes.
This allows members of defined contribution (DC) schemes to access their entire pension pot from the age of 55 without incurring heavy tax penalties. Up to 25 per cent can be taken tax-free and the remainder is now taxed at the saver’s marginal rate.
The pension income provided by DC schemes is variable, being based on factors such as the amount paid in, charges and investment performance. DB schemes, in contrast, pay a guaranteed pension income based on earnings and length of service.
The problem is that while DB scheme members are often attracted to the flexibility offered in the new environment, many fail to appreciate the value of their guaranteed arrangements.
The number of people cashing in their DB pensions was on the rise even before the reforms, as employers sought to reduce their pension costs by offering members cash incentives to transfer out.
Usually the critical yield, the return that the alternative arrangement must achieve year-on-year just to match the DB pension, potentially could be high.
The current cash equivalent of the transfer value, providing a detailed breakdown of the calculations, is also important. This is where interest rate expectations might come into play.
The current cash value can fluctuate significantly and right now, due to low gilt yields, there are increasing inquiries about a potential window of opportunity to act before interest rates increase and currently high transfer values are likely to fall.
There are plenty more factors to consider, including objectives, other assets and income, and the individual’s health and family history.
There are some scenarios in which transferring out might be the best course of action. They include cases where health issues may curtail the individual’s retirement, or where there’s no-one to inherit the pension at death.
“I would advise most DB members to stay put and benefit from a guaranteed income in retirement that they’d be unlikely to get from any other arrangement”
“The thought of being able to turn an income stream into a large capital sum can often appear attractive at first glance, but you have to think about the returns and the risk associated with the alternative arrangement”
For bespoke final salary pension transfer advice contact Credencis.
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