Transferring a Defined Benefit Pension: What’s in Your Best Interests?
What is a Defined Benefit Pension Plan, in essence?
In the simplest terms possible, a defined benefit pension plan is one that guarantees you a certain level of income in retirement. Your pension is based on your salary and length of service with your employer; as such, it’s often referred to as an occupational pension or final salary scheme.
Unlike a defined contribution pension plan, where the amount you get is based on a specific sum of money you contribute to your retirement fund, the amount of your pension is not dependent on how much you contribute. Instead, it’s determined by your salary and years of service with your employer.
What are the key benefits of a Defined Benefit Pension?
The key advantages of a defined benefit pension are:
- Retirement income is guaranteed – typically for life;
- Retirement income is often linked to inflation;
- You often don’t need to make contributions to the scheme yourself;
- Your next of kin can receive a portion of your pension after you die; and
- In the UK, your DB pension scheme is protected by the Pension Protection Fund (PPF).
DB pensions are typically seen as ‘golden’ pension deals. To replicate the terms to get a guaranteed, inflation-linked income with a defined contribution pension, you’d need to buy an annuity – which can be very expensive.
So, you’re thinking of transferring a Defined Benefit Pension?
The holder of a DB pension knows that, from a set future date, they will have a known and guaranteed income for the rest of their life. That’s a pretty nice little setup for retirement. So trading in this pension for what is known as a Cash Equivalent Transfer Value (CETV) is not an easy decision. A CETV can be invested in a personal pension with much more flexible access but will lose those valuable guarantees – amongst potentially many other benefits. So, how do you choose?
The current guidance from the FCA is quite clear: financial advisers are told we should start from the assumption that a transfer out of a DB scheme is generally unsuitable, and only then consider other factors. And who are we to argue with the FCA?
That said, a new consultation paper proposes a different position:
‘An assessment of suitability should focus on whether a transaction is right for the individual and should be assessed on a case-by-case basis from a neutral starting position. The adviser needs to demonstrate that the transfer is in the best interests of the client.’
The science (or perhaps there’s a touch of artistry at play) is in determining the best course of action for each individual.
What are the main motivations for transferring a Defined Benefit Pension?
There are many reasons why people transfer their defined-benefit pensions.
- Greater flexibility and access: This includes flexibility over the nomination of beneficiaries, timings and benefit methods;
- Greater control over how assets are invested;
- Inheritance benefits: Typically, on the death of DB pension holders, the beneficiary gets 50-60% of the pension benefits that were due. With a defined contribution scheme, the entire remaining pot can be passed on;
- Increased tax efficiency: Tax savings are possible, depending on where the client expects to be a tax resident and what type of scheme is being set up;
- Leaving a UK tax environment;
- Take advantage of high transfer values as a result of prolonged low-interest rates – though this trend has reversed in recent months;
- Flexibility surrounding poor health or reduced life expectancy: A DB pension lasts as long as you do – if you have reason to think that might not be as long as you’d hoped, transferring out makes sense.
What are the options for Expat Pension Transfers?
For expatriates around the world, transferring an existing UK defined benefit pension scheme has 2 main options—Qualifying Recognised Overseas Pension Scheme (QROPS) and International Self-Invested Personal Pension (SIPP).
QROPS
If you are close to surpassing the lifetime allowance, transferring your pension fund overseas can help. That’s because by moving it out of the UK tax net entirely—and into a different country’s financial system (which is not bound by these rules)—longevity charges no longer apply. However, outside of the EEA, you may be subject to an Overseas Transfer Charge of 25%. Ouch.
INTERNATIONAL SIPP
Because of their lower costs and continued UK jurisdiction, International SIPP plans are often a better option than QROPS for smaller transfer values.
Our previous blog exploring the differences between QROPS and SIPPS should be useful for you to work out which option is best for you. Read our clear expat pension transfer advice.
How do you calculate a Transfer Value (CETV) for a Defined Benefit Pension?
The transfer value (CETV) is the amount that the pension will be valued at when you take your money out of it. The simplest way of accessing your CETV is to use your statutory right to request it annually from your UK Ceding Scheme.
You can find online guides, like this defined benefit pension transfer value calculator, which can be useful when you want an informal ballpark to help loosely inform your plans. But remember this is a guide and won’t produce reliable DB transfer values.
There are added complexities with overseas pension transfers into QROPS or ISIPPS, so it’s best to seek professional input from an international financial adviser when making this decision.
Choosing between transferring a Defined Benefit Pension and keeping it intact
The first thing to consider when deciding whether to transfer or keep your defined benefit pension is whether flexibility or certainty is more appealing or important to you and your family. It also depends on the strength of your financial portfolio and how reliant you will be on the income from your DB pension in the future.
Although it’s tempting to look at what other people are doing with their pensions as an indication of what’s best for yourself, this isn’t always helpful because everyone has different circumstances.
Spend time evaluating your options with input from a Pensions Transfer Expert
The first step in evaluating your options is to talk to a qualified, independent pensions adviser. They can help you understand how the new pension rules affect your current defined benefit plan, and what steps you might take to protect yourself from risk and maximise your retirement wealth.
If you’re wondering whether transferring your defined benefit pension is right for you, let’s unravel the mystery together. Contact us today.
