Anyone remember Pension Liberation schemes? Back before the last government’s pension freedoms released us from the regulatory chains, all sorts of bottom-feeders tried to entice savers to move their pensions into byzantine schemes run from famously safe places like Panama.
This trickle of people cashing in their Defined Benefit (‘DB’, or ‘final salary’) pensions turned into a flood when George Osborne introduced his pension freedoms in 2015.
Yet considering how momentous a personal decision it is, there’s not much discussion about the actual process of transferring out of a defined benefit scheme.
You only get one shot at preparing for retirement, so this is not something you want to screw up.
So today I’m going to cut through the convoluted world of DB pension transfers and try to explain how they work.
Buckle up! We’ll start with baby steps but we’re going to go deep.
Defined Benefit pensions
A Defined Benefit or DB pension is a pension in which an employer promises a set of benefits based on a predetermined formula.
Thus – hold on to your hats folks – the ‘benefit’ is ‘defined’.
The benefit – that is, the pension income you get when you retire – is usually based on a combination of factors including salary, length of employment, and retirement age.
Benefits are typically expressed in pounds per annum. Most people, when they retire, can also take some of their benefits as a tax-free lump sum (aka the Pension Commencement Lump sum ‘PCLS’ in fancy terms).
If you leave an employer before you retire, your benefits in that employer’s scheme are referred to as ‘deferred’ benefits. This benefit is revalued each year before you retire, and, once in payment, the benefit increases according to the scheme rules.
Most schemes also provide a death benefit, usually 50% of the benefit, paid out to the widow(er) and dependants. The benefits payable vary according to the rules of the scheme (which you can and should request to see).
The big benefits of a defined benefit scheme
With a DB pension, the investment risk lies with the trustees of the scheme – and with your employer who sponsors the scheme.
It’s up to the trustees to invest the scheme’s assets to make enough investment return to meet their promises. And if there is a deficit between the money in the scheme and the amount needed to meet the promises made, then the employer has to top-up the scheme.
This means that for a saver with a DB pension, there are fewer sleepless nights when, say, the stock market loses its marbles because Trump decides to start a trade war.
Similarly, there’s no admin or management required by member of DB schemes. Your scheme is responsible for all the paperwork. You just receive money in your account each month and a P60 at the end of the year.
Easy as pie, and like annuities, this simplicity can provide for great peace of mind.
What is Defined Contribution?
In contrast, the income you receive in retirement from a Defined Contribution pension (‘DC’, not to be confused with David Coulthard) is based on the amount you’ve and your employer has put into it over the years and the investment return you’ve made.
Unlike with a DB pension, the investment risk and responsibility now lies with the saver. It’s your responsibility to manage your pot. Great news for Monevator if it means more eyeballs on the site!
While some people get their thrills from investment – The Accumulator, I’m looking at you – for most people a DC pension means more work to do, more risk, and potentially more sleepless nights.
Why would you transfer from DB to DC?
You might be thinking why on earth would anyone transfer from the safety of a DB pensions scheme – with its guaranteed, rising income for life with no investment or management risk – to take on the uncertainty of a DC scheme?
I mean, there’s always bungee jumping and cave diving with sharks if you want a little more excitement in your life?
However there are some valid reasons why you might consider transferring from DB to DC:
- Flexibility – A DB pension pays a set income for life with no ability to access capital except in particular circumstances (such as if you’re seriously ill or your benefits are very small). In reality many people find that their expenses are lumpy. You’ve got to fund those round the world cruises somehow! Most DC arrangements can offer greater flexibility (such as cash, drawdown, and annuities).
- Ill health – You or a family member might have a life-limiting illness that means the flexibility of DC is preferable. DB schemes can cash out your pension where (broadly) you’re expected to live for less than one year or can pay your pension early if you meet certain ill-health requirements, but if you don’t meet that standard you’ll have to plan ahead.
- Relative importance of capital over income – If you have many other significant pension pots, you may end up with more income than you need but less capital than you’d like. Transferring out of one of your DB schemes may help balance your income and capital more appropriately for you.
- Little need for death benefits – Your spouse may have their own substantial pension, meaning that you’d rather your pension goes towards other family members or dependents.
Who can transfer out of a defined benefit scheme?
Most private sector DB pensions are transferrable – with some strings attached.
Unless you are within 12 months of retirement age you usually now have an automatic right to transfer. If you don’t have an automatic right to transfer, you can ask the trustees or administrators of the scheme to let you transfer anyway (called a ‘discretionary’ transfer).
Unfortunately, if you’re got a public sector pension it’s unlikely that you can transfer out. In 2015 the Government changed the rules such that unfunded pension schemes – such as the NHS Pension Scheme – can’t be transferred out.
There’s also the potential option of a partial transfer. This where part of your pension can be transferred out at retirement. Not all schemes allow members undertake partial transfers, and in some schemes they are prohibited. Indeed there appears to be only one scheme actively exploring this.1
How do you transfer?
What follows applies if you have an automatic right to transfer.
To start with you need to get a statement of your Cash Equivalent Transfer Value (CETV) or ‘Transfer Value’. You’ve got a statutory right to request one statement per 12-month period.
The scheme trustees don’t have to provide any more in the twelve-months. But, generally speaking, unless you’re taking the mick and asking for several every year, they’ll likely issue you a second one if you ask nicely (though they might charge a fee).
The trustees usually have three months to fulfil a request for a Transfer Value statement.
Based on some fancy number crunching, the Transfer Value sets out the pounds and pence value of your benefits as at a certain ‘guarantee date’.
With your Transfer Value in hand, you’ve got three months in which to accept. If you do accept, the trustees must generally pay out within six months of the ‘guarantee date’.
If your Transfer Value is above £30,000 you must get regulated advice before you transfer. Your advisor will consider the value of the pension pot as well as your retirement needs and priorities (more on this in a bit). They’ll also look at your attitudes to investment risk and your capacity for loss, taking into account your other pensions and assets.
The advisor must then make a recommendation – either stay in the scheme or transfer out. (Nobody say Remain or Leave!) They must explain why their advice applies.
The scheme usually then pays the agreed lump sum into a DC plan (usually a SIPP) or uses it to buy an annuity, as recommended by the advisor.
You do not have to follow the adviser’s recommendation but may ask for a transfer to go ahead in any case. However, the advisor and the pension provider that was proposing to facilitate the transfer may decline to do so.
In that event, you’ll need to find an alternative pension provider to transfer to.
Before you transfer your pension
It’s important to know before you transfer that it is very, very unlikely that you can reverse a transfer.
A transfer means a substantial change in risk – especially investment risk. And you become responsible for managing your pension. This something you might welcome as a sprightly 50-something but perhaps less so as a nonagenarian. Unfortunately we won’t all age as gracefully as Queen Liz.
Similarly, after transferring and unless you opt for an annuity, the benefits you’ll receive will change from a set regular income for life into some type of drawdown plan. More flexibility means more options, but also more ways for things to go wrong.
Another downside: Pension transfer advice does not come cheap. You are usually looking at a total cost of around £3,000 to £4,000, though it could be substantially higher.2
Before you even think about transferring it’s worth asking whether the cost of advice is worth it. This is where something called ‘Triaging’ comes in.
Triaging: good and bad
Triaging – in this less bloody context – is where an advisor, planner, or accountant provides information about DB and DC pensions to help a saver decide whether to take advice.
In effect, it’s a bit like a weeding-out service, to help prevent members from taking unnecessary, expensive advice.
The purpose is to educate and inform. Not advise. A member receiving a triage service may have the pros and cons of a DB transfer explained to them, an overview of how DB benefits work, and the differences between DB and DC pensions laid-out.
But, importantly, they won’t be told whether it’s worth them transferring.
Because of the chill hand of the FCA, there is a limit to what someone offering Triaging can do.3 It must ultimately be the customer’s choice whether they to proceed to get advice. Some therefore consider triaging to be a bit of a waste of time.
However, bear in mind that again they only provide guidance.
STOP PRESS! Rather annoyingly, between writing the bulk of this post and it being published the FCA released new survey data on DB to DC transfers. (The inconsiderate fiends!) Anyway, the FCA’s data found that nearly 70% of clients were advised to transfer – a level the FCA has publicly stated it finds to be too high. It does seem a shocking figure, but it’s open to debate how representative the FCA’s survey is. The survey data doesn’t appear to take into account customers triaged out (see my comments above) and according to the Personal Finance Society it wasn’t a truly representative sample of advisers. Similarly, the survey data relates to the period up to October 2018. This is an important date as we’ll see below.
Accepting then that the situation seems to be developing quickly, I still think it’s helpful to provide some of the regulatory background to give an idea of the environment potential transferees are walking into.
Following some harrowing findings on investigating how the system outlined was working, the FCA brought in a few changes in late 2018 on transfers that involve regulated advisers. (For instance, the FCA found less than half of the advice given out was suitable.)
In short, the starting assumption is now that a DB transfer is unsuitable. For a transfer to be suitable it has to pass what’s called an Appropriate Pension Transfer Analysis ‘APTA’. This is a series of factors that advisors must consider and then base their recommended action on.
The FCA also brought in something called the Transfer Value Comparator ‘TVC’. This is a graphical comparison of your Transfer Value compared to how much it would cost to replace the DB benefits with an equivalent annuity.
Below is an example of a TVC:
Pretty clear, no?
One final regulatory matter. On 1 April, the FCA increased the Financial Ombudsman’s award limit from £150,000 to £350,000. The Personal Finance Society thinks that this will lead to many advisers leaving the DB transfer market due to the rising cost of professional indemnity insurance.
Factors to consider with transfers
We mentioned above about the Appropriate Pension Transfer Analysis, so let’s end by looking at what the factors it takes into account and what they mean in practice:
Returns – What potential returns could an investor receive from the proposed investment arrangements? This should be commensurate with the assets being invested in. (So for example you shouldn’t forecast equity-like returns for a gilt-dominated portfolio).
Charges – All charges – both upfront and ongoing – should be included. For drawdown portfolios these can be significant.
Pattern of income/capital/cashflows – The proposed transfer should set out a cashflow analysis or explain how the saver can meet their income and capital retirements. This should be comparative – in other words contrasting what’s being given up with what’s being gained.
Plan beyond life expectancy – What happens if the saver lives beyond their forecast life expectancy? What is the plan given they may run out of money in retirement?
Death benefit – The analysis should take into account any death benefits given up, and to the extent income/capital is required on death, how those requirements can be met.
Trade-offs and priorities – It’s unlikely that all of a saver’s objectives can be met, so it should be clear what trade-offs may be needed and how those fit into a saver’s priorities.
Pension Protection Fund (‘PPF’) – Advisors should also be clear and balanced about the pros and cons of a scheme entering the PPF (or a PPF-plus arrangement). Have a look at my earlier post for more information on the PPF.
Defined Benefit pensions are incredibly valuable, but there are circumstances where a DB transfer might be suitable. However the starting point from the FCA’s perspective is that all DB transfers are unsuitable.
If you’ve got a pension pot of over £30,000 you must get advice. This advice must set out a value comparison between what you’re giving up and what you’re getting. It must also consider the factors mentioned above, and explain how they apply in any particular case.
Transfers are expensive – at least several thousand pounds – so it’s worth considering getting some more information or going through Triage to work out whether getting advice is worth it.
Obviously all our thoughts above are just for additional information, as opposed to advice, so don’t think they’re the last word for you!
Have a look at these previous posts on DB transfers where transferees share their experience (but bear in mind both were written prior to those 2018 changes):
- Ford: http://www.pensions-expert.com/DB-Derisking/Ford-set-to-offer-partial-transfers?ct=true.
- At time of writing, for example, see: https://www.moneymarketing.co.uk/pension-transfer-charges/) ((This is leaving aside the controversial practice of ‘contingent charging’. See: https://www.ftadvisor.com/pensions/2019/05/16/mps-urge-fca-to-ban-contingent-charging/
- Advisors have been strongly warned not to cross the ‘advice boundary’
- Collectively being rebranded, along with the Money Advice Service, into the Money and Pensions Service