Does the new world of pension freedom and choice pave the way for fresh thinking on transferring out of defined benefit pension schemes?
In the old regime, clients would hardly ever be well-advised to give up a guaranteed employer pension. Indeed, the regulators warned strongly against such advice. Many IFAs refused to execute transfers for insistent clients for fear of future misselling claims.
But things have changed. Not only can clients pass their pensions on to loved ones but transfer values have risen enormously. Capital sums worth 30 to 40 times the annual pension are proving increasingly attractive, with billions of pounds already transferred.
A number of clients will have a few past pensions from previous employers, with some quite small deferred entitlements. Pre-1997, pension income accruals may not be inflation-linked, making the DB guarantee less attractive. Clients with a good base of guaranteed DB income could cash-in some deferred pensions and retain others.
Those who transfer do not have to annuitise, even with small sums. They can just take their tax-free cash, which may be a higher sum than they would get from their DB scheme (but they should check they are not giving up an enhanced lump sum or protected pension age).
That money can be invested to allow clients comfortable taking investment risk to benefit from long-term tax-free returns.
FCA steps up scrutiny of DB transfer adviceAnother big change is that there is no more 55 per cent death tax on unused DC funds if the client passes away. Whether the client is single or not, a DC pension fund can pass on to loved ones in full, whereas a DB scheme will only provide a fraction of the pension for a partner and perhaps none for other survivors.
Clients in poor health could also use a transfer to provide a fund for long-term care. In fact, the Government should think about allowing tax-free DC withdrawals if used for care. All that said, given the sharp rise in transfer values, the lifetime allowance is an essential consideration.
I would love to see the damaging and illogical lifetime allowance abolished but, while it exists, it provides a stumbling block to transfers.
The DB lifetime allowance test of 20 times starting pension means a £40,000 DB income is worth well below £1m but could generate a £1.5m transfer value with a hefty tax charge.
Other downsides include the fact some clients transferring could lose prior enhanced protections and transferring to Qrops can cause tax problems too. Advice comes into its own in these situations.
So there are some compelling arguments in favour of DB to DC transfers but the decision is irrevocable, so caution is vital. People with only one DB pension, who value guaranteed income with inflation and partner protection, and do not want to worry about investment risk should stay put.
But clients who like the inheritance benefits of DC, are comfortable taking investment risk with their pension, or are worried their ex-employer might fail could certainly be better off transferring some past entitlements. DC pensions are better than ever before. Let’s make the most of them.
Ros Altmann is former pensions minister