Up until ‘pension freedoms’ it was pretty much unheard of to transfer a defined benefit pension (otherwise known as a final salary pension).
They were considered gold plated pensions. A guaranteed income for life at a level that could never be matched by modern day defined contribution pensions.
But when the then Chancellor George Osborne announced pension freedoms in 2014 it changed the game. It allowed people to flexibly access their defined contribution pensions meaning they could take from their pension pot what they wanted, when they wanted from age 55. Defined benefit pensions do not allow this same flexibility.
During the same period, interest rates have been very low meaning transfer values offered (in exchange for giving up your guaranteed income) on defined benefit pensions have been historically high from a pure monetary value point of view.
There can be clear reasons why you may want to transfer a defined benefit pension, however the system is now turning against you. Here’s why and what you can do about it.
Why are so many people deciding to transfer a defined benefit pension?
According to a recent market wide data analysis from the Financial Conduct Authority (FCA), 234,951 defined benefit pension scheme members received advice on whether to transfer between April 2015 and September 2018.
Across recommendations for and against transfer, the average transfer value was £352,303 equivalent to a total value advised upon of £82.8bn.
In the majority of cases it is going to be right to keep your defined benefit pension. However in certain circumstances it may be right to transfer.
The basic problem with a defined benefit pension is as follows:
- No flexibility – There will be a set point in time (normal retirement age) when you have to take the income. You may be able to adjust this date but once the income starts you can’t change it. This means you can’t spend more in your early retirement years and less in later life for example.
- Less tax free lump sum – Defined benefit pensions typically pay less as a tax free lump sum at the point you start receiving your pension income.
- Income reduces by half on first death – Typically, the income paid by a defined benefit pension will reduce by half and be paid to your spouse on death.
- Income could die with you – If you don’t have a spouse then the pension will probably be lost with no benefit for your children. Even if you have a spouse the pension is usually lost on second death.
- Relying on the company surviving – Defined benefit pensions are not completely without risk. They are provided by the company you worked for. If that company fails then your pension income could be reduced significantly.
Why is it so hard to transfer a defined benefit pension?
Section 48 of the Pension Schemes Act 2015 requires that trustees or scheme managers check that financial advice has been taken before allowing a transfer to proceed, where the proposed transfer involves a defined benefit pension or other safeguarded benefits worth more than £30,000.
This is a good thing because transferring a defined benefit pension is such a crucial, potentially life-changing decision.
Advice has to come with a cost. Financial Advisers obviously can’t work for free but it’s what cost is right?
In an ideal world an appropriate cost would be the market rate for the time taken to do the work.
The problem is Financial Advisers can’t just charge based on their time.
By agreeing to advise on defined benefit transfers they are taking on a massive liability. The FCA has said many times that it expects most people to remain in defined benefit schemes so to advise to transfer out leaves Financial Advisers open to massive scrutiny.
There is no deadline for the amount of time a client can complain about advice. A client could complain years and years after the advice. A Financial Advice firm being found against on a defined benefit transfer complaint could be put out of business due to the money involved.
So Financial Advisers take on this liability for ever.
The section 48 rule states that a client must take advice not that they have to follow it. However pension/investment platforms that offer private defined contributions are being sneaky. Many have implemented policies that means they don’t accept defined benefit transfers unless the adviser has specifically recommended they do it. This is NOT what the rules say.
So you could pay quite a high fee for the vital advice, be advised not to do it, want to do it anyway and then be blocked by certain providers.
One way around this is for Financial Advice firms to charge a contingent fee. This means they only charge a fee (deducted from the pension transfer) if the advice is to transfer. The FCA are against this and considering whether to ban this practice because they believe it incentivises the adviser to recommend transferring whether it’s in the clients best interest or not. If they don’t they don’t get paid.
The alternative to contingent charging is that the client has to pay an upfront fee for the advice and potentially be told the recommendation is not to do it. Still very valuable advice but not what you want if you are hell bent on transferring.
Professional Indemnity insurers have now decided they are uncomfortable with insuring this risk for Financial Advisers and therefore have increased insurance costs massively. Our own premiums shot up 250% in one year! They are also banning adviser firms from doing it so there are now less advisers in the market offering this service.
In fact we are no longer doing the advice directly but working with a specialist who does the work on our behalf and takes on the liability.
So what’s best practice if you want to transfer a defined benefit pension?
- Do as much research as you can beforehand around the advantages and disadvantages of transferring a defined benefit pension. Many Financial Advisers offer triage services which means they will educate you in what you should think about without actually advising you on your individual case.
- Don’t request a transfer value until you are ready to pay for advice. Let the Financial Adviser do it. The values are only guaranteed for 3 months and there will be a cost to get another one after this. Speak to colleagues instead and get a feel for what transfer values could be. As a rule of thumb consider between 16 and 20 x pension income.
- Be prepared to pay for the advice. It might not go the way you want but it will still be valuable. This is life changing stuff.
- Find a provider that will accept your transfer without a positive recommendation from a Financial Adviser.
If you would like help understanding your position and whether you should be considering taking proper advice on a defined benefit transfer then take advantage of our free 15 minute call. You can speak to a Chartered Financial Planner who will listen to your situation, give you an outline of what you need to consider and guide you in the right direction.
Stock market linked investments and any income from them, can fall as well as rise and is not guaranteed. Any figures quoted are for illustrative purposes and should not be taken as a forecast or guarantee. Past performance should not be seen as an indication of future returns and clients may get back less than they have invested.