Transferring out of a final salary pension scheme has long been seen as a taboo by many in the industry. But the issue has been thrown into much greater focus since the pension freedoms were introduced. This is partly because many schemes are offering transfer values higher than the historical average but also as a result of customers finding the freedom in a defined contribution scheme attractive. This includes access to funds, flexibility over income and the ability to cascade unused funds down the generations after death.
The numbers of people looking into transferring out of final salary has surged over the past year or so but despite the obvious attractions of pension freedoms many are likely to be better staying put. Saying that, there are situations where a transfer will be appropriate advice, so it is important each case is judged on its own individual merits. For me, there are two distinct scenarios.
Some people have a deferred final salary benefit and are many years away from retirement. Here the critical yield is a key factor, as it helps indicate what kind of investment return is needed to match the benefits being given up. While there are always exceptions, in many cases the required yield will be too great. So, unless there are unique circumstances such as serious ill health, the downside risk means a transfer often will not be suitable. However, for those with substantial benefits, any weakness in the sponsoring employer’s ability to support the pension scheme is worth taking into account.
The situation for those transferring to take immediate benefits is different. In these cases a critical yield is a lesser factor or indeed irrelevant if the transfer is taking place at the scheme retirement date.
The FCA recognises this by not requiring an automated transfer value analysis in this situation. The key in these circumstances is a comparison of the benefits being given up compared to those available in the new arrangement.
“The ability for family to inherit the entire remaining pension fund free of inheritance tax is a strong driver for some”
There are a number of factors that could indicate a transfer may be suitable. The ability for family to inherit the entire remaining pension fund free of inheritance tax is a strong driver for some, compared with the often poor level of death benefits available for a final salary member.
In a similar vein, people who are single have the ability to re-shape death benefits to suit their individual circumstances, which is preferable to an irrelevant benefit automatically provided by the scheme. Final salary schemes also lack flexibility, so a transfer can give income flexibility and tax planning opportunities, allowing advisers to help clients control the amount of tax they pay.
Add in the potential for greater amounts of tax-free cash and possible health issues, and there are a range of reasons why a transfer may be worth exploring. However, the move from a defined retirement benefit to the uncertainties and risks inherent in income drawdown is a huge step.
This is where new hybrid solutions offering annuities and drawdown in one wrapper can help. The annuity element can produce a guaranteed income personalised to the client’s circumstances and take into account their health and lifestyle. This allows the adviser to match some or all of the guaranteed income the final salary scheme is providing and invest any excess money in the drawdown element, giving the client a level of certainty not available under a traditional drawdown solution.
A recent case that came across my desk allowed a client to use an annuity to match the guaranteed income offered by the final salary scheme and have around £80,000 left over in drawdown. That was driven by a combination of a generous transfer value, moderate health issues and a restructuring of death benefits from a joint life benefit to a 20-year guarantee.
Final salary transfers are increasingly on the radar and although there are risks for both advisers and their clients, there are certain situations where a transfer can be the right decision. Any adviser practising in this area will know to tread carefully; however, great client outcomes can be delivered in the right circumstances.
Andrew Tully is pensions technical director at Retirement Advantage